A share’s price on its own is meaningless | Fin24

A share’s price on its own is meaningless

Jul 18 2018 11:34
Simon Brown

A share price is a strange thing. It’s what we refer to much of the time when talking about shares. In one sense it means everything. But in another it means nothing.

It means everything in the sense that that’s what we’ll pay, and our profit or loss and dividend yield, price-to-earnings ratio (P/E) and other ratios will all be calculated from that price. 

But it actually tells us very little.

If I mention one stock is priced at R66 while another is trading at R200, we think we know a lot about the two stocks. Actually, though, we know nothing. 

In this example the R66 would be FirstRand while the R200 is Standard Bank. But FirstRand is actually the larger of the two in terms of total size as it has 5.6bn shares while Standard Bank has 1.6bn shares. 

Hence, FirstRand has a market capitalisation of around R371bn while Standard Bank’s market capitalisation is around R320bn. Price on its own is meaningless. 

I have written before about how everything in investing is about ratios and comparing two numbers against each other. 

Yet, as investors and traders we often fall into the trap of stressing price and therefore put far too much focus on the price rather than the underlying business and valuation. 

Staying with the example above, neither price nor market capitalisation tell us anything about profitability or valuations. 

We’d need to dig into headline earnings per share (HEPS), cost-to-income levels, growth prospects and the like. And whichever comes out as a better valuation is what we should be buying – not the one that has a lower price on face value. 

Talking to a group of new investors recently I mentioned that Naspers* was looking like an attractive investment at around R3 000. 

Almost every one of them said I had to be wrong, because how could a R3 000 share go any higher? Yet, it now trades at R3 400, some 13% higher.

The problem is a mindset that says a 10c share can double in price more easily than a 1 000c share. Or a R100 share, for that matter. This logic is wrong.

Firstly, a 10c share is likely teetering on the verge of bankruptcy and is best avoided, but Naspers was once a 1 000c share, then a R100, and then a R1 000 and is now a R3 400 share. And it has been over R4 000.

The reason why the share price doesn’t matter (unless it’s indicating potential bankruptcy), is because what does matter is the total rand value one invests, as well as the valuations. 

Putting R10 000 each into FirstRand and Standard Bank means we have invested R10 000 in each. The number of shares we end up owning is not important. 

If profits are growing at 15%, a perfect investing world (which the investing world is not) would see the share go up by 15% regardless of what the starting price was.

Way back in the day we had to trade shares in lots of 100. Then price did matter. But now we can buy just a single share. 

I accept that some can’t afford a single Naspers share, but Naspers is the outlier in price terms as the only share above R900.

So, when you’re investing, focus on the amount you invest into each stock. Importantly, also focus on what that represents as a percentage of your overall portfolio.

One of my hardest lessons was learning to adjust my invest amounts upwards as my portfolio grew. I got stuck at investing R20 000 per transaction, even when this was no longer a meaningful percentage of my portfolio.

Eventually, I realised it was a silly fear. I then upped the amount so that each new purchase would be a significant percentage within my portfolio. 

*finweek is a publication of Media24, a subsidiary of Naspers.

This article originally appeared in the 19 July edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.

investment  |  portfolio  |  shares