Investors may think differently when considering what constitutes expensive or cheap stocks. To some investors, the saying of expensive vs. cheap stocks could indicate the level of stock prices and how much their investments may cost. To other investors, the expression of expensive vs. cheap stocks could denote the relative value between a stock's market price and its intrinsic worth. How closely stock prices track company earnings and equity might provide better signs as to whether stocks are expensive or cheap.
Investors may not be able to tell from market prices alone whether a stock is expensive or cheap. While some stocks command triple-digit sums, other stocks trade at single-digit prices. But high-price stocks are not necessarily expensive and low-price stocks are not automatically cheap. Investors may bid up a stock's price because they expect strong growth in the stock. The greater the growth potential of a stock, the more likely its high stock price is justified. On the other hand, if a stock's low price has yet to fully reflect a company's lack of earning power, the stock could still be considered expensive.
Investors often compare stock prices with per-share company earnings when performing stock valuation. Thus, whether a stock is expensive or cheap may depend on the level of its price-to-earnings ratio. In general, the larger the price-to-earnings ratio, the more expensive the stock, and vice versa. For stocks that have posted large earnings, the relatively high stock prices may prove to be not expensive if the price-to-earnings ratio is still low. The relatively low prices of stocks that have reported small earnings may turn out to be not cheap if the price-to-earnings ratio is still high.
Investors may also compare stock prices with company equity value to determine whether a stock is expensive or cheap, especially during periods of volatile earnings. A temporary increase or decrease in company earnings could make stocks suddenly look cheaper or more expensive than what they might be in the long run. A price-to-equity comparison often provides a more stable stock valuation measure. The ratio of a stock's price over its equity value often is compared to ratios for similar stocks, or an industry average. The higher the ratio, the more expensive a stock may be, and vice versa.
The different number of shares outstanding for different stocks can make stocks appear to be more expensive or cheaper than what they actually are. Stocks with fewer shares outstanding likely trade at higher prices, but may not be expensive if the ratios of price to earnings and equity are both low. Conversely, stocks with more shares outstanding likely trade at lower prices, but may not be cheap if the ratios of price to earnings and equity are both high. Without taking shareholder base into account, investors may also misinterpret stock prices for companies with the same equity value.
An investment and research professional, Jay Way started writing financial articles for Web content providers in 2007. He has written for goldprice.org, shareguides.co.uk and upskilled.com.au. Way holds a Master of Business Administration in finance from Central Michigan University and a Master of Accountancy from Golden Gate University in San Francisco.