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These 3 Dirt-Cheap Shares May Not Be Bargains At All

When it comes to dirt-cheap shares, China Fishery Group Limited (SGX: B0Z), Swiber Holdings Limited (SGX: AK3), and TA Corporation Ltd (SGX: PA3) would have to belong to the list.

Valuation table for China Fishery, Swiber, TA Corp

Source: S&P Capital IQ

As the table above shows, the trio carry really low price-to-earnings (PE) ratios of less than 7 at their current prices.

For some perspective on why “dirt-cheap” fits here, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund which tracks the fundamentals of the market barometer, the Straits Times Index (SGX: ^STI) – is at least twice as expensive as them with its PE ratio of 13.6.

Beware cheap garbage

But before you rush out to embrace those three shares, do note that even shares which look really cheap can end up being horribly expensive mistakes too if their businesses end up sinking.

And to that point, there are reasons for investors to be wary of the trio of China Fishery, Swiber, and TA Corp.

Deteriorating fundamentals

The chart below (click for larger image) shows how the three shares’ returns on equity and balance sheet have changed over the past two years.

China Fishery, Swiber, and TA Corp's historical returns on equity (ROE) and total debt to equity (TDE) ratios

Source: S&P Capital IQ

I trust it’s obvious to see that all three companies have seen their returns on equity fall alarmingly over that period – this can be a sign that the economics of their businesses have deteriorated significantly.

To compound the issue, note too that the three shares have also seen their leverage (represented by the total debt to equity ratio) grow throughout the timeframe under study. This is a problem because the use of higher leverage is supposed to help a company earn a higher return on equity, all things being equal.

When it rains it pours

Borrowing costs are also creeping up in Singapore. As a sign of the times, the three month Singapore Swap Offer Rate (SOR) – a benchmark for commercial loans – has spiked from 0.2% near the end of February 2014 to more than 1.0% today.

With their heavily leveraged balance sheets – they have very high total debt to equity ratios ranging from 91% to 175% – pricier debt may just result in financial difficulties for China Fishery, Swiber, and TA Corp.

A Fool’s take

So what we have here are three companies that have 1) shrinking returns on equity despite higher leverage, 2) highly-geared balance sheets, and 3) an environment in Singapore where borrowing costs have spiked.

These factors, when taken together, don’t bode well for the future business prospects of China Fishery, Swiber, and TA Corp.

That said, none of all the above is meant to say that the trio would necessarily be poor investments at this point as their businesses may just improve in the future.

But given what we’ve seen so far, there’s a chance that the three shares may not be bargains after all despite their dirt-cheap valuations. Bargain hunters would need to proceed with caution and be fully-aware of the risks involved.

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 company mentioned.