It is no secret that stocks like Google (GOOG) and Apple (AAPL) have gone up tremendously over the past several years and that some investors have been intimidated by their “expensive” valuations. A lot of people have missed out on huge gains because they had the perception that their stocks were overvalued because of their high share prices. However, these are just mirages and here is a trick that I heard Cramer mention a few years ago to help you out: divide the share price by 10.
Much Cheaper
As you know, nominal share prices are inherently meaningless, and it is the market capitalization that is what matters. Market cap is price multiplied by shares outstanding. The price can be manipulated endlessly through splits and reverse splits, but not the market cap. If you divide Apple’s share price by 10, you would get about $33 per share. It is supposed to earn $23.30 in 2012, which would be $2.33 after dividing by 10. Would you buy a $33 stock that is supposed to earn $2.33 per share with Apple’s growth prospects? I bet a lot more investors would even though it is the same thing.
People understandably have a mental block paying $630 per share in the case of Google, because of the perception of it being expensive, as well as the fact that 100 shares of that would be north of $60,000, which is out of most people’s price range. However, the important thing is the percentage gains that can be achieved, not the price of the stock. Buying 100 share lots used to be important before the advent of online trading because odd lots cost more in commissions, but that isn’t the case anymore. There is nothing wrong buying 10 shares of Google and letting it sit.
P/E
This is why the price/earnings ratio is so important. It is a standardized number that doesn’t regard what the price of the stock is. It only matters what it is in relation to earnings per share. Using the p/e ratio, it is possible to compare a stock like Berkshire Hathaway (BRK.A) to Citigroup (C), even though the former is many thousand times the share price of the latter.
Dividing by 10 isn’t a groundbreaking device by any means, but it can help you get over the mental block of buying a stock that has a high share price. Imagine investors who used this trick when Berkshire Hathaway was at $1000. They would have been very happy today if they bought the stock at that level. Maybe they would have if they divided by 10.
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