A Simple Case for Why This Blue Chip May Be a Tasty Bargain

Value investors – those who love sniffing out bargains in the stock market – often believe in a simple but powerful concept called reversion to the mean.

In his classic investing text Security Analysis, Benjamin Graham included a quote from Horace which can be a good description of what mean reversion is: “Many shall be restored that now are fallen and many shall fall that are now in honour.”

When used in a more narrow investing sense, it can be the idea that below-average valuations are often followed by above-average results.

Right now, the conglomerate Jardine Cycle & Carriage Ltd  (SGX: C07) might be one such blue chip – the company’s a blue chip by virtue of it being part of the 30 constituents of Singapore’s market barometer, the Straits Times Index (SGX: ^STI) – which could possibly enjoy the benefits of a positive reversion to the mean.

Jardine Cycle & Carriage's price-to-earnings ratio (PE ratio) since start of 2010

Source: S&P Capital IQ

The company’s valued at just 10.2 times its trailing earnings at its current share price of S$30.56. As you can see in the chart just above, Jardine Cycle & Carriage’s present valuation is near the lowest it’s ever been over the past five-plus years since the start of 2010 and this is something which can help set the stage for a mean reversion to potentially occur.

It’s also worth pointing out that historically – as the chart above also makes clear – Jardine Cycle & Carriage’s share price has tended to rebound whenever the firm’s valuation is in the neighbourhood of where it is today.

But, investors should note that Jardine Cycle & Carriage is not necessarily a bargain just because it has a below-average valuation at the moment. Investor Ric Dillon has a succinct explanation:

“On the behavioural-finance side, one of many inefficiencies comes from people anchoring on the past. People assume something is cheap, say just because it hasn’t traded at such a low valuation for five or ten years. But that doesn’t matter, what matters is what will be.”

In other words, plenty still hinges on Jardine Cycle & Carriage’s eventual business results. On this front, there might be some causes of concern. In the first quarter of 2015, the conglomerate’s revenue and profit had suffered year over year declines of 14% and 18% respectively. This had come on the back of a 6% slide in revenue and a 10% decrease in profit in 2014.

The company’s outlook, at least for the near future, is also not particularly bright, as can be seen from the comments of Ben Keswick, Chairman of Jardine Cycle & Carriage, in the company’s earnings release for the first quarter of 2015:

“[Jardine Cycle & Carriage] is facing greater challenges in Indonesia with lower levels of economic growth, depressed commodity markets and increased competition in the car sector, while a weaker rupiah exchange rate continues to reduce Astra’s contribution.”

There’s an emphasis on Indonesia given that the main bulk of Jardine Cycle & Carriage’s revenues and profits (more than 90% in 2014) come from its majority-owned subsidiary, the Indonesia-based conglomerate Astra.

But that being said, Keswick’s comments on Jardine Cycle & Carriage’s future outlook also contained a slight positive note on the longer-term picture:

“Nevertheless, our businesses remain at the forefront of their chosen markets and are underpinned by the strength of their balance sheets.”

To give weight to Keswick’s view that the conglomerate’s businesses are still leaders in their respective markets, Astra’s Automotive segment (the biggest profit contributor for Astra) still holds huge market shares; Astra’s current share of the wholesale market for cars and motorcycles stand at 49% and 68%, respectively.

All told, bargain hunters who are interested in Jardine Cycle & Carriage by virtue of its low valuation at the moment would have to weigh the risks (one pertinent one would be the fact that the company’s businesses aren’t firing on all cylinders currently) and potential rewards in order to come up with an intelligent investing decision.

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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.