Why Crazily Expensive Shares Can Still Be Bargains

The word “bargain” is likely the last thing an investor would associate with Raffles Medical Group Ltd (SGX: R01) at the moment and there’s a good reason why that’s so.

At its current share price of S$4.65, the healthcare services provider – Raffles Medical runs its flagship Raffles Hospital in Singapore along with a wide network of medical centres and clinics – is selling for nearly 40 times its trailing earnings of S$0.121.

With the long-run average price-to-earnings (PE) ratio of Singapore’s market barometer the Straits Times Index (SGX: ^STI) sitting around 17, the situation with Raffles Medical looks like a recipe for disaster doesn’t it?

Well… not quite.

You see, except for the share price, the first two paragraphs of this article could have been the exact description of what Raffles Medical looked like when it was trading in the neighbourhoood of S$1.30 to S$1.50 a share some eight years ago – and some 250% ago – in June 2007. On certain days that month (see chart below), Raffles Medical was even valued at more than 40 times its trailing earnings.

Raffles Medical's Price-to-Earnings (PE) ratio since June 2005

Source: S&P Capital IQ

But despite it carrying such a high valuation back in June 2007, Raffles Medical is still today a massive long-term winner (the Straits Times Index is down by 7% since the start of that month).

There’s a lesson in there for us and that is, companies that look expensive can still turn out to be great bargains if their businesses do manage to grow.

This is an important point to note because it’s easy for investors to look at a richly-valued share and toss it into the garbage bin without further consideration of its growth prospects – that can be a mistake.

With this in mind, can Raffles Medical do what it did in 2007 and post solid long-term returns from today onward despite it selling for an expensive-looking valuation of nearly 40 times its trailing earnings now?

There are a number of important growth drivers at work with Raffles Medical currently which might push its profits higher in the future.

One’s an upcoming medical/retail centre (the development works are slated for completion in the first quarter of 2016) in the Holland Village area in Singapore which would give the company 65,000 square feet of gross floor area to play around with for rental purposes and the provision of medical services.

Raffles Medical’s current plan is to utilise 9,000 square feet of space in the centre for medical services with the rest of the usable floor area being rented to its anchor tenant DBS Bank and a host of retail and food & beverage outlets.

Another’s the expansion of Raffles Hospital which would see its gross floor area expand from the current 300,000 square feet to 520,000 square feet. When the expansion’s up and running (plans are for the construction to be done in the first quarter of 2017), Raffles Medical’s intention is to occupy 50,000 to 100,000 square feet for its own use and find tenants for the remaining area.

Over time, as Raffles Medical grows its healthcare services, it’d then gradually occupy the rest of the hospital’s new wing.

Yet another avenue for growth is Raffles Medical’s 70:30 joint-venture with Chinese real estate developer Shanghai LuJiaZui Group to develop the 400-bed Shanghai New Bund International Hospital Project in Shanghai, China. For perspective, Raffles Hospital has a total capacity of 380 beds and has less than 200 beds that are operational at the moment. The new hospital’s slated for opening in mid-2018.

While there are risks with the Shanghai project – the upcoming hospital will be Raffles Medical’s first outside of Singapore – management’s upbeat and has even guided that the new hospital will be capable of delivering better profit margins than Raffles Medical’s current operations in Singapore.

It should also be noted that Raffles Medical’s partner in this project, Shanghai LuJiaZui, has links to the Chinese government and has a solid track record in developing Shanghai’s financial district.

Given what we’ve seen with Raffles Medical’s future prospects, it’s likely the case that it can earn materially higher profits in the mid- to long-term future. But would that be enough to turn it into a market-beating winner in the share market over the next five to 10 years? That’s something only time can tell.

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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 owns shares in Raffles Medical Group.