Here’s Why Trading Without Understanding A Stock’s Value Is A Bad Idea

I remember an encounter I had with a friend a year ago.

I was explaining to him my job at the Motley Fool Singapore and what we stood for. Our purpose is to help the world invest, better – and we try to do so partly by espousing the merits of finding great companies which we can invest in and hold for the very long-term (a timeframe measured in years and decades).

Long-term? Pfffttt….

However, my friend was not sold on the idea. He reasoned that such a method is too slow to make money in the stock market. He went on to explain that he had been trading shares of casino and resort owner Genting Singapore PLC (SGX: G13) for over a year now.

His strategy at that time was to catch Genting Singapore’s shares at around S$1.30 and then sell it for S$1.50. Rinse. Repeat. Over the year he was doing so, he had been able to pull it off on a number of occasions with Genting Singapore’s shares fluctuating around that range.

He argued that there’s no need to invest for the long-term if he is able to double his investment capital in a short amount of time simply by trading in and out of Genting Singapore’s shares if the phenomena of the shares yoyo-ing between S$1.30 and S$1.50 will continue over the next few months at least.

Is there value… or not?

I was trying to understand how he determined that he should buy Genting Singapore’s shares at S$1.30 and sell them at $1.50. To me, those two price levels seemed arbitrary.

Even on all the occasions at which Genting Singapore was trading at between S$1.30 and S$1.40 in 2013, the lowest price-to-earnings (PE) and price-to-book (PB) ratios that the firm had carried were 29 and 1.7, respectively. Did these represent value in the eyes of my friend?

As our conversation progressed, I asked him what he would do if Genting Singapore’s shares were to fall to S$1.10. He explained that he would buy even more as it’d enable him to lock in an even larger profit when the firm’s shares returned to S$1.50. I pressed on, asking what he’d do if Genting Singapore’s shares fell from S$1.10 to S$0.80. He told me he’d buy even more and sell it all when they go back to S$1.50.

I tried my best to convince him that pegging arbitrary share prices as a bargain without having a concept for the intrinsic value of the stock may not be the best way to invest. But, I think my words fell on deaf ears.

As mentioned earlier, the conversation with my friend had happened a year ago. Today, Singapore Genting is trading at S$0.90 per share. I assume (though I really hope not) my friend is now holding onto a large block of the company’s shares which are most likely deep in the red.

Meanwhile, I’m still unsure as to why Genting Singapore should be trading at S$1.50 per share. Based on its current financials and share price, the firm’s selling for 31 and 1.1 times its respective trailing earnings and book value.

Those aren’t exactly low valuations, especially when we compare it with the SPDR STI ETF (SGX: ES3), an exchange-traded fund which tracks the fundamentals of Singapore’s market barometer, the Straits Times Index (SGX: ^STI). The SPDR STI ETF has a PE and PB ratio of 13.5 and 1.3 at the moment.

If Genting Singapore’s shares were to trade at S$1.50 now, it’d be worth 51 times its trailing earnings and 1.9 times its book value.  That may not make much sense for a company which has just seen its revenue and profit plunge by 23% and 64% year over year, respectively, in the first quarter of 2015; these follow an 8% fall in revenue and a 30% slide in profit in the fourth quarter of 2014.

A tragic tale, often heard

This story involving my friend is not uncommon. In fact, for many people I’ve met and spoken to about the stock market, this is the way they invest.

They trade in and out of a number of stocks in the hope of making a quick profit. And when the price of the stock falls way below their expectations, they will simply buy more and more to average-down their purchase price.

At the end though, they would be holding a large investment in a company not because they love the future prospects of the company or that it has a fantastic value-to-price ratio at the moment. Instead, they’re merely holding on to the investment to avoid crystallizing a loss.  What might be even scarier is to think that they’d repeat the process with many different stocks!

Such a predicament may be prevented if they had paid more attention to the value of a stock in relation to its share price instead of arbitrarily thinking a certain price represents a bargain just because it has been bouncing around that range previously.

There's a lot more to talk about with this topic and if you'd like to do so in person, you can come meet David Kuo and the rest of the Fool Singapore team on August 15! 

Please join us at Invest FAIR Singapore on 15 August. (Suntec Centre, Booth B-16). Come chat with us at our booth, and see our MAS-licensed Director, David Kuo, give his official SGX investor presentation.

You won't want to miss this! Add Invest FAIR Singapore to your calendar today.

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As mentioned at the start, The Motley Fool's purpose is to help the world invest, better.

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim does not own any companies mentioned above.