Expert: Paul Henneman - 3/26/2004

Question
Hello:

Why are low-priced stocks, for example $2.50/share, from small companies generally more risky than much higher-priced stocks, for example $75.65/share, from large companies?

I thank you for your reply.

Answer
Thank you for your question!
There are many reasons for this. On a basic level, since the stock is trading at a lower price, even small changes in stock price mean a much higher percentage change in overall value of your investment. For example, a 50 cent change in price on a $50 stock is not much. But a 50 cent change on a $2.00 stock is 25%!
The other problem is that most stocks trading at a few dollars are much smaller companies, with fewer outstanding shares and small or even 'micro' capitalization (overall worth, number of outstanding shares times share price). So, if a major investor decides to sell, the stock price will plummett. Or vice vera, a large buyer could really drive the price up. But, with mid cap or large cap companies, millions can be traded with out having such huge implications on stock price.
The final reason that I can think of is the type of investor that invests in small cap stocks. There are alot of 'get rich quick' schemes and investors out there. There is alot of activity to get small cap stocks out in the news through some sort of analyst coverage or press release, get investors attention, and drive up the price. But, once the price sees significant gain, those early investors behind these actions take the gain and the price often falls back below where it started.
Small companies are risky. But, carefully selected, they can offer the wise investor strong performance. A small company that is quickly growing and has a bright future could be a good stock to hold. Just be careful of hype, make sure it is for real! I would not advise anyone to have more than 10% of their investment portfolio in small cap stocks.
I hope this helps! Please do not hesitate to follow up with me if I can be of any further service.

Sincerely,
Paul Henneman
President
ValuEngine, Inc.
(800) 381-5576