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One Important Thing Every Investor Should Know About the Stock Market

Over the last decade since the start of 2004, shareholders of South-East Asia’s largest bank DBS Group Holdings (SGX: D05) must have thought they were living in a twilight zone if they had checked their brokerage statements.

Between then and now, the bank had grown its tangible book value (a very important measure of the intrinsic value of a bank) by almost three-fold from S$7.44b to S$27.6b. Yet, its share price barely budged – okay, there was an 11% increase – from S$14.7 to S$16.29 today.

On the other hand, DBS’ local peers Oversea-Chinese Banking Corporation (SGX: O39) and United Overseas Bank (SGX: U11) had both did much better than it in terms of share price appreciation but had displayed relatively anaemic growth in business values. What gives?

DBS

OCBC

UOB

Share price: Jan 2004

S$14.70

S$6.05

S$13.20

Share price: Today

S$16.29

S$9.28

S$19.61

Share price change

11%

53%

49%

Tangible book value: Jan 2004

S$7.44b

S$7.98b

S$9.82b

Tangible book value: Today

S$27.6b

S$20.7b

S$19.4b

Tangible book value change

271%

159%

97%

Source: S&P Capital IQ

Turns out, it was the difference in the starting valuations that the three bank shares had, and that’s the important thing every investor should know: the starting valuations of your investment would determine your future returns.

DBS carried a significantly higher valuation as compared to its peers at the start of 2004, which made any growth in its business (i.e. the increase in tangible book value) hard to be reflected in commensurate share price growth.

DBS

OCBC

UOB

Price to Tangible book value: Jan 2004

2.9

2.0

2.1

Source: S&P Capital IQ

My American colleague Morgan Housel also shares a similar thought on the importance of valuations and wrote this (emphasis his):

Buy stocks when they’re cheap, and future returns will likely be high. Buy when they’re reasonably valued, and you’ll do just fine. Buy when valuations are high, and you’ll suffer for years. You get what you don’t pay for. This is the single most important (and ignored) lesson of investing.”

Investors learnt about the importance of valuations the hard way when Keppel Telecommunications & Transportation (SGX: K11) ascended sharply by 580% from S$0.85 a share in Feb 2004 to a high of S$5.80 in Dec 2007. At that peak, shares of the company were trading at 62 times trailing earnings and despite earnings growing by 24% since then, its shares have collapsed some 70% to S$1.75 today. “Buy when valuations are high, and you’ll suffer for years.” Indeed.

To give a few more spins on the topic, the Straits Times Index (SGX: ^STI) had more than doubled from its March 2009 lows of 1,457 points to 2,989 points today partly due to its low valuations back then; the index was selling for around 6 times earnings at the trough.

In Greece, the country’s ASE Index was one of the best performing stock markets in the world from June 2012 to October 2013, climbing almost 150%. All that happened despite the country’s horribly shrinking economy largely because the ASE Index was selling for an absurdly low cyclically-adjusted price earnings (CAPE) ratio of around 2 back then. “Buy stocks when they’re cheap, and future returns will likely be high.” Indeed.

To be certain, I’m not advocating investors rush out to purchase anything that carries a low valuation as those might turn out to be traps. I’m just calling out one crucial thing about stocks investors should know: Valuations, matter. Don’t ignore this important lesson.

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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 writer Chong Ser Jing doesn’t own shares in any companies mentioned.