The Motley Fool

When Cheap Shares Become Expensive Nightmares

Editor’s note: The fourth column in the first table had the date incorrectly labelled as “16 March 2009” initially. The error has been corrected to reflect the correct date, 16 March 2015. The Fool regrets the error. 

Buying shares when they’re carrying low valuations is a sound way to invest. But, that doesn’t mean we should be indiscriminately buying up every share that looks cheap.

Bargains galore

Six years ago at the start of 2009, bargains were aplenty. Back then, Singapore’s market barometer the Straits Times Index (SGX: ^STI) was valued at just six times its trailing earnings.

For some perspective, that’s a long way lower than the index’s average price-to-earnings (PE) ratio of 16.6 over the 20-year stretch from 1993 to 2012.

There were also many individual shares that were available at valuations lower than that of the Straits Times Index at that time.

The fallen ones

But, within that group of dirt-cheap shares were some that eventually turned into expensive nightmares.

The quintet of Cosco Corporation (Singapore) Limited (SGX: F83), Dukang Distillers Holdings Ltd (SGX: GJ8), Global Yellow Pages Limited (SGX: Y07), Pacific Andes Resources Development Ltd (SGX: P11), and Swiber Holdings Limited (SGX: AK3) are good examples.

Table for performance of cheap shares

Source: S&P Capital IQ

You can see from the table above that the quintet’s remarkably low valuations at the start of 2009 couldn’t save their share prices from suffering horrifying collapses.

It’s the business that matters

This leads to the question: Why is this so? Why have these cheap shares – which are supposed to be bargains – become such abject failures?

Table of business performance for cheap shares

Source: S&P Capital IQ

Turns out, it’s not just superficial valuation metrics that matter – the subsequent business performance of the shares are very important too. From 2009 till today, the quintet has seen their businesses decimated, as evidenced from the drastically shrunken per-share earnings figures. As billionaire investor Warren Buffett once said, “If a business does well, the stock eventually follows” – the reverse holds true too.

A Fool’s take

This look back at history into how dirt-cheap bargains can become pricey mistakes is a great reminder for investors to not invest in a share just because it looks cheap.

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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.