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A Dangerous Way to Look at Share Prices

Over the Chinese New Year festive period, a cousin of mine asked me, ‘Do you think Apple’s (NASDAQ:AAPL) share price will hit $700 again?’ The iPhone and iPad manufacturer saw its share price hit an all-time high of $705 in the later months of 2012 before starting a long decline to its current share price of around $440.

My memory’s fuzzy about my response, but it had something to do commenting on Apple’s share price.

I realised belatedly that my cousin had displayed a psychological bias called Anchoring – a phenomenon where we grab a number, any number, for an estimate of a figure we are vague about. Because of that, investors tend to grab a business’s share price as an anchor of what its true ‘value’ is.

On hindsight, my response should have been, “Do you think Apple can sell even more products and earn even more money in the future?’ The focus should have been on what Apple’s business performance will be like in the future.

If a stock falls 30% from its 52 week high, we think it is ‘cheap’ because we anchored its value based upon its highest share price. If a stock is now 30% above last year’s highest stock price, we think it is ‘expensive’ because the anchor is now a lower stock price. This way of thinking is dangerous for investing.

Instead, what we as Foolish investors should do, would be to think of what the business can achieve from here on out.

Wilmar International Ltd (SGX: F34) and Cosco Corporation (SGX: F83) have both seen share price declines of more than 20% compared to a year ago. Instead of anchoring on the higher share price for what their shares are truly ‘worth’, we should be looking at how these 2 businesses might perform in the future.

Wilmar, an agriculture business company, released its full year earnings result on 22 Feb 2013. Despite the 21.6% fall in profit to US$1.26b, Chairman and CEO of Wilmar, Mr. Kuok Khoon Hong commented that they are “cautiously optimistic of our long term prospects due to good economic growth in our main markets of China, India and Indonesia and the robust business model we have built up over the years.

Wilmar’s profits ultimately depend on prices of commodities like sugar and crude palm oil, both of which declined significantly in 2012. Thus, investors should attempt to understand long-term trends in commodity prices (which is really tough to do!) to better understand how Wilmar will do going forward based on its current share price and future prospects.

Cosco, a marine engineering and shipping company, saw its full year net profit decline by 24% to S$105.7m in 2012.  Management commented that they “expect even more difficult and challenging business and operating conditions in 2013.”

The company’s business is closely linked to the Baltic Dry Index (BDIY: IND), and improvements in the index should translate to better business results. As it stands, the BDI, a measure of shipping costs, is only about 17% higher than a 25 year low of 647 seen on 6 Feb 2012. Management is also not optimistic about any BDI improvement this year.

In some better news, Cosco’s order book of US$6.1b at the end of 2012 was an improvement over third quarter’s US$5.7 billion – signalling an improvement in demand for vessels in the future.

Investors in Cosco should really be trying to understand; how the BDI changes along with the world’s economy (again, a really hard thing to do!); and the factors affecting vessel demand. Only then, can a better picture emerge of how Cosco might fare in the future and hence determine any merits for investment.

Mutual fund legend Peter Lynch would have the last word in this article with an anecdote that Foolishly highlights why we at the Motley Fool prefer to study a business’s fundamentals, and not its past share price, for its investment merits. Michael Dell, CEO of Dell Inc., once asked Peter Lynch about the direction of Dell’s future stock price. Lynch’s answer was, “If your earnings are higher in 5 years, your stock will be higher.”

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Contributor Chong Ser Jing owns shares in Apple.