Penny Stocks vs. Large Caps – Does the Stock Price Matter?

Was reading this article on Investopedia.

Basically the argument put forth is that its much harder for a $350bn company to grow to $700bn, as compared to a $2bn company to grow to $4bn.

I remember reading an argument against investing in penny stocks for exactly the _opposite_ reason =). The opposite reasoning goes like this: Many people think that its much easier for a $0.30 stock to double to $0.60, than for a $30 stock to double to $60. In the former case you have a $0.30 gap while in the latter you have a $30 gap; obviously its easier to increase by $0.30 right? Think about that for a moment, should that be true? Why?

It might be helpful to note that in both cases you have 100% gain. If I give $1 to a small company as opposed to a larger company, is it more likely that the small company will be able to give me $2? No! If both companies have the same investment opportunities and have the ability to take advantage of them, then there is no reason why the initial stock price matters. What matters is only the % return, _not_ the price.

Infact, a $0.30 stock is probably worse off just because its small size may not allow it to fully realize the available opportunities. Coming back to the original article, that is probably true of a large-cap $350bn company. Operational inefficiencies of such a behemoth will likely hamper its ability to use its capital efficiently, hence the difficulty in achieving similar results as a smaller outfit.

The key point to note here is that size is not the true problem. Rather, its the ability of the company to invest its capital efficiently. You can very well have a large company that is efficiently run (though less likely, it'll be a gem). Just something to think about when you see statements as such those above.


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