December 2014 has just ended. That means we’re at the start of a new month as well as the start of a new year. I’ve a habit of looking at how expensive shares in Singapore are at the beginning of every month in order to get some useful insight on how I can approach bargain hunting as well as investing. But given that we’re in the first few days of 2015, investors also want an idea of what lies ahead for stocks – and that’s where my look at valuations might provide some clues. Insights on bargain hunting from looking…
December 2014 has just ended. That means we’re at the start of a new month as well as the start of a new year. I’ve a habit of looking at how expensive shares in Singapore are at the beginning of every month in order to get some useful insight on how I can approach bargain hunting as well as investing.
But given that we’re in the first few days of 2015, investors also want an idea of what lies ahead for stocks – and that’s where my look at valuations might provide some clues.
Insights on bargain hunting from looking at valuations
When the market’s really cheap, investors might want to focus on distressed and beaten-down shares with ugly businesses because they might be the ones with the largest gap between price and value for investors to exploit; shares with stronger business fundamentals might never see such wide gaps appear.
On the other hand, focusing on quality businesses which can compound wealth over the long-term might make more sense if the market is pricey on the whole. That’s because such shares are likely to be “short-term expensive, but long-term cheap.” Put another way, quality businesses can have high valuations, but they would be able to grow into them, and then some.
As for shares with poor business economics, they’re also likely to be pricey if the market’s frothy. Investors who invest in them are thus faced with two disadvantages: (1) a business that cannot compound wealth over the long-term; and (2) an expensive share price.
Looking at valuations
A simple way to approach the question of how cheap or expensive the market is lies in its price/earnings (PE) ratio. At present, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund which closely tracks Singapore’s market benchmark the Straits Times Index (SGX: ^STI) – is valued at 13.6 times its trailing earnings.
A look back at 20 years of history from 1993 to 2012 shows that the Straits Times Index has an average PE of 16.6. With this as a backdrop, the index’s current valuation can be said to be very reasonable (perhaps even cheap), though it certainly isn’t dirt-cheap; dirt-cheap is when the Straits Times Index was valued at nearly 6 times earnings at the start of 2009 during the Great Financial Crisis.
Another valuation measure I like to look at regarding the overall market would be the number of net-net shares which exist currently. A net-net share is one which has a market capitalisation lower than its net-current asset value (total current assets minus total liabilities).
I trust it’s obvious to see that net-net shares are extremely cheap as investors are getting a discount on a share’s current assets sans all liabilities, with long-term assets thrown in for free. Thus, it follows that if net-net shares start appearing in large quantities in the market, it’s a sign that the market’s really cheap.
With this in mind, let’s take a look at where we stand now.
Source: S&P Capital IQ
As of 31 December 2014, there are 108 net-net shares in Singapore. Looking at how the number of net-net shares has evolved in Singapore since 2005, it’s perhaps fair to say that Singapore’s market is likely to be in a “Goldilocks” type of valuation currently. In other words, stocks in Singapore are not too expensive (it’s certainly not as expensive now as it was in the second half of 2007) and yet not too cheap (the first half of 2009 had net-net shares show up in much higher quantities).
Looking at 2015 and beyond
Singapore’s market looking like it is reasonably cheap now (though certainly not close to a fire-sale bargain yet) is probably welcome news for Singaporean investors as we move into 2015. That’s because buying cheap shares helps stack the odds of success in the investor’s favour.
But this comes with a caveat: Buying cheap shares is a great thing only if the investor’s willing to hold for many years. Over the short-term, cheap valuations offer no protection against temporary losses in the market.
So, the verdict’s still out when it comes to what shares in Singapore can do in 2015. But at the very least, we’re starting the year with some reasonably cheap shares, and that’s a nice thing for investors to have.
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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 company mentioned.