How to Best Invest $1,500: Go Cheap or Go Big?

NEW YORK ( TheStreet) -- If you look around the Internet, you find no shortage of writers and message board regulars pumping the snot out of low-priced stocks such as Alcatel-Lucent ( ALU), Frontier Communications ( FTR) and Sirius XM ( SIRI).

As I noted Monday in an article where I discussed selling two low-priced stocks, including SIRI, and long plays on two others, there's nothing necessarily wrong with dipping into the sub-$5 netherworld.

As long as you take bullish touts for the ALUs, FTRs and SIRIs of the world with a grain of salt and limit your exposure, there's no reason not to take part in this type of speculation. Who am I to tell you that my bull case for an investment in Nokia ( NOK) carries any more validity than the conviction that underlies your long position in ALU, FTR, SIRI or some other sub-$5 stock?

However, if you're looking to invest a relatively small sum, say $1,500, or speculate in a sub-section of your portfolio, you really need to assess why you're going the low-priced route.

Be Weary of Back-of-the-Envelope Math

Dateline August 2000: ALU hits a high of $82.88. It's been practically all downhill since then. The stock now trades for about $1.58. It used to pay a dividend. That's long gone.

But you still have folks who give themselves handles such as "Global Value Investor" asking questions such as "Can Alcatel Lucent Hit $5 Per Share?" with the flimsiest of cases supporting a long position.


And, despite FTR's 76% move down since August 2000 and slashed dividend, you still have tortured longs getting excited over one dead cat bounce after another.

Then, of course, you have SIRI. This stock traded as high as $61 in 2000. It certainly created more bag-holders than penny stock millionaires, thus the full-force pumping we endure from SIRI loyalist longs on a daily basis.

When a stock craters relentlessly from such heights over the course of many years, there's generally a reason. It's not market manipulation. Nor is it a scenario where a gaggle of permabulls gets it, while the rest of the world wanders around in a clueless stupor. Beware of the notion that some set of external forces created not only the decline, but the persistent stagnation in a stock that fell from grace.

Several purely psychological factors drive us into these types of stocks absent any remotely rational reasons for going long.

Our minds often pull a George Costanza on us -- It's not a lie if you believe it. To justify taking a shot at easy riches, we make ourselves believe anything. We buy what the pumpers sell because we want it to be true. In the end, we're usually left asking ourselves Is a dream a lie if it don't come true or is it something worse?. Some folks never learn.

Because of some combination of X, Y and Z, it simply cannot go any lower! We hear that line in relation to ALU, FTR and SIRI as well as dogs ranging from Research in Motion ( RIMM) to Radio Shack ( RSH). It can't go lower because of book value, cash, refinanced debt, valuable patents or the prospects of a merger or acquisition.

No union of the above-mentioned represents an investment case. That's what I attempt to drive home when I compare Nokia and RIM. The bull case for RIM is shallow, generally containing many of the preceding reasons why "it can't go lower." Yet it always does.

While it's perfectly sane to think Nokia is doomed as well, I am long because I consider it distinct from RIM. The company made the difficult decisions RIM either refused to make or has yet to even truly consider. If my speculative bet on NOK plays out, it will be fantastic. If it doesn't, I will hardly take life-changing lumps. I went small. And I can look back on the investment knowing that I went into it of sound and rational mind.


Too often, we listen to the shallow arguments bulls make for a low-priced stock and we let what I like to call the"lifted skirt and perfumed inner thigh" of small numbers draw us in. It has quite the allure. A $1.50 stock is akin to a lady of the night staring seductively from across the bar.

She makes you think silly thoughts -- you're young again. You're not bald. You don't have a gut. You can party all night. It sounds so appealing that, because you want to believe it so badly, you actually do believe it just long enough to get sucked in. That's what an ALU, FTR or SIRI quote page followed by a trip to the comments section of an article on one of these stocks can do to otherwise rational people. Technically, you're not lying to yourself because you really do believe it. The mind can play horrible tricks on us.

We're attracted to the $1.50 stock because $1,500 can buy 1,000 shares. We should really put that $1,500 into 2.5 shares of a stock like Apple ( AAPL), but we do not. Or 2.75 shares of Intuitive Surgical ( ISRG), but we do not. Owning a relatively tiny and fractional lot of shares just doesn't appear nearly as sexy as owning (enter booming voice) 1,000 shares!

Plus low-priced stock lovers use the "law of large numbers" premise to argue against buying AAPL or ISRG over low-priced stocks with "so much room to grow."

Then we scribble the math. If the $1.50 stock doubles and hits $3.00, we turned $1,500 into $3,000. Heck, if "Global Value Investor" is correct and $5 happens, we have $5,000 or a 233% gain.

We turn the tables of rational thinking on ourselves. Intuitively, particularly when this emotional state of mind takes over, we downplay the potential for upside in a stock like AAPL or ISRG, relative to the low-priced stock (remember the law of large numbers and the sexy allure of the low-priced stock).

It's a $585 stock. How in the world can it go to $1,170, let alone $600 or $700?

Immediately, without taking into account why AAPL grew into a $585 stock and why ALU, for instance, costs just $1.58, we discount the possibility of a double for AAPL. Shockingly, we think it's way more realistic in ALU. And then we seal our fate when we run the numbers -- $585 to $600 is $15 higher. It's a $115 higher to $700. All ALU has to do is move a measly $1.50!

Sigh.

If you find yourself running those numbers to justify the purchase of 1,000 shares of something over 2.5, 2.75 or even 100 shares of something else with a fixed amount of cash, run away. These calculations should rarely, if ever, come into play when you're making an investment. Your conviction regarding future upside is pretty much all that matters.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

At the time of publication, the author was long NOK.