Low Share Prices Do Not Imply a Low Valuation

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The phenomenon of “meme” stocks largely involved stocks trading at low share prices. Though this was not universally the case, some meme stocks could have been purchased for less than you would spend on a pumpkin spice latte at Starbucks.

Price is not value. Price is what you pay. Value is what you get. Or, as my colleague Wayne Thorp put it, price is arbitrary while value is fundamental.

The key for investors is to determine whether a difference between a stock’s price and its value exists. The goal is to pay less for a stock than another investor can reasonably be expected to pay for the same stock in the future. A stock’s price alone will not convey this information. Its valuation can shed light on such information.

To help explain the difference, I’m going to use a comparison Wayne wrote earlier this year:

The price of a stock is determined by a number of factors, many of which are driven by human characteristics and emotions such as fear and greed. In addition, market tendencies and events can and do affect the price of a stock. However, rarely do these factors significantly affect the value of stocks.

Factors that can influence stock prices include:

• Investor demand
• Broad market trends
• Media and analyst reports
• Economic factors
• Company news, such as earnings reports, financial issues, etc.

A company derives its value from fundamental factors including:

• Earnings
• Market share
• Sales volume over time
• Valuation metrics such as the price-earnings (P/E) ratio
• Competitors

In short, a company’s stock price, especially in the short term, is primarily driven by external factors, while fundamental factors such as profit margins or earnings are long-term drivers of a company’s “true” value.

Notice that there is more to a stock’s value than just its valuation metrics. A stock can have a low valuation ratio because it isn’t a good company. Therefore, value investors frequently seek out additional traits to ensure that the stock is a bargain. Quality is a key companion trait to seek out because it suggests that the market is unfairly pricing a profitable entity too low.

Consider Seaboard Corp. (SEB). It has one of the highest share prices of any stock in our Stock Investor Pro database. Shares of Seaboard closed today at a price of $4,052.26. Yet, this agribusiness and transportation stock has a low valuation, as is evident by its A+ Investor Value Grade of A. Lending support to the idea that this stock could be potentially undervalued is the A+ Investor Quality Grade of B.

In contrast, meme stock BlackBerry Ltd. (BB) closed today at $10.73. While one could buy nearly 380 shares of BlackBerry for the price of just one share of Seaboard, the valuations are far different. Shares of BlackBerry have an A+ Investor Value Grade of D. This suggests the stock is expensive despite its low share price. The high valuation is not supported by the stock’s underlying fundamentals either, as its A+ Investor Quality Grade is a very average C.