Peter Lynch once passed on a piece of sage advice to American technology company Dell’s then-CEO Michael Dell. It goes like this: “If your earnings are higher in 5 years, your stock will be higher”. If we take Lynch’s advice to heart, then investors in these three companies; Sembcorp Marine (SGX: S51); Olam International (SGX: O32); and Keppel Corp (SGX: BN4) should be laughing their way to the bank if we consider how their earnings have grown in the past five or six years. But, as you shall see below, that’s hardly been the case. Marine engineering firm Sembcorp Marine’s…
Peter Lynch once passed on a piece of sage advice to American technology company Dell’s then-CEO Michael Dell. It goes like this: “If your earnings are higher in 5 years, your stock will be higher”.
If we take Lynch’s advice to heart, then investors in these three companies; Sembcorp Marine (SGX: S51); Olam International (SGX: O32); and Keppel Corp (SGX: BN4) should be laughing their way to the bank if we consider how their earnings have grown in the past five or six years.
But, as you shall see below, that’s hardly been the case.
- Marine engineering firm Sembcorp Marine’s last-12-months’earnings per share (LTM EPS) had grown by 58% from the start of 2008 to today. It’s risen from S$0.16 vs. S$0.26. But, the share price has barely budged from $4.04 at the start of 2008 to current prices of around $4.30
- From Jan 2008 till today, commodities trader Olam International’s LTM EPS more than doubled from 7 cents to 17 cents. Its current share price, however, has been languishing around $1.67, a far cry from the $2.85 at the start of 2008.
- Property developer, infrastructure and marine engineering firm Keppel Corp. had almost doubled its LTM EPS from a split-adjusted S$0.54 to S$1.03 since 2008. And if you guessed that its share price remained stagnant in that period, you’d be right. The shares have remained essentially flat from a split-adjusted $10.44 to $10.71.
Why would the share prices of these companies not tag along earnings growth, considering that their earnings have gone up substantially? The answer might lie with their high starting valuation.
LTM PE Ratio
|1 Jan 2008||Current|
If we look at the PE ratios of the three companies at the start of 2008, they are far in excess of the historical PE of 15 for the Straits Times Index (SGX: ^STI), meaning their PE ratios were arguably high. The problem with high PE ratios is that they often signify high growth expectations and if the company’s eventual earnings growth disappoints, then the company may be de-rated to a lower PE, negating any increase in the earnings. This is what we have seen with Sembcorp Marine, Olam and Keppel Corp.
Foolish Bottom Line
When we invest, we’ll ideally want to find companies that can grow their earnings. I have shared examples of how earnings growth can be harmful for shareholders if excessive dilution of existing shareholders’ stakes occurs. So, that’s one area to consider when looking at a company’s growth. The other important area to focus on is the starting valuation.
I started the article with a piece of sage advice from Peter Lynch. Here’s a nugget of wisdom from Warren Buffett who once wrote that an investor’s goal “should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now.”
In other words, pay too high a price and even the fastest growing companies can make for disappointing investments. Choose wisely and pay wisely.
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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 doesn’t own shares in any companies mentioned.