Finance question

[flash9286]

Why does lower stock price equal higher rate of return? I understand that the stock price is probably low because there is more risk in the stock and I understand that more risk means a higher rate of return. But does low price stock eventually out perform other stock and end up with a higher rate of return?

[DaShi]

I'm not sure what you're saying but:

buying 100 shares at $1 will only require the stock to go up one point to double your investment. Buying 1 share at $100 will require the stock to go up 100 points to double your investment. Thus, the more expensive stock will need much better performance to get an equal outcome as the lower stock. Then again, that low stock may be low for a reason and a single point downward could wipe you out.

[KrazyHorse]

My head hurts. You guys are idiots.

[DaShi]

Well, I'm not sure if that is what he's asking, so I gave him the basic of the basics. Please add more. I'll admit, I'm no expert in this field.

[flash9286]

Never mind, I heard on the radio today that lower stock price=higher risk=higher expected rate of return.

[Japher]

radio = stupid

don't listen to stupid people

[Kuciwalker]

Hint: the dollar value per share of a given stock is meaningless. Imagine if tomorrow MSFT split all of its shares (everyone with 1 share now had 2, and each share was worth 1/2 what it was today). Would that have any influence on whether you should buy the shares or not, or their future performance? (no)

[flash9286]

That wouldn't affect the risk of the stock.

I think this was what the radio guy was talking about. http://books.google.com/books?id=hr1...return&f=false

It still seems kind weird. Shouldn't both shares in the example be priced the same, since they both have the same expected cash flows. Is it efficient to be risk averse?

[Japher]

The example is just to illustrate how risk effects price. If risk (long and short) and projected cash flows are the same (as well as shares outstanding, past performance, cyclical effects, etc) than they should be priced the same. That example gives no reason why the risk is assumed to be greater than that of the other. This, however, does not imply that a stock which is valued lower than another similar option is not at fair market value, in a perfect market it is. Again, the example only serves to show the impact of risk aversion on stock prices and does not imply that lower priced stocks have a greater risk associated with them.

There are other reasons companies target price ranges of their stock; such as growth. A company has a number of ways to intentionally lower their stock price or increase the market share in order to raise capital to spur growth. In these instances there would be a greater amount of risk involved in the investment as the use of the influx of cash is up and the air, and sometimes unknown. Similarly, increasing the stock price can show vulnerability or even strength, dependent on how they do this.

Personally, I like volatile stocks and active companies. The lumbering giants are good when dividends are high or if you want to anchor your portfolio. Otherwise I look for companies with lower stock prices compared to their industry with strong or nwe product offerings and market channels and, if possible, new or newer upper management (C-level or board). Then I look a history and project performances.

[Kidlicious]

Never mind, I heard on the radio today that lower stock price=higher risk=higher expected rate of return.

Hmmm... I think higher price is riskier.