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The Most Sensible Way to Think About Buying Shares

My American colleague Morgan Housel wrote yesterday, what he thinks is the only daily market update an investor should pay attention to:

New York – S&P 500 Companies earned $2.71 billion of net income on Tuesday. $890 million of that will be paid out as dividends, with the remainder retained for future growth.

For Morgan, that’s a great market ‘update’ because it brings to focus what really matters in the share market: the corporate growth of the businesses that constitutes the market. That’s the most sensible way to think about shares.

In fact, it’s also tangentially related to the most sensible way to thinking about buying shares. Far too often, share market participants (note: not investors) care too much about the squiggly, moving lines on a share price chart and forget that underneath all that lies a living, breathing business that employs tens, hundreds, thousands, or even hundreds of thousands of employees.

These employees create products and services that are sold for a profit which accrue to us, the shareholders. Over time, as the profits from those businesses grow, so too would the value of our stake in them increase. And, lest we forget, that ‘stake’ is the shares that we own in those businesses.

So, when it comes to buying shares, the most sensible way to think about it would be to think about buying shares as though you were buying a business.

The following is an example of what I’m talking about. The telecommunications operator Starhub (SGX: CC3) is currently worth S$4.16 a share. Over the past 12 months, it earned a profit of S$0.21 per share. From that, you can tell that you’ll need 20 years (S$4.16 divided by S$0.21) for Starhub to earn enough profits to recoup your investment, assuming its annual profits remain stagnant over the next two decades.

The next consideration you might think about would then be Starhub’s ability to grow its profits. If for instance, you think the company could grow its per share profits by 20% a year, you’ll need only 8 years before Starhub can earn enough profits to recoup your investment.

Theoretical future profits for Starhub assuming 20% annual growth

Year

Profit per share for Starhub

0

S$0.21

1

S$0.25

2

S$0.30

3

S$0.36

4

S$0.44

5

S$0.53

6

S$0.63

7

S$0.76

8

S$0.91

Sum in profits for Years 1 to 8

S$4.18

Under the theoretical scenario of 20% annual growth in profits, would it be reasonable, in your opinion, to purchase shares of Starhub if it would only take 8 years to recoup your investment?

Of course, such thinking oversimplifies some of the inherent complexities when it comes to investing in shares, but it’s still a very sensible way to think about buying a business, which is what shares are all about.

16 years ago on 11 September 1998, shares of Vicom (SGX: V01) were worth S$0.26 each. Over the past 12 months, its profits are at S$0.33 per share. Some might think investing is a complicated endeavour that requires advanced mathematics or some arcane insight into how the economy works. But, the thing is, all an investor needed to do with Vicom back then was to simply keep his focus on what the business might earn 10 or 20 years down the road. With profits that had grown from S$0.036 per share back then to S$0.33 today, shares of Vicom have increased by some 2,162%, completely obliterating the Straits Times Index’s (SGX: ^STI) comparative gain of ‘just’ 270%.

Think about buying a business when you think about buying shares. That’s the most sensible way in my opinion. What about you? Share your thoughts in the comments section below!

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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.