Cast Your Line in the Low-Priced Lake

 | Jan 13, 2013 | 6:00 PM EST
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The low-priced stock meme is circulating, so let's take a closer look at recent results for this intriguing idea. In a post from last July I found that, on average, the lowest-priced stocks regularly outperformed the highest-priced names. The results surprised me, because I started out trying to prove that the highest-priced stocks were the most attractive, since high-growth stocks are all trying to be like Buffett's Berkshire-Hathaway (BRK.A) and avoid splitting.

So what have you done for me lately? Or, more formally, how have low-priced stocks done since that post? The answer, it turns out, is "not too bad." The table below shows stock performance over the last six months, grouped by price.

Recent Stock Performance by Price

In this particular period, while the lowest-priced names did fine, they did not outperform the average return. Still, the two highest-priced tiers underperformed -- the returns definitely skewed low. Now, clearly six months of data does not prove anything. I can guarantee there will be some period when the highest-priced tier will do better. But, if we look at this in the context of a long time series -- as I did in that earlier post -- we get yet another data point indicating the usefulness of the approach.

How should an investor use this information? Well, one way not to use it is to buy a stock simply because the price is low. The most frequent amateur mistake I encounter is someone buying a $0.25 stock, saying it should be easy for the shares to go to $0.50. In reality, the price is irrelevant. What matters are the expectations.

With that in mind, low-priced stocks tend to have low expectations, usually because things have gone wrong in the past, whereas high-priced stocks tend to carry high expectations. As I note when I review other indicators, such as earnings momentum and valuations, the key to making money is finding companies that perform better than expectations. A low bar helps!

Use low price as a starting point for further research. If you want to catch fish, go where they are biting. The low-price corner of the lake is a good spot to cast your pole and start looking.

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