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The Stock Market’s filled With Landmines – Here’s How You Can Side-Step Them

The stock market can be a great place to build lasting long-term wealth.

One good example of this can be seen in how the SPDR STI ETF (SGX: ES3) – an exchange-traded fund tracking Singapore’s market barometer, the Straits Times Index (SGX: ^STI) – has gained 8.35% per year on average (including dividends) since its inception 13 years ago in April 2002. That sort of return can double one’s money every nine years.

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But, when shares are considered individually, then it’s important to note that landmines can be very common. Consider this study done by J.P. Morgan on the Russell 3000 universe (the Russell 3000 is a broad market index in the U.S. that’s made up of thousands of stocks):

  • From 1980 to 2014, 40% of all shares in the Russell 3000 sample had delivered negative returns over their entire lifetimes in the stock market.
  • Over the same period, 40% of all shares in the same universe have suffered a permanent decline of 70% or more from their peak values.

Swedish economist Erik Falkenstein once wrote that (emphasis mine), “in expert tennis, 80% of the points are won, while in amateur tennis, 80% are lost. The same is true for wrestling, chess, and investing: Beginners should focus on avoiding mistakes, experts on making great moves.” The statistics that we’ve seen from J.P. Morgan’s study highlight the importance of focusing on what to avoid when it comes to investing.

So, what should investors stay clear of? One area which deserves caution from investors would be shares with pricey valuations.

While great companies can often grow into their high valuations and deliver satisfying returns for investors, it’s also worth noting that great companies are great because they are rare. And if a share with a mediocre business – something which is far more common – is bought at an expensive price, then it’s likely that the investor would suffer.

When scanning the universe of Singapore-listed companies recently, I had chanced upon two companies that might deserve closer scrutiny from investors. They are namely Singapore Medical Group Ltd (SGX: 5OT) and Jason Holdings Ltd (SGX: 5I3).

Singapore Medical Group and Jason Holdings Valuation

Source: S&P Capital IQ

Both shares carry very high valuations as you can see in the table above and that alone can be worrying; for some perspective, the SPDR STI ETF has PE and PB ratios of only 13.5 and 1.3, respectively.

What compounds the problem here is that both firms have not had a history of generating any solid growth in their businesses, as you can observe in the table below. In other words, there’s a chance that they’re not high quality businesses that could grow into their valuations.

Singapore Medical Group and Jason Holdings Business 3

Source: S&P Capital IQ

None of the above is meant to say that Singapore Medical Group or Jason Holdings will necessarily be a poor investment going forward. But given what we’ve seen, investors ought to proceed with caution and assess both companies’ growth prospects carefully and discern the odds that they’d able to grow their profits materially higher in the future.

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 companies mentioned.