Page 435 - How to Make Money in Stocks Trilogy

Twenty-One Costly Common Mistakes Investors Make 305

10. Buying more shares of low-priced stocks rather than fewer
shares of higher-priced stocks. Many people think it’s smarter to buy
round lots of 100 or 1,000 low-priced shares. This makes them feel like
they’re getting a lot more for their money. They’d be better off buying 30 or
50 shares of higher-priced, better-quality, better-performing companies.
Think in terms of dollars when you invest, not the number of shares you can
buy. Buy the best merchandise available, not the cheapest.
Many investors can’t resist $2, $5, or $10 stocks, but most stocks selling
for $10 or less are cheap for a reason. They’ve either been deficient in the
past or have something wrong with them now. Stocks are like anything else:
the best quality rarely comes at the cheapest price.
That’s not all. Low-priced stocks may cost more in commissions and
markups. And since they can drop 15% to 20% faster than most higher-
priced issues can, they also carry greater risk. Most professionals and insti-
tutions normally won’t invest in $5 and $10 stocks, so these stocks do not
have a top-notch following. Penny stocks are even worse. As discussed ear-
lier, institutional sponsorship is one of the ingredients needed to help pro-
pel a stock higher in price.
Cheap stocks also have larger spreads in terms of the percentage differ-
ence between the bid and ask price. Compare a $5 stock that trades $5 bid,
$5.25 ask with a $50 stock that trades $50 bid, $50.25 ask. On your $5 stock,
that $0.25 difference is 5% of the bid price. On your $50 stock, that $0.25
difference is a negligible 0.5%. The difference is a factor of 10. As a result,
with low-priced stocks, you tend to have much more ground to make up
from your initial buy point just to break even and overcome the spread.
11. Buying on tips, rumors, split announcements, and other news
events; stories; advisory-service recommendations; or opinions you
hear from other people or from supposed market experts on TV.
Many people are too willing to risk their hard-earned money on the basis of
what someone else says, rather than taking the time to study, learn, and
know for sure what they’re doing. As a result, they risk losing a lot of money.
Most rumors and tips you hear simply aren’t true. Even if they are true, in
many cases the stock concerned will ironically go down, not up as you
assume.
12. Selecting second-rate stocks because of dividends or low
price/earnings ratios. Dividends and P/E ratios aren’t anywhere near as
important as earnings per share growth. In many cases, the more a company
pays in dividends, the weaker it may be. It may have to pay high interest
rates to replenish the funds it is paying out in the form of dividends. Better-
performing companies typically will not pay dividends. Instead, they rein-
vest their capital in research and development (R&D) or other corporate