When is a Share Price Cheap?

My wife said the other day that an ETF that trades under $6 per share is "cheap." When I asked her what she meant, she said one doesn't need a lot of money to buy a share, and it is affordable to most people.

A low share price for a stock or ETF certainly fits the above definition of cheap, but when it comes to stock market investing it's better to look at potential buys in terms of whether they are good deals or good value, not simply price per unit.

So, for example, a stock can be cheap if it is trading below what it is actually worth to you.* Suppose XYZ trades at $500 a share while you think it's worth $1,000. Suppose stock ABC trades at $1 per share, but you think it's worth $0.50. Stock ABC is expensive and XYZ is cheap, even though XYZ's share price is 1,000 times higher than ABC's.

The price per share of a stock, with a couple of exceptions I'll get to below, doesn't really matter. That is because it can be anything. What matters is the market capitalization, or market cap.

The market cap is the company's worth at any given moment, as priced by the market. That is, if you could buy up all the shares at once, the market cap would be what you would pay to own the entire company.** The share price is really just the market cap divided by the number of shares outstanding.

So, if company DEF has a market cap of $1,000,000 and 4,000 shares outstanding, the price per share is $250. If the company decides to do a 2 for 1 stock split so that each share becomes two, it will have 8,000 shares outstanding. With a market cap of $1 million and 8,000 shares, the price per share is $125. It's still the same company with the same market value, but the share price is different. Does preferring the shares after the split at $125 over the before split price $250 make sense in terms of value? No.

Everything said about stocks above applies to funds: the price per share does not indicate whether it is a good or bad deal. But there's another sense of "cheap" when it comes to funds like ETFs, CEFs, and mutual funds. This concerns the fund's fees. A fund that is cheap in this latter sense has low or no fees, which include management fees and loads.

This is particularly relevant when you are deciding between different index funds that all track pretty much the same index like, for example, the S&P 500 or the total US stock market.

Consider three ETFs that track the S&P 500: SPY (State Street), VOO (Vanguard), and IVV (iShares). As of 6/1/19, they have net expense ratios of  0.0945%, 0.03%, and 0.03% respectively. Both Vanguard and iShares have lower fees than State Street and on that basis are cheaper. (But note that there may be good reasons to prefer SPY to the others, e.g., liquidity.)

The ETF that my wife said was cheap was the InfraCap MLP ETF (AMZA),  which invests in master limited partnerships in the energy infrastructure sector. That's mostly oil and gas pipeline companies. AMZA has a net expense ratio of 2.4%. This means that if the equities AMZA invests in stay unchanged through the end of the year, one's investment in AMZA will drop by 2.4%. That's pretty expensive, especially considering that similar funds like MLPI, MLPB, AMLP, and PYPE each have a net expense ratio of 0.85%. Their share prices are higher than AMZA's, but they are all cheaper, at least from a fee perspective. This is not to say they are better than AMZA, which may have merits that justify the almost three times higher fees.

There are exceptions, of course. Share price can matter when one doesn't have enough capital to buy a whole share. You can buy fractional shares in most if not all mutual funds, but for common stocks, ETFs, and CEFs this depends on your broker. Most brokers only let you buy whole shares (with the exception of dividend reinvestments). So, if a stock trades at $100 per share but you only have $25 and your broker doesn't allow fractional share purchases, you can't buy that stock. But if the stock does a 4 for 1 split, you will be able to buy it.

In a related way, share prices can attract particular buyers. A stock with a low share price can attract smaller investors, which may lead to the share price increasing. This is one of the reasons companies do stock splits, even though it changes nothing about the business and actually costs it money to do.

* I say "worth it to you" because this is more about the future than present value. The current value of the investment is whatever its market price is.

** Of course, were someone to try to buy up all the shares at once, the price would go up immediately because of the increased demand.

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