Blue chip shares have traditionally been considered amongst the safest of bets, while many caution against the risks of buying penny shares. Times are certainly strange when you can find both together.
Penny shares can often appear superficially attractive to novice investors, for the simple reason that a low price can make something look like a bargain. After all, if a supermarket sells things off cheap, you're getting the same item at a lower price, aren't you? The flaw with applying that analogy to shares is that an individual share is not always the same thing -- what might be a bargain one day can become an overpriced the next. At the Motley Fool we try to discourage beginners from investing in penny shares, and in fact will not open a new discussion board for small companies with share prices lower than 50p.
Low price
Is a company with shares priced at, say, 20p, better value than a similar company with shares priced at £1? Many beginners seem to think so, but the share price on its own really says nothing either way. If the former company has five times the number of shares in existence than the latter, the two companies will be valued identically (they will have the same market capitalisation). Whether the total valuation of a company is a bargain or not depends entirely on the health of its business.
Some people also seem to think that a share with a lower price can't fall as far as a higher priced one, and so you have less to lose buying the cheaper ones. But that is simply not true. The most any share can fall is exactly the same -- 100%. So if you invest £1,000 in a company, the most you can lose is £1,000, regardless of whether the shares are priced at £100 or 1p each.
How did it get there?
The other question we need to ask when thinking about penny shares is "How did it get there?". It's very rare that a company joins the stock market at a price of a few pennies, so whenever you see a very low share price you can be pretty sure that it used to be a lot higher in the past and that something bad has happened to get the price down where it is today.
Investing in something with a poor track record is not many people's idea of a surefire route to riches. That doesn't mean that looking for unfairly low priced shares is necessarily a bad strategy, or that seeking out companies ripe for recovery can't bring home the bacon (both can be good strategies if you know what you're doing), but it does mean that a low share price on its own is more often a sign of a dog than a star.
Dog stars?
So what about blue chips? Those are companies that are considered the stalwarts of the stock market, the safest of bets, the companies that are as unlikely to go bust as one could hope. Companies like the constituents of the FTSE 100, for example.
But if we take a look at the lowest priced shares in the FTSE 100 today, here's what we see:
Blue chip companies in the FTSE 100 at penny share prices are not something we see very often. What does that tell us? Well, there may be one or two worth having amongst the detritus there (I think Barclays is probably the best amongst the banks and the one most likely to recover, and some insurers may well be over-sold these days, but that's a story for another day), but it does tell us one thing.
It answers the question I posed above, the one we should always ask when thinking about buying low-priced shares -- "How did it get there?". We know precisely how the finance sector got where it is today, and we know that the shares we are looking at today are very different from their former selves from before the banks went on their reckless lending spree. I doubt many people today will be rushing out to buy RBS shares simple because 20p isn't a lot of money.
So whenever you think about buying a low-priced share, be sure you know the answer to that vital question.
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