The Most Important Thing That Can Save Your Investment Capital

Two days ago, newswires in Singapore reported that from March 2016, members of the Central Provident Fund (CPF) would no longer able to use their savings within the CPF to invest in shares which are on stock exchange operator Singapore Exchange Limited’s watchlist.

The Straits Times quoted the CPF board as saying that the “restriction serves to safeguard members’ CPF savings as securities placed on the SGX watchlist could potentially be delisted.”

There are a few conditions which may cause a share to get chucked into SGX’s watchlist, with one of them being the share having a record of pre-tax losses (excluding one-off events) for three of its most recent completed financial years.

Given that forced delistings can be painful events for investors, and the fact that shares which have perpetually money losing businesses often tend to make for risky investments, it seems that regulators in the CPF board are stepping in to help protect investors’ capital. This is great. But it’s not enough.

What’s really needed here – the most important thing that can help save your investment capital – is education. Investors need to learn about what investing really is and what makes investing risky.

I won’t pretend to have all the answers. But I can still help to plug in the gap. So, here goes.

What investing really is

In billionaire investor Warren Buffett’s seminal 1984 investing essay, “The Superinvestors of Graham-and-Doddsville,” he gave a succinct description of what investing is:

“The common intellectual theme of the investors from Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market. Essentially, they exploit those discrepancies without the efficient market theorist’s concern as to whether the stocks are bought on Monday or Thursday, or whether it is January or July, etc …

While they differ greatly in style, these investors are, mentally, always buying the business, not buying the stock [emphasis mine].”

I think there’s really nothing more complicated than that when it comes to investing. There’s always a real business behind a share (and if there isn’t, run!) and investing is about comparing the value of that business with the price of its shares.

This segues nicely into what makes investing risky.

What’s risk

When it comes to risk, the experience of the big, respectable, blue-chips like sugar and palm oil producer Wilmar International Limited (SGX: F34) and real estate outfit CapitaLand Limited (SGX: C07) can be very instructive.

Wilmar and CapitaLand valuations

Source: S&P Capital IQ

As you can see in the table above, the pair had carried very high valuations back in October 2007. Despite the value of their businesses having grown (as alluded to by the higher profits and higher asset values), their sky-high valuations back then became a heavy anchor that prevented their investors from enjoying any future share price growth – the net result is that long-time investors in both companies are still sitting on losses even after more than seven years.

So, what makes investing really risky is this: When the price of a share becomes significantly higher than the value of its underlying business.

A Fool’s take

There’s only so much regulators can do to protect us – just because a share’s not on SGX’s watchlist does not mean it’s not risky. What we really need to do is to get educated about investing. What I’ve just given here are the broad strokes but as they say, the devil’s in the details. So, the real trick here is to never stop learning.

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.

Like us on Facebook to follow our latest hot articles.

The Motley Fool's purpose is to help the world invest, better.

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.