I’ve Made A 70% Gain On This Stock In Less Than 2 Years: Here’s Why I’m Worried

Credit: Amy McTigue

Back in August 2013, shares of healthcare services provider Raffles Medical Group Ltd (SGX: R01) had traded at S$2.90 apiece for a brief window of time. That was when I managed to buy some shares in the company.

Today, with Raffles Medical trading at S$4.91, I’ve made a gain of nearly 70% in less than two years.

That’s a great return – but it’s something that I would like to attribute largely to luck (I’ve always felt that a time frame of five years or more would be ideal in establishing whether or not I’ve made a good investment). It’s also something which worries me.

Good returns; bad returns

You see, not all great returns are created equal. As my colleague Chin Hui Leong explained recently in a great article of his:

“If a stock price rises (or falls), we should try to understand if it is backed by a company’s fundamental growth (decline), or whether it is simply a result of investor exuberance (pessimism).”

Gains in a stock’s price may have a more sustainable backing if it’s powered mostly by growth in its underlying earnings instead of having the market bid the price higher. Unfortunately, the latter’s what’s happening with my investment in Raffles Medical currently as you can see in the table below:

Raffles Medical valuation table

Source: S&P Capital IQ

While the healthcare provider’s earnings had indeed shown some steady growth, it was mainly an expansion of its price-to-earnings (PE) multiple that had propelled its stock price to its current heights.

A basis for worry

At more than 40 times its trailing earnings currently, the market’s expecting some great things from Raffles Medical. For some perspective, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund tracking Singapore’s market barometer, the Straits Times Index (SGX: ^STI) – is valued at just 13.5 times its trailing earnings.

The chart below plots the evolution of Raffles Medical’s PE ratio over the past 10-plus years since the start of 2005:

Raffles Medical PE ratio from start of 2005 to today

Source: S&P Capital IQ

You can see that the company’s current valuation is also near the highest it’s ever been over that period – this adds to my worries.

The route to success

The last time Raffles Medical was valued at more than 40 times its trailing earnings was back in July 2007, just prior to the onset of the Great Financial Crisis. Back then, the firm’s shares were trading at $1.58 at their highest, so investors would still obviously have done very well if they had bought at that time and held on.

But, the success of the investment was also predicated upon the fact that Raffles Medical’s earnings had grown strongly by more than tripling from S$0.037 per share at that time to S$0.121 today.

For Raffles Medical to become a winning investment from this point forward, it’d have to showcase some solid earnings growth in the future. The company does have some really promising and clear growth opportunities in the years ahead, so it just might be able to produce the supra-normal growth that’s needed to justify its current price.

But, I’d still be watching its business developments and high valuations like a hawk.

Staying firm

Now, some of you may wonder: Why not sell the company’s stock now if you’re worried? I choose to hang on for two good reasons.

One, truly great returns come from patiently holding the shares of great companies. Like The Motley Fool’s co-founder David Gardner once wrote, “Find good companies and hold those positions tenaciously over time to yield multiples upon multiples of your original investment.”

Second, frequent trading has been shown to be a key factor in causing investors to perform poorly. That’s why I aim to invest for the long-term and would never been in a hurry to sell – even if my gains worry me.

I’d feel compelled to sell only if Raffles Medical becomes outrageously overvalued – like how Japan’s Nikkei 225 Index had a PE of more than 100 at its peak of around 39,000 points in 1989 – or, if its business case breaks down completely.

(For interest’s sake, the Nikkei 225 is today only at 20,000 points or so; such is the danger that comes with egregiously-priced stocks).

What do you think about my decision? Chime in with your thoughts in the comments section below!

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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.