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Hey Newbie,


I want to do research on different companies and start with some low priced stocks to get a feel how this will work for me until I am comfortable buying pricier stocks.

This is the #1 pitfall for most new investors. A stock is not cheap because of its price. A $1 stock could actually be more expensive in many ways that a $100,000 stock. Sounds weird but it's true.

Imagine company A:

It sells for $1. There are 10,000,000 shares out. It makes $50,000 in a good year, but it's been a bad year. They lost $15,000. They have $250,000 in cash and $5,000,000 in debt.

Imagine company B:

It has only 100 shares priced at $100,000.
That $100,000 is certainly expensive. But what it that company had $5,000,000 in cash, and earned $400,000 annually?

If you could buy the whole company, which would you buy, A or B?

You could buy all of A or all of B for $10,000,000. They are effectively the same price.

That's the measure of "cheap". If you focus on share price, you lose the big picture.

The same is true for the pieces of A and B that you might be buying.

One $100,000 share of company B is backed up by $4,000 of earnings and $50,000 in cash. That's $0.04 of earnings per dollar spent plus $0.50 of cash in its accounts for every dollar you spent.

How about company A? Each $1 share is backstopped by $0.005 in annual earnings in a good year (but a LOSS this year) and $0.025 in cash. And it comes with $0.50 worth of debt to boot! There's nothing cheap about it!

The biggest mistake many people make is confusing share price with value. They have nothing to do with each other. It's simply not true that a cheap share price means a cheap stock. It's most often the case that a $1 stock is worth virtually nothing (especially in a strong market; it's $1 for a reason). They are companies that are almost always in severe financial distress. That makes them unsuitable as investments. They're solely trading assets, or control assets in preparation for bankruptcy/reorganization. (Plenty of people make money trading stocks. But that's not really about value. It's about momentum. It's a whole different ball game. Some traders ignore fundamentals altogether.)

If you want to learn to pick individual stocks, ignore price and investigate some of the respected names. Read up a little on their financials. Read press releases and articles. Listen to a conference call. Learn why you think they would be a good company to run or own. Those good companies are the companies to focus on. Don't dumpster dive. It takes a lot of experience to dumpster dive and even then you'll get it wrong. Cheap does not equal a good investment. One share of Apple might look expensive, but it's worth a whole lot more than $200 worth of a $1 stock. You may get lucky in the pennies and make money. But it's because you got lucky on a $1 scratch off lottery ticket.

It's all so tempting to a lot of newbies. You can see some amazing pops in penny stocks, but there's a reason. People are intentionally trying to manipulate them. Resist the urge. The occasional huge pops are often followed by huge crashes. These are shark infested waters that are rarely if ever backed by fundamental value.
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