Too many investors focus solely on a stock's price. But sometimes, high-priced stocks are actually cheap. To sort out truly expensive stocks from expensive-looking ones that offer good value, you have to understand the difference between share price and the total value of a company.
Let's look at a simple (if slightly unrealistic) example involving two publicly traded lemonade stands. Ali's stand is in downtown New York and is incredibly popular. She has the pop stars and financiers visiting on a daily basis. Meanwhile, her sister Elizabeth is stationed in Fairbanks, Alaska -- not exactly the perfect climate for lemonade. To keep things simple, let's say that Ali's business is 10 times as profitable and has 10 times as much revenue as Elizabeth's.
But the first thing you learn about these companies is that shares of Elizabeth's stand go for $100 each, while Ali's shares cost $10 each. Would you assume that Ali's stock is a huge bargain, while Elizabeth's is way too expensive?
Many would, but I haven't told you enough about the company for you to draw that conclusion. Let's look now at the capital structure of each business -- that is, how many shares each company has outstanding:
Price Per Share
Number of Shares
Total Value (Market Cap)
Ali's Awesome Ade
Elizabeth's Exquisite Lemons
With the whole picture, the relative valuations make sense. Elizabeth's stock is worth more than Ali's because there are so many fewer shares outstanding. On the whole, Ali's business is worth 10 times as much as Elizabeth's -- exactly what you'd think from a business that generates 10 times the profit and sales of another.
From lemonade to Wall Street
My goal today, then, is to highlight five stocks like Elizabeth's that look expensive because they're trading for triple-digit price tags. But when you look at their market cap and their potential moving forward, it's evident that they still have room for growth.
Here are the first three stocks that I think deserve your attention.
Google (NAS: GOOG)
Amazon.com (NAS: AMZN)
Deckers (NAS: DECK)
Source: Yahoo! Finance.
Now take these companies and compare their size with the market leaders in their respective fields.
The competitors' market caps are important, because I believe they show how much room there is for growth should these companies continue to expand and innovate.
Competitor's Market Cap
Apple (NAS: AAPL)
Wal-Mart (NYS: WMT)
Nike (NYS: NKE)
Source: Yahoo! Finance. Relative size equals competitor's market cap divided by company market cap.
Though you can never make perfect comparisons between companies and what they do, this gives you a sense of how much room a company has to grow. Google has strong leadership in place for continued innovation. Amazon will continue to be to e-commerce what Wal-Mart has been for one-stop-shops. And though Deckers may never fully compete in athletic wear with Nike, it is dominating its niches with its Ugg brand boots and Teva sandals.
You'll need some serious money for this one
I'll admit, my fourth recommendation for your money, Berkshire Hathaway (NYS: BRK.A) , might be out of most people's range. Berkshire's "A" shares currently run at $110,400 per share! Truth be told, the "B" shares probably make more sense -- but as they were not in the triple digits to meet my criteria, I technically couldn't include them.
Either way, Warren Buffett's collection of businesses is selling dirt-cheap right now. I won't pretend to understand all of the inner workings of this behemoth, but I do know that its price-to-book value is nearing historic lows.
One last super-cheap stock
I couldn't include my final stock as a candidate because it's already at the head of its field. In fact, its market cap makes it the second-largest company in America. That company is Apple.
So why would a stock with a market cap of $368 billion be on my list?
It's not hard to see why the company is so successful, either. Take a ride on the railways of any major city and you'll see passengers playing on their iPads, calling their friends on their iPhones, and listening to music on their iPods.
Remember, when it's time to buy a stock, the price you pay means absolutely nothing in isolation. The size of the company should be measured by market cap -- not price. And even if you know what the market cap of a company is, you still need to complete your own due diligence before making any serious decisions.
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At the time thisarticle was published Fool contributor Brian Stoffel loves a tall glass of lemonade. He owns shares of Berkshire Hathaway, Apple, Google, Deckers, and Amazon.com. The Motley Fool owns shares of Wal-Mart, Apple, and Google.Motley Fool newsletter serviceshave recommended buying shares of Amazon.com, Google, Apple, Wal-Mart, and Nike; creating diagonal call positions on Nike and Wal-Mart; and creating a bull call spread position in Apple. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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