Investors Beware: Buying Cheap Shares in Singapore Can Be Dangerous Too

It’s common wisdom in investing that buying shares when they’re cheap would give us good odds of success.

But, that doesn’t mean that investors should be blindly buying any share which looks cheap. In fact, the odds of stepping on a landmine with a dirt-cheap share can be surprisingly high, as I’m about to show you.

When cheap equates to garbage

At the start of 2009, Singapore’s market barometer the Straits Times Index (SGX: ^STI) was valued at just 6 times its historical earnings. That’s a really low valuation, especially if we consider that the index’s average PE (price-to-earnings) ratio from 1993 to 2012 had been 16.6.

According to S&P Capital IQ, 288 of the 750-odd shares that are listed in Singapore today was available for dirt-cheap prices (at six times trailing earnings or lower; shares with negative earnings were ignored) back then.

But surprisingly, of those 288 shares, 94 have share prices that are lower today as compared to the start of 2009.

To give some perspective on how underwhelming the performance of those 94 shares have been, investors who had invested into the Straits Times Index through the SPDR STI ETF (SGX: ES3) (an exchange-traded fund which mimics the fundamentals of the Straits Times Index) since the start of 2009 would be sitting on capital gains of 85%.

The lessons to be learnt

A deeper look at those 94 shares revealed that 93 of them have an earnings per share figure that is lower today as compared to the start of 2009.

For me, the experience of that group of 94 is a searing reminder that cheap shares – even dirt-cheap ones – can still go on to become extremely expensive mistakes if their businesses deteriorate over time.

A Fool’s take

Currently, the quartet of Swiber Holdings Limited (SGX: AK3), Pacific Andes Resources Development Ltd (SGX: P11), Ezra Holdings (SGX: 5DN), and Nam Cheong Ltd (SGX: N4E) would likely appear on the radar of bargain hunters given their low trailing PE ratios of less than 6.

PE ratios of really cheap shares

Source: S&P Capital IQ

With the SPDR STI ETF valued at a PE of 13.7 at the moment, it’s fair to say that the quartet does seem really cheap on the surface.

But, as I’ve mentioned earlier, a share with a low valuation can still turn out to be a pricey error if its business deteriorates. Investors ought to take a closer look at the quartet to ensure that they can at least maintain their business results in the future.

For more investing analyses and important updates about the stock market, sign up to The Motley Fool Singapore's free weekly investing newsletter, Take Stock Singapore. Written by David Kuo, it can help you grow your wealth in the years ahead.

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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.