The stock market is a place where participants can buy and sell pieces of ownership of publicly-listed companies with prices quoted on a daily basis. At any one point in time, prices of these listed-companies are available at the click of a mouse. But, that convenience alone can’t help anyone make intelligent investing decisions.
Let’s consider the case of telecommunications operator Starhub (SGX: CC3). Its shares have done well since the start of 2012, rising by almost 40% to $4.05 on 26 June 2013. Starhub’s gains have outstripped the 16.1% and 20.8% returns of its industry rivals, SingTel (SGX: Z74) and M1 (SGX: B2F), and also outperformed the broader market, represented by the Straits Times Index’s (SGX: ^STI) gain of “only” 15.5%. In short, Starhub’s shareholders have had it good.
But it was hardly a smooth ascent. There were many bumps along the way – the most notable being Starhub’s recent 15% slide from a 52-week high of $4.76 set on 30 April 2013. Simply said, using the market’s quoted prices, it seemed to be suggesting that Starhub’s value as a company is wildly erratic and prone to changes by the minute.
Can a business’s entire value really be subject to change that frequently? The chart below might shed some light on this issue.
It plots the percentage changes in Starhub’s trailing-12-months’ earnings per share (TTM EPS) using the TTM EPS on 1 Jan 2012 as the base. There’s also the percentage change in the TTM Price-Earnings ratio, using the TTM PE on 1 Jan 2012 as the starting point, plotted on the same chart.
The earnings or profits made by a company are often taken to be a close proxy for its true value, i.e. its intrinsic value, something that’s distinct from its quoted market price. And the chart shows Starhub’s earnings – and by extension, its intrinsic value – improving gradually.
But, the change in its TTM PE ratio was another matter altogether. Its TTM PE, which underwent wild swings, was 16.4 at the start of 2012 and dipped by 6% to 15.4 at its lowest before increasing by 38% to 22.6 at its highest.
Mathematically, the PE ratio is obtained by dividing the quoted price of Starhub’s shares by its TTM EPS. But in reality, it encompasses the aggregated pessimism or optimism that market participants feel about the company. As Morgan Housel from the Motley Fool writes, the PE ratio simply “reflects people’s feelings about the future” for any specific share.
When people are optimistic and feeling good, they pay more for each dollar of earnings. When people are pessimistic and feeling poor, they pay less.
What this means is, the price of a company’s shares are affected by market psychology, which can change in a dime. But, the true value of a company changes slowly and can be detached from its share price at times.
Foolish Bottom Line
Legendary investor and fund manager Philip Fisher once said, “The stock market is filled with individuals who know the price of everything, but the value of nothing.” To come out ahead of the game, there has to be a focus on value.
Market participants focusing solely on share prices get dragged along by the fleeting nature of market psychology and that’s foolish. Investors with a focus on the fundamentals and appraisal of intrinsic values have a firm anchor for intelligent decision making and that’s Foolish.
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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.