Two Shares The Market Expects Big Things Of

Ser Jing - Two Shares The Market Expects Big Things Of (pic) At Monday’s close, the Straits Times Index (SGX: ^STI) is at 3,173 points, with a trailing Price-Earnings ratio of 13.1 if we use the data of the index tracker SPDR STI ETF (SGX: ES3) as a close proxy. This puts the STI’s current valuation below its historical mean of around 16.

The index’s current PE by no means allows us to predict its returns over the next few months, or even the next year or two. But, it does give investors a sense that the market’s not expecting too much from the 30 companies within the index in terms of delivering earnings growth.

After all, the PE ratio, according to my Foolish colleague David Kuo, “can be seen as an indication of the expected future growth of [a] business.”

While the market’s not having pie-in-the-sky expectations for the STI, here are two shares where the market seems to be expecting big things of: KS Energy (SGX: 578) and UPP Holdings (SGX: U09).

KS Energy is a company that wears a few corporate hats. It distributes parts and components for customers in the oil & gas, marine & offshore, petrochemical, and mining industries among others. In addition, it charters rigs that it owns to third-parties and also provides drilling and rig management services to others, with both sets of customers coming from mainly the oil & gas industry.

The company’s recent second quarter results, released on last Wednesday, saw its profit for the half-year period jump by more than six times from $377,00 a year ago to S$2.7m. This gave the company a PE ratio of 63 based on its earnings for the last 12 months.

KS Energy had seen massive losses totalling S$177m for 2010 and 2011 but has since started to see signs of a turnaround. The company had posted a small profit of S$1.3m last year as it started to get a handle on its costs. That said, at its current PE ratio, the market’s likely expecting a large rebound in its earnings going forward.

The chart below shows a range of possible prices that shares of Kris Energy might be worth depending on its growth rate and PE multiple. The cells enclosed with a red outline show the growth rates and PE ratios that KS Energy needs to have for its shares to at least double in price at the end of five years.

The chart’s no magic panacea and its mileage might vary for each individual. But, it does help give us a sense of what to expect from the company in the future for investors to achieve good returns. And in turn, investors can then judge the feasibility of those expectations to help make better-informed investing decisions.

2 shares market expects graph 1

Next up, we have UPP Holdings, a company that operates paper mills and sells industrial grade paper products in addition to a having a business arm that “focuses on identifying new investment opportunities locally and overseas that has the potential to increase revenue streams and produce good returns on investments.”

Recently, the company also expanded its business operations by inking a deal where it’ll acquire a new natural-gas-powered 50 MW power plant in Yangon, Myanmar for S$59m.

The electricity generated will be sold to Myanmar Electric Power Enterprise for US$0.034 per kWh, subject to adjustments. There’s a also a guarantee that MEPE will be purchasing at least 350m kWh a year, giving UPP Holdings a minimum revenue of around US$11.9m a year from the power plant asset. For comparison, the company brought in sales of S$51m and S$50m for 2011 and 2012 respectively.

The company’s management had previously concluded in a strategic review that its paper-related business “is increasingly commoditised” and would face more pressure on profit margins in the future. Because of that, the company had actively sought to explore suitable investment opportunities and found the Myanmar power plant to be a good deal.

UPP Holdings’ recent half-year results saw its profit for the first six months of the year fall by 28% year-on-year to S$941,000.

At the company’s current share price of S$0.36, it’s selling for an astonishing 185 times trailing-12-months’ earnings. The chart below (similar to the one for KS Energy) highlights some possible returns that investors can expect from UPP Holdings.

For investors in UPP Holdings to double their investment over the next five years, the company not only has to achieve stellar per-share-earnings growth, but it has to be pegged with a very high earnings multiple. Investors have to bear in mind the odds of the company meeting such growth projections and valuations.

2 shares market expects graph 2

Foolish Bottom Line

While the PE ratio can be useful in setting expectations in addition to performing valuation work on a business, it is certainly not the most rigorous analysis of a company’s valuation. In fact, analysis of the ratio alone to make investing decisions without due consideration of the business prospects and underlying business-related risks of a share can be a fool’s errand. Use it 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.