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24 June 2022

Share Prices - Do They Matter?

“It’s only a Pound”. A phrase that may sound familiar to parents and undisciplined shoppers alike, it is all too often uttered in financial markets. Used to measure gains and losses, share prices cut over the conversation – ‘Has it gone up? Has it gone down?’ – so loudly that it’s hard to think of much else. Rather than changing the conversation, we dial down the noise and cast a critical eye to the meaning of share prices, and whether they matter as much as it might seem.
 
Which is cheaper? Equity A for £2, or Equity B for £500? Many could be forgiven for giving the answer of A to that misleading question, but the misdirection highlights the false dichotomy that investors often perceive. In comparing shares, the investor is rarely comparing like-for-like, the price of a share consists of two elements: the value of the company, and the number of shares in issue. This means that a comparison of the two is more often than not, a comparison of the shareholder policy decided upon by the Chief Financial Officer (CFO) or specifically the number of shares they have decided to issue, which is no indicator of whether the asset is ‘cheap’. A more useful indicator is assessing the price relative to its own history – an equity selling for £500 that has historically traded at £2,000 with the same number of shares no longer appears so dear. Moreover, with regards to performance, returns are measured in purely percentage terms, meaning Equity A moving from £2 to £4 is equivalent to Equity B increasing from £500 to £1,000.
 
This is not to say that prices are not important: the price of a share can have volatility implications for shareholders. Share prices are the most recent highest price paid for an equity and move because of a relative imbalance in trading volumes. When the number of sell orders exceeds the number of buy orders, sellers must lower the price they offer until it attracts enough buyers and balances purchases and sales. Shares with high-trading volumes are less volatile because a seemingly large influx of trades to one side or the other are small in proportion to the overall trading volume, and smaller premiums or discounts need to be offered to balance the volumes.
 
Investing in Equity A is a small commitment relative to Equity B and encourages higher trading volumes as fewer investors are priced out of trading in the shares. Higher share prices are consequently associated with, all else being equal, lower trading volumes than lower share prices, which makes those equities more illiquid. Illiquidity increases volatility since a smaller imbalance is needed to be the same in relative terms, and higher premiums or discounts must be offered to attract buyers and sellers, altering the price. The reverse can also be true, with Berkshire Hathaway being an extreme example, where a share price of US$487,000 is intended to ensure its investors are serious about investing in the company. The strategy has worked, and shares have an extremely low trading volume with as little as 18 of its A shares changing hands a day on average.
 
Stock splits are a poorly understood phenomenon which can cause strange behaviour. In a two for one split, companies offer to award shareholders two shares for every one they previously owned, doubling the number of shares and, in theory, halving the price (without changing the value of the company) to make their shares more liquid and accessible. Volatility often increases in the short term as investors flock in the belief that they can double their shares for free, and the euphoria driving prices up causes holders to take advantage of higher prices and sell their holdings. Others sell the new ‘free’ shares and maintain the same number of shares, in effect reducing their position by 50%.
 
One of the most important lessons in investing was illustrated by the father of value investing, Benjamin Graham, using the example of ‘Mr Market’, a door-to-door salesman driven by panic, euphoria, and apathy. Though not always thought of as such, houses are an asset class, and are widely held and understood. If Mr Market came to the reader’s door and offered £10,000 to purchase their house, they would most likely politely decline and slam it shut. If, however, the reader was offered the chance to buy his house for £10,000 the savvy reader would probably snap up the bargain. This is because the values they ascribe to both houses are independent of the price Mr Market has offered.
 
When purchasing any asset, prices merely reflect the quoted price investors can buy and sell them for, and it is wise to observe that few fret about the constantly fluctuating value of their houses, because the information is not available to them. Only with rigorous analysis can an investor determine the value of an asset. In the case of equities, where they are in effect buying and selling ownership of companies, that value assessment can be based on a multitude of factors. What is the threat from competition? Is it in a growing market? Are its assets worth more than the market appreciates?
 
Some of the most common answers to the refrain ‘If you could say one thing to your past self, what would it be?’ include ‘Buy Apple’, ‘Buy Amazon’, and ‘Don’t get a mullet’. Yet these answers belie the fact that the road to success is laden with setbacks in investing and life. Many pinpoint the dominance of Apple to the release of the iPhone in 2007, however, the price sensitive investor would have been burned many times. In a seven-month period between 2012 and 2013, its share price fell by 43.8% among many other similarly devastating drawdowns in the past ten years alone. Amazon shareholders faced the bursting of the dotcom bubble, losing 92%, and the dark depths of the financial crisis, where their shares lost 54% of their value. Holders of the mullet need not be reminded of their loss. This is not though to say never sell because you might be holding the next Amazon, sell because the value of the business has changed and remember if you make a loss or forgo a gain, that there is no shame in being wrong. Step back, assess the mistake, and learn from it, all investors are always learning from their mistakes, they are, after all, only human.
 
This article was taken from the February 2022 issue of Market Insight. To subscribe to our investment publications, please visit www.redmayne.co.uk/publications.
 
Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. The value of investments and any income derived from them may go down as well as up and you could get back less than you invested.
 
Share Prices - Do They Matter?

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