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July 25, 2024 at 11:51 AM
Buying low-priced stocks can make sense in theory but in practice can prove hazardous, Susan Dziubinski, a Morningstar investment specialist, wrote in a blog post this week.
On one hand, it is easier for an investor to spend relatively little money and accumulate a meaningful position in a stock if that stock trades for, say, less than $10. The investor then hopes the position will surge in value over time, because small changes in the stock price can produce big gains, Dziubinski says.
On the other hand, the low-priced stock landscape is littered with untested companies that have hit a rough patch, are run by managers who have made poor capital decisions and have shaky balance sheets. That cheap stocks are often thinly traded only adds to their volatility.
“And you can’t have the potential for sizable gains without the other side of the coin: the potential for sizable losses,” Dziubinski notes.
Still, investors who want to buy low-priced stocks do not lack for opportunities, she says. Morningstar recommends that they look to high-quality companies whose shares trade on major exchanges, do so for less than $10 and are also undervalued relative to their intrinsic worth.
Quality companies, she writes, generally have greater staying power and stronger balance sheets. Moreover, buying stock for less than they are worth helps to mitigate price risk that often accompanies investing in cheap stocks.
All the best stocks on Morningstar’s list that trade for less than $10 earn the firm’s economic moat rating of at least narrow, which means that analysts think these companies have established advantages that should enable them to fend off competitors for at least a decade.
The best low-priced stocks also look undervalued, meaning that they are trading below Morningstar’s fair value estimates.
“Price risk is reduced when investors can buy the low-priced stocks on the cheap,” Dziubinski says.
See the accompanying gallery for Morningstar’s list of 10 stocks to buy for less than $10. All data is as of July 19.
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