Expensive vs Cheap Stocks: A Guide for Investors in 2023

In the world of stock investing, the saying from Basant Maheshwari, a well-known investor and portfolio manager, 'You can not get Haapus Aam at the cost of banana,' serves as an intriguing reminder about the nature of investment value. This phrase suggests that each investment has its own unique value, and one should not judge a stock merely by its price.

Pros and Cons of Expensive Stocks

Expensive stocks, often those whose value has already been recognized by the market, offer a certain level of stability and moderate returns. Investing in such stocks typically provides peace of mind, as the underlying value has been well-established. They also tend to provide good sleep because of the stability and the fact that the company's fundamentals are strong. However, despite these advantages, expensive stocks may be more susceptible to manipulation due to lower trading volumes, as they are less frequently traded.

Pros and Cons of Cheap Stocks

On the other hand, cheap stocks can be highly volatile. In fact, they may have the potential for higher returns, but also carry a similar level of risk. The potential upside and downside are both considerable, which can be unsettling for some investors. These stocks might represent undervalued opportunities, but they also require more active management and a keen eye for detail.

Key Considerations for Stock Selection

When investing, it’s essential to focus on the fundamentals of the company rather than its price alone. For instance, the rise and fall of the Nikola Corporation illustrate the risks of basing your investment decisions solely on hype and promises. The company made promises about hydrogen fuel-powered cars, attracting significant investment from major corporations. However, the promise was later revealed to be a con, leading to a significant loss of investor confidence and substantial financial difficulties for the company.

It's important to understand that having more shares of a cheaper stock is not inherently different from having fewer shares of an expensive stock. The percentage change in the share price determines gains or losses, which is a fundamental principle of investing. This principle underscores the importance of diversification and a well-thought-out investment strategy.

Both expensive and cheap stocks can be suitable for different investors and scenarios. However, 'penny stocks' — those not traded on major exchanges and primarily driven by fraudulent activities — should be avoided. These stocks often have a high risk-to-reward ratio and can be misleading to uninformed investors. Watching films like 'The Wolf of Wall Street' can provide insights into how these stocks are often manipulated for ill-gotten gains.

Valuation and Prospects

When evaluating stocks, consider the prospects of the company, such as their market share growth or decline, and the price-to-earnings (P/E) ratio. The P/E ratio tells you how much you are paying for each dollar of the company's earnings, offering insights into whether the stock is overvalued or undervalued. Forward P/E ratios help in anticipating future earnings growth.

There is a phenomenon known as 'regression to the mean,' which suggests that companies at the extreme ends of their P/E history tend to move towards an average over time. Companies with lower P/E ratios are likely to see their P/E rise while those with higher P/E ratios may see their P/E fall. However, this process can take years to play out.

Conclusion

Investing in stocks is a journey that requires careful consideration of various factors. While expensive stocks provide stability and moderate returns, cheap stocks offer the potential for higher returns but also carry more risk. Understanding these differences and focusing on the fundamentals of the company will help investors make more informed decisions. Happy investing!