Hi Reader,

The share price might be the first thing you see.

But, it's often the last thing you should consider.

WHY SHARE PRICE ISN'T EVERYTHING?

Picture this: you're in the reduced aisle of a supermarket and you've found a product on sale.

Before buying, you'd consider factors like the quality, price and expiration date, right?

Investing should be no different.

A low share price might appear to be a bargain, but this isn't necessarily the case.

For example, imagine two companies in the same industry.

One has a higher share price, generates consistent profits and has a strong market position (meaning it has a large customer base, a dominant market share, or a well-established brand).

The other has a lower share price but is struggling financially.

In this instance, the lower share price doesn't guarantee a better long-term investment.

To truly understand the value of a company, we need to delve deeper.

WHAT MAKES THE SHARE PRICE MISLEADING?

A common pitfall is assuming a lower share price means a cheaper company.

To understand why this isn't always the case, we need to introduce a key metric: Market Capitalisation.

This is calculated by multiplying the share price by the number of shares outstanding.

Market capitalisation represents the total value of a company.

For example, Sainsbury's has a lower share price (£2.65) than B&M (£4.53).

At first glance, one might assume B&M is 70% larger than Sainsbury's due to its higher share price.

However, Sainsbury's has many more shares in circulation (2.3bn) vs B&M (1bn).

This means that a company with a lower share price could potentially be worth more.

Consequently, an investor drawn to Sainsbury's lower share price might overlook the fact that it's a larger company with potentially less growth compared to B&M.

THE PROBLEM WITH MARKET CAPITALISATION

Market capitalisation offers a snapshot of a company's size, but just like share price, it's a limited metric.

As two companies with similar market capitalisations can have vastly different valuations.

For instance, while Sainsbury's boasts a larger market capitalisation than B&M, the latter generates higher profitability (6.7%) compared to Sainsbury's (0.4%).

This highlights the importance of considering factors beyond market capitalisation when analysing investment opportunities.

Profitability is crucial for a company's long-term health, but even profitable companies can be overvalued or undervalued.

Investor sentiment and expectations significantly influence a company's share price, as reflected in metrics such as the price-to-earnings ratio (PE) ratio.

A lower PE ratio generally indicates a cheaper valuation, suggesting that investors are paying less for each pound of earnings.

In our example, B&M's PE ratio of 12.4x is much lower than Sainsbury's 46.5x, suggesting that B&M might be more attractively priced.

KEY TAKEAWAYS

• Do your homework: Thoroughly research companies before investing, considering factors beyond market capitalisation and share price.
• Focus on Fundamentals: Prioritise a company's long-term fundamentals over short-term price fluctuations.
• Adopt a Long-Term Perspective: Investing is a marathon, not a sprint. Stay invested through market fluctuations to build wealth over time.

See you next month,

Ozbourne Foreman

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Disclaimer: I do not provide financial advice. Any views or opinions shared are for informational purposes only and should not be considered as professional advice. Always consult with a qualified financial advisor before making any investment decisions.