Is It Worth Paying More for High-Quality Stocks?
“Dad, you’re so cheap! Why can’t we buy the name-brand chips??”
OK, my kids have a point. When it comes to shopping for most of the things we buy for our home, I always look for the lowest price.
Can you blame me? After all, with seven kids the expenses add up quickly. I need to make our money stretch as far as possible!
Most of the time, that means finding the lowest price possible for the things we buy day-to-day.
But as I’ve learned, there are certain areas (including some investments) where it’s actually smart to pay a premium price.
Today, I want to show how you can build your wealth quickly if you’re willing to pay a little more for some very specific stock opportunities.
You Get What You Pay For
When it comes to buying cheap stuff, the phrase “you get what you pay for” definitely applies.
Last year, I found some great backpacks at a back to school sale. I couldn’t believe they were only $10 each — and the kids loved the colors!
But not even halfway through the school season, the zippers started breaking and the straps came off. We wound up having to replace the backpacks and paying more than if I had just found some quality products to start with.
I’ve learned that making wise spending choices can mean much more than just finding the lowest price tag.
For some purchases, I want to spend as little as possible. I don’t really like paying an extra 20% to get a “name brand” item.
But for other purchases, it makes sense to pay a little more for quality. That way, your merchandise will last longer, your trip will include more memories, or the doctor you visit may have a little more experience.
The same concept applies to investments.
Sometimes you want to buy stocks as cheaply as possible. That way, you get the best value for the cash you’re investing.
And other times, it pays to fork over a little more. That way, you own shares of a great company that is growing quickly and driving the value of your investment steadily higher.
But how do you know which companies are unnecessarily expensive and which stocks you should spend a little more on?
I’m glad you asked…
A Good Investor Knows What His Investment Is Buying
Whenever you buy shares of a stock, it’s important to remember that you’re actually purchasing a piece of the company.
Think about what your decision process would be if you were actually buying out an entire business.
Chances are, you’d be asking questions like:
- How much money did this company make last year?
- What areas of growth are still available?
- Do you have a loyal customer base?
- What are your competitors doing?
- Can the business expand into new geographic areas?
Depending on what industry you’re investing in, there could be dozens of important areas to understand.
The same can be true for stocks. Before buying shares, you should know as much as possible about the company and what you’re getting when you buy.
While you can spend a lot of time researching details for companies and individual stocks, there are a couple basic metrics that will give you a solid foundation for what you’re investing in.
The first is known as the price to earnings (or PE) ratio. This is simply a comparison of how much you’re paying for a stock compared to how much the company is earning.
A PE ratio of 7 is generally very low. Which means you’re getting a discount (or paying a low price) for the piece of the company you’re buying. On the other hand, a PE of 50 would be very high and represents a premium price for buying this company.
The second thing you need to look at is how fast the company is growing profits.
This is a bit more subjective. But for every stock, there are typically Wall Street estimates for how much a company will earn for the next year or two. (You can find the Wall Street estimates for these stocks using a lot of free services like MarketWatch or Yahoo Finance).
The faster a company is expected to grow earnings, the more you should be willing to pay for that stock. Because as the earnings grow for the next few quarters or years, the price you pay today will become more and more reasonable.
So always take a look at how much you’re paying for a company’s earnings and how fast those earnings are expected to grow.
“Expensive” Can Be “Worth It”
As you consider a broad range of different stocks to invest in, you’ll quickly notice that some stocks are very expensive while others are very cheap.
I’ll admit, the penny pincher in me naturally leans toward buying the less expensive stocks. But just like buying kids’ backpacks, sometimes it makes sense to buy the more expensive plays.
Often, the stocks that are more expensive are the ones that have the most growth potential.
For instance, many of the companies who are building 5G networks, or selling devices that will connect to these networks, have stocks that are trading with very high PE ratios.
That means you have to pay a lot more for every dollar each of these companies earns.
But when you consider the scale of opportunity with the 5G network rollout, these expensive stocks could still be very good opportunities! After all, these companies could double or triple earnings this year — and again next year.
And it doesn’t take much time until this kind of profit growth makes these stocks reasonably priced based on much higher profits.
So when you’re putting together a list of stocks you would like to invest in, consider starting with some cheap stocks — especially ones with stable businesses that pay great dividends.
But also splurge on a few expensive plays. After all, the value you get from these investments could be well worth the price you pay.
We’ll continue to look at plenty of opportunities in both categories here at The Daily Edge. And I look forward to hearing about your success as these investments work together to give you some great returns.
Here’s to growing and protecting your wealth!