There are many different ways to select stocks to buy. Each stockbroker likely has their own methodology for which stocks to buy and when. And even amateur investors can try to find undervalued stocks to grab a bargain.
But while a particular company’s stock price is indicative of many things, it’s not the definitive figure some people think it is. For one thing, stock prices are rarely a good way of estimating the true value of any particular company.
The share price does not correspond to the enterprise value
A recent example used by YouTube finance guru Humphrey Yang gives a good insight into this phenomenon. At the time of his video, Apple was trading at $136 a share and Facebook was trading at $277 — more than double.
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As Yang points out, some people might assume that the difference in share prices means Facebook is actually the more valuable company. Unfortunately, they would be wrong. This is how Yang explains it:
“Since Apple has 17.1 billion shares on the market and Facebook only 2.4 billion, Apple’s actual market value is four times Facebook’s,” he says. “The stock price rarely means anything. For Apple, it takes $969 worth of Apple to get the same ownership as Facebook stock.”
In other words, stock price is only part of the value equation. The number of shares in circulation is also included in the calculation. In the above case, Apple owns more than seven times Facebook’s shares, so even at half the stock price, Apple’s total value is significantly higher than Facebook’s.
Of course, you can’t go the other way around and judge a company solely by the number of shares. If Company A owns twice as many shares as Company B, but Company B’s price per share is twice as high, the two companies would be equal.
Receive a small share in many companies
These details are just some of the things that can make it difficult to successfully profit from buying stocks in individual companies. There are just so many variables – most of them require a lot of research and experience to even predict (and even then it’s extraordinarily difficult).
For this reason, most experts — including Yang himself — recommend that most people stick with investments like index funds. Essentially, an index is a “list” of a market segment. An index fund is an investment portfolio that buys stocks of all companies included in that index.
For example, the S&P 500 Index is a market index that tracks the 500 largest publicly traded companies in the United States. An S&P 500 index fund would invest a small portion in each of the 500 companies in the S&P 500 index.
So instead of buying shares in individual companies, you can use your favorite online stockbroker to buy shares in an index fund. This gives you a small share of many companies, all with a single purchase.
Index funds offer built-in diversification, so you don’t have the same risk of going bust if a single company goes bust. More importantly, without your intervention, your portfolio will most likely perform better. In fact, index funds have reportedly outperformed the vast majority of actively managed funds over the long term.
A hobby account for your individual investments
For some people, investing is more than just a way to build wealth; It’s a hobby they enjoy. If that describes you, it might be worth grabbing an easy-to-use investing app and opening a separate account from the rest of your portfolio. (Check out a good new customer bonus and you can even get free stock.)
Put some “fun money” in this account and invest it directly in the companies you think could be successful — while investing more judiciously in your retirement accounts. This allows you to practice the skills you need to navigate the market before involving your entire portfolio. (FYI, this is also the method I recommend for people who want to explore cryptocurrency investing. Most apps even let you get free cryptocurrencies.)
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