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Investing Is All About Buying Low And Selling High. Sounds Easy? Think Again

Buy and sellThe secret of investing is really simple: You buy a share at a low price, and sell it at a high price. Besides collecting dividends along the way, that’s really all there is to it in investing. But, there’s a problem: What is a low price and what is considered high?

For some investors who are just starting out on their investing journey, they might use the price of a share alone as a guide to how cheap the share is. If I go with that framework, Jardine Cycle & Carriage (SGX: C07), with its share price of S$45.75, would be an expensive share while Ascendas REIT (SGX: A17U), with a price of S$2.31, would be a cheap share. But, most investors will understand that the actual price of a share does not tell you anything about how cheap it really is.

Most investors would instead compare the cheapness of different shares by looking at common valuation metrics such as the price to earnings ratio (PE ratio) or the price to book ratio (PB ratio). In this case, Jardine Cycle & Carriage looks way more expensive than Ascendas REIT. The former has a PE ratio of 14.5 and a PB ratio of 2.7; the corresponding figures for the latter are 11.6 and 1.15 respectively.

However, even using those ratios can’t tell us the full story. Such metrics can only be a guideline and shouldn’t be taken as gospel in terms of measuring how cheap a share is. That’s because companies from different industries typically trade at very different ratios. Thus, comparing such ratios across diverse companies might be useless for investors. This is certainly the case with Jardine Cycle & Carriage and Ascendas REIT: The former is a conglomerate with huge palm oil and automobile distribution businesses in Indonesia; the latter is a real estate investment trust which owns business parks and industrial properties in Singapore.

There’s another factor that muddies the waters regarding how expensive or cheap a share can be. When using simple valuation ratios like the PE ratio, or more complex valuation techniques like the discounted cash flow model, the investor is required to input many different assumptions. As assumptions are subjective in nature, the value of any particular can differ greatly from one investor to the next. Thus, the concept of a share being expensive or cheap might not be as simple as it sounds.

Foolish Takeaway

The main takeaway here is that valuation is a subjective process and the next time someone excitedly tells you how “cheap” a share is, remember that it is very important to understand the underlying assumptions that the person has about the share in question. You have to be comfortable with those assumptions as well – if not, what’s cheap to another, might seem very pricey to you.

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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 Stanley Lim doesn’t own shares in any companies mentioned.