Welcome back for Part 2 of our 4 Part series on Stock Investing Myths. As we told you in Part 1, even though there’s plenty of information about what works and what doesn’t when it comes to investing in the stock market, many myths still refuse to die and, if you have heard one (or several), this blog series will hopefully persuade you not to be fooled by it.
Off we go.
Myth #3: The only option that you have are Large-Cap stocks
While it makes sense that the investment media focuses on stocks that belong to the Dow Jones industrial average or the S&P 500 index, because they’re the most widely held companies and also the most familiar, the fact is that they also make up only about 10% of the US exchange listed stocks.
As an individual investor, you are certainly not tied down to any investment objective or restriction, and thus taking advantage of the many stocks outside of the large-cap index is a freedom that you should take advantage of. Another reason is simply that, as the size of the company goes down, the potential for returns on their stock goes up.
Simply looking at history will show you what we’re talking about. Small-cap stocks have outperformed large-cap stocks since 1926. Their annualized return of 11.9% is better than the 9.8% of the large-cap stocks and, since smaller companies are often overlooked by investors, there’s a much better chance that their stocks will be underpriced. The only two caveats are that smaller-cap stocks have less trading volume and are a bit more volatile, the trade-off that you pay for the higher level of returns that they bring
Myth #4: A low-priced stock will double its value more easily than high-priced stock.
Okay, so a kindergartner could tell you that if you take a stock that’s trading at $2 per share, it would only take a $2 increase for it to double in price. For a $20 stock to double in price it would need to increase by $20, so it stands to reason that making money with the $2 stock would be easier.
The only problem is that this logic ignores one of the most basic concepts of investing, the fact that the entire market capitalization of the company has to double in order for its stock price to double in value. (This assumes that there’s not been a change in a number of outstanding shares.)
Market capitalization, which is the value of the entire company, can be determined by multiplying the number of outstanding shares by the current price of those shares. Knowing this simple formula allows you to see why, whether a stock trades for $2 or $20, the only way its stock price will double as if the entire company doubles its current value.
Frankly, if a stock is trading for less than the price of a single bottle of water, you should already be asking questions about it’s worth. Usually investors perceive a high level of risk when any stock is trading for $2 per share or less. You won’t find these companies traded on the exchanges or filing quarterly reports with the SEC either.
And there you have it, two more myths debunked. We hope you’re finding this information valuable, as well as interesting. Make sure to come back and join us for Part 3 and learn even more about investing myths.