Investing Tip:

A Good Stock vs. A Good Company

A Good Stock vs. A Good Company

Many people (including some investment professionals) get confused about the difference between a good company and a good stock. Sometimes people want to purchase a stock no matter what the price, because it's a good company. Or they won't buy a stock no matter what the price, because it's not such a good company. But the price of the stock *does* matter a great deal.

Let's look at an analogy involving cars. Say you walk onto a car lot and they have two cars for sale. One is a Honda Accord (which is an excellent car) and one is a KIA, which (with apologies to any KIA owners reading this), is not as good a car. But let's say that the Honda Accord is priced at $100,000 where the KIA is only $5,000. No matter how good the Honda is, or how bad the KIA is, you cannot justify buying the Accord. Yet I see people do this all the time with stocks. No matter how high the price, they say "but it's such a great company". And that is true. A good company's stock does deserve *some* premium. Back to our car analogy. If the KIA was $14,000 and the Honda was $19,000 then the Honda might indeed make sense, it *is* worth a premium. But not 20 times worth.

When you are making a decision to buy a stock, you need to compare it to other similar stocks. If the price is outrageous, no matter how good the company, it's probably not time to step in. The real trick is to buy that *Honda* for $5,000. That's what I spend my day doing, looking for the stock market equivalent of $5,000 Honda Accords. I believe that in the long run, this is one of the important keys to investment success, looking for quality bargains. In many ways it's not unlike shopping for a car.

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Donald Steinmann and Advanced Financial Management assume no responsibility for any actions taken due to comments made in The Investment Tip Of The Week.