Investing? Here’s Why Stock Prices Don’t Matter

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Understanding how to value companies requires knowing more than the price per share. Here’s why. 

There are many different ways to pick stocks to buy. Every stock broker probably has their own methodology for which stocks to buy and when. And even amateur investors can try to find undervalued stocks to pick up a bargain.

But while the share price of a given company is indicative of a lot of things, it’s not the end-all-be-all number that some folks may think it is. For one thing, stock prices are rarely a good way to gauge the actual value of a given company.

Share price does not equal company value

An example used recently by YouTube finance guru Humphrey Yang gives a good look at this phenomenon. At the time of his video, Apple was trading at $136 a share, and Facebook was trading at $277 — more than double.

As Yang points out, some folks might assume that the difference in stock prices means Facebook is actually the more valuable company. Unfortunately for them, they’d be wrong. Here’s how Yang explains it:

“Since Apple has 17.1 billion shares on the market, and Facebook only has 2.4 billion, the actual market value of Apple is four times that of Facebook,” he says. “Share price rarely means anything. For Apple, you need $969 worth of Apple to get the same ownership as one share of Facebook.”

In other words, the share price is only one part of the value equation. The number of shares in circulation is also a big part of the calculation. In the above case, Apple has more than seven times the shares Facebook has, so even with share prices half as high, the overall value of Apple is significantly more than Facebook.

Of course, you can’t go the other way and judge a company entirely by number of shares, either. If Company A has twice as many shares as Company B, but Company B’s price-per-share is twice as high, the two companies would be of equal value.

Getting a small slice of many companies

These details are just a few of the things that can make it hard to successfully profit off of buying stock for individual companies. There are just so many variables — most of which require a lot of research and experience to even begin to predict (and even then, it’s exceptionally difficult).

That’s why the majority of experts — including Yang himself — recommend that most folks stick with investments like index funds. Essentially, an index is a “list” of a segment of the market. An index fund is an investment portfolio that buys stock in all of the companies in that index.

For example, the S&P 500 Index is a market index that tracks the largest 500 publicly traded companies in the U.S. An S&P 500 index fund would invest a little bit into all 500 companies in the S&P 500 Index.

So, instead of buying stock in individual companies, you can use your favorite online stock broker to buy shares of an index fund. This gives you a little slice of many companies, all with a single buy.

Index funds offer built-in diversification, so you don’t have that same risk of going broke if a single company goes belly-up. More importantly, your portfolio will very likely perform better without your interference. Reports have found that index funds actually do better in the long run than the vast majority of actively managed funds.

A hobby account for your individual investments

For some people, investing is more than a way to build wealth; it’s a hobby they enjoy. If that’s you, then perhaps it might be worthwhile to grab an easy-to-use investing app and open up an account separate from the rest of your portfolio. (Look around for a good new customer bonus and you can even get some free stock.)

Put a little “fun money” into this account, and use it to invest directly in the companies you think might do well — while leaving your retirement accounts more prudently invested. This way, you can practice the skills you need to navigate the market before getting your entire portfolio involved. (FYI, this is also the method I suggest to folks who want to dip their toes into crypto investing. You can even get some free crypto with most apps.)

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The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.Brittney Myers has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple. The Motley Fool has a disclosure policy.

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