Is That Stock Really Too Expensive?

From time to time in meetings, stocks are shot down because they're "too expensive." Normally, when the topic comes up, what we're looking at is a stock whose per share price is high, but whose overall future growth prospects look good. Normally, such a stock will be solidly in the buy range, with good management trends, dividends and all the trimmings. As Loot Lizards, we find anything over $80.00 a share to be intimidating "because it would have to go up a lot per share to recover costs."

But from a mathematical standpoint, is any stock really too expensive if the prospects for share price growth look good?

In a word, no.

The NAIC Stock Selection Guide works on the premise that if we look at the past trends for this stock, and apply them to estimating future growth, we'll end up with good stocks whose share price will grow. In order to provide a baseline for comparison, the SSG uses a percentage value, rather than a "I'll go up $10.00 a share" sort of analysis. The NAIC suggests looking for at least 8% historical annual growth. In one of their publications, they suggest putting a cap of 15% on the estimated growth rates. (The Loot Lizards usually apply the cap at 20%.)

So let's look at an example. We're looking at two stocks. One is Bedrock Quarry, trading at $30.00 a share; the other is Spacely Sprockets, trading at $90.00 a share. The Loot Lizards have $908 to spend tonight, and we like both stocks equally. Both stocks have good prospects for growth, and we've estimated that each will grow at 20% in the coming year. We could get 30 shares of Bedrock Quarry or 10 shares of Spacely Sprockets.

Let's say we buy 30 shares Bedrock Quarry, for $900.00 + $8.00 in commissions, or $908.00. Over the next year, BQ goes up 20%, just like we said it would (after the initial 4 month Loot Lizards Tank). One year later, BQ is trading at $36.00 a share, and we decide to sell it. We sell 30 shares for $36.00 each ($1080.00), then pay the broker $8.00. So we end up holding 1072.00 after selling BQ. If we subtract the initial investment, we've made $164.00, or 20% of our initial investment, less commissions.

Let's say we buy 10 shares of Spacely Sprockets, for $900.00 + $8.00 in commissions, or $908.00. Over the next year, SS goes up 20%. One year later, SS is trading at $108.00 a share and we decide to sell it. We sell 10 shares for $108.00 a share ($1080.00), then pay the broker $8.00. So we end up holding $1072.00 after selling SS. If we subtract the initial investment, we've made $164.00, or 20% of our initial investment, less commissions.

Spacely Sprockets had to go up by $18.00 a share to make $164.00, and Bedrock Quarry had to go up by $6.00 a share to make $164.00, but both of these stocks went up by 20% in terms of their initial share prices, and we ended up making exactly the same dollar amount from each.

So as long as the stocks are going to experience the same rate of growth (or shrinkage, because we are Loot Lizards, after all), there is no real difference in how much we'll make on a stock based on the share price.