At What Price Would Benjamin Graham Buy Singapore Airlines Ltd

For most investors, a quick glance at Singapore Airlines (SGX: C6L) fundamentals would suggest the company is a bit on the expensive side.

Its historic price to earnings is a whopping 40. That is around three times the market average. This corresponds to a meagre earnings yield of just 2.5%. Its dividend yield, whilst slightly greater, still stands at a somewhat uninspiring 2.1%. This is roughly in line with the risk-free rate of return currently available on a 10-Year US Treasury bond.

One of the most powerful tools available to a value investor is the price to book value. This ratio gives an estimate of the margin of safety in an investment.

If a company is priced at a discount to its book value, in other words  the ratio is less than one, then an investor should be able to recoup most of their investment should the investment go badly wrong. Singapore Airlines has a ratio of 1.15. It, thus, offers no such margin of safety.

With Singapore Airlines looking fairly dear, what price would the shares have to fall to before it appealed to a value investor such as Graham?

Graham would hope for his investments to offer an earnings yield at least twice the risk free rate of return. The risk free rate of return currently stands at around 2%, so we could reasonably hope for an investment to have an earnings yield of around 5%.

The current share price is over S$12. If earnings were to remain fairly constant, Singapore airlines would need to see its share price fall by roughly 70% to just under S$3.50 a share to possess an earnings yield of 5%.

To fall in line with the market average earnings yield of around 7%, the airline’s price would have to fall by as much as 80% to a share price of S$2.40.

Such price changes are drastic and would likely spell disaster for Singapore Airlines. A focus instead on the dividend yield and price to book ratio might provide more realistic guidance for value investors.

The fall in share price required for the dividend yield to rise to 2.5%, just a 0.5% improvement on the risk free return, is similar to that required for the price to book ratio to slip below one.

In these two scenarios, a slide of around 15%, to a share price closer to S$10 a share, could alert value investors to a possible value investment.

Presently, it would seem that Singapore airlines would have to fall by around 15% to close to at around S$10 a share before it would start to resemble a value opportunity.

Even then investors should be wary of the level of risk involved in the investment. The current ratio of 1.15 is quite some way off the value of 2 that Graham would require and would suggest the potential rewards may not compensate for the downside risk.

Finally let us not forget the sage words of Warren Buffet, one of Graham’s disciples, who deems the airline industry a “death trap” for investors.

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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 Adam Kuo doesn’t own shares in any companies mentioned.