Great Company, Fair Price, or Fair Company, Great Price?

By Motley Fool Staff
How much difference does it make whether you buy stock in a great company at a fair price or at an overvalued price? As long as it goes up, won’t you still make money in the long run?

Well, you’re right to think of the long run, but there is a difference. You may make less money if you’re buying an overvalued company. (And you may also end up actually losing money, too.)

Consider the example of Holy Karaoke, Inc. (Ticker: HYMNS), which we’ll say is trading at a fair price of $10 per share. If it’s expected to grow at 12% per year for the next 10 years, we can estimate that it will be at $31 per share then.

If you buy it at $10 per share, and it does hit $31 in 10 years, your total gain over the decade will be 210%. However, if you have to cough up $15 per share, it will return only a total of 107% on its way to $31. That’s about 7.5% per year. Worse still would be buying it at $20 per share. Sure, you’d make money, but your total gain would be just 55%, or roughly 4.5% annually. You can profit without considering the price you pay, but price does make a difference.
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