WHY YOU SHOULDN'T LET HIGH SHARE PRICES PUT YOU OFF
Mark Lister, 12 May 2020
Earlier this year CSL, a very successful Australian healthcare company, saw its share price crack A$300 for the first time.
Some New Zealand investors would baulk at the thought of buying shares in a company as pricey as that, but they shouldn’t.
A company’s share price tells us absolutely nothing about whether it’s expensive or cheap and if anything, it could be taken as a sign of a strong track record of performance.
In New Zealand, only a handful of companies have a double-digit share price. Mainfreight is the highest of these as it approaches NZ$40, while the likes of Fisher & Paykel Healthcare, a2 Milk and EBOS aren’t far behind. Almost half of the top 50 have share prices below NZ$3.
In larger markets it is commonplace for shares to trade at much high prices. Of the 30 companies in the Dow Jones index in the US, the average share price is US$118. Nike is US$90, Johnson & Johnson close to US$150, and Apple is highest at US$310.
Plenty of great US businesses are priced even higher. One share in Google would cost you US$1388, while Amazon shares are US$2380 apiece.
That’s not necessarily a stumbling block for small investors these days either. There are options for people who want to own a fraction of these shares, including our own mySTART product.
It’s been around since 1996 and it allows smaller investors to drip feed as little as NZ$100 a month into a wide range of companies and funds across multiple global markets. They get access to our proprietary research too, which is where the true value is (and what some other fractional investing platforms can’t offer).
Many New Zealand companies have conducted share splits over the years, often when prices have entered the $10-20 range. For example, Port of Tauranga conducted a 5-for-1 share split in 2016, which saw the price fall from almost $20 to around $4.
Investors didn’t lose any money, as they owned five times more shares than before. This offset the share price fall and left the total value of their holding unchanged.
Ryman Healthcare did something similar back in 2007, as did Fisher & Paykel Healthcare a few years before that.
Companies do this in the hope of creating additional liquidity and as Auckland Airport said at the time of its split, ensuring the shares remained attractive to retail investors.
Less sophisticated retail investors do seem to have a preoccupation with share prices, favouring those in the sub-$3 range which they perceive as better value and shying away from those that trade at higher levels.
However, it shouldn’t make any difference. The share price of a company doesn’t tell you whether it is good value or not, unless you compare this to the share of earnings, profits and dividends you get for each share.
Consider two companies – one with a share price of $1 and one worth $10. The $1 company makes just 5c of annual earnings per share, while each share in the $10 company gives the owner $1 of earnings. In terms of what you get for each slice of the pie, the company with the higher share price is better value.
Determining which shares will be the best investments is far from that simple, and analysts consider a plethora of other attributes including growth opportunities, earnings reliability, competition and industry trends.
However, my point is that it takes a lot more than simply looking at the share price of a company to establish its value.
I remember one experienced Australian retail investor telling me he only bought shares in companies that were trading above $10. He reasoned that only the best companies would grow their businesses enough to see their share prices get this high, and this was essentially part of his screening process.
That’s certainly not a perfect approach either, but it’s arguably more sensible than focusing at the other end of the spectrum in the hope of finding a bargain.
Ryman shares would be NZ$60 today if that share split hadn’t taken place in 2007, Port of Tauranga would be NZ$35 and Fisher & Paykel Healthcare shares would be close to NZ$150!
These companies have been some of the strongest performers on the local market over the past two decades, so maybe the best shares are in fact the ones that sometimes look the most expensive (on the face of it).