The Most Important Subject to Learn In Investing

Investing is a part of finance but to become a better investor, I’m more and more convinced that the most important subject to learn about is history.

Why do I say so? It’s because of the lessons that the past can teach us about the future. One of the easiest ways for investors to lose their shirts is to overpay for stocks. But what’s striking about this is how often this theme repeats itself through the years.

Let’s start with 1989, keeping in mind that similar boom-bust episodes have been occurring in years far earlier than that.

Lurching from one disaster to the next

At its all-time peak in late 1989, the Nikkei 225 stock market index in Japan was trading at nearly 39,000 points. And, it was valued at more than 100 times its trailing profits at one point in that year.

That’s a patently absurd valuation for a country’s stock market index to carry as it’d be incredibly tough for a collection of hundreds of companies to grow at rates that can justify that sort of valuation. The Nikkei 225’s at 20,300 today, nearly 50% lower as compared to where it was 26 years ago.

It didn’t take too long for the Americans to have their shot at absurdity though. During the dot-com bubble, the companies in the tech-heavy Nasdaq Composite Index had carried an average price-to-earnings (PE) ratio of more than 150 when the index peaked in March 2000 at more than 4,800 points.

The Nasdaq subsequently fell by more than three-quarters at its trough in 2002 and today, sits at only 5,059.

Next came the Chinese, who quite clearly didn’t learn much from the Japanese and Americans. In late 2007, companies within the Shanghai Composite Index had a median price-to-earnings ratio of as high as 66. China’s main market index had peaked at just above 5,900 points in October 2007; today, nearly eight years later, it’s at less than 3,800.

Circling to home in Singapore, the stunning 90%-plus collapse of the penny stock Blumont Group Ltd (SGX: A33) in a matter of days in October 2013 is another example of how history is running on a loop. Near its peak of S$2.45 a share on 30 September 2013, Blumont was valued at around 500 times its trailing earnings and 60 times its book value. The share is today, trading at a pitiful price of S$0.006 each.

Now, given that the Blumont horror story had occurred less than two years ago, you’d have expected that the lessons from that would still be fresh in the minds of investors in Singapore. But, that apparently wasn’t the case with those who owned stock in Jason Holdings Limited (SGX: 5I3) – this is also what prompted me to write the article you’re reading now. The following’s what I had written about Jason Holdings in a piece I had published yesterday:

“I first came across the company earlier this May and was alarmed at its valuation.

When I eventually penned my article on Jason Holdings on 26 May to prod investors to proceed with caution with the company, its shares were trading at S$0.64 and it was valued at 330 times its trailing earnings and 9.4 times its book value. To compound the problem, Jason’s business hadn’t been able to grow much from 2009 to 2014 (see the link given earlier).

For perspective on just how demanding those valuations were, 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) – had a trailing price-to-earnings (PE) ratio and price-to-book ratio of just 14 and 1.3, respectively, back then.

Today, Jason Holdings’ shares are exchanging hands at S$0.138 apiece, a mighty decline of 78% in less than three months, after suffering a violent slide in July.”

As you can see, Jason Holdings’ shares had collapsed over the past month as a result of its high valuations, just like how all the other earlier examples did.

A Fool’s take

Although we should always be looking forward as investors, there’s a lot to be gained from looking at the past as well. Learning about history is how we can connect the dots and find patterns about past successes and failures in a bid to repeat and avoid them, respectively, in the future.

In a March 1972 interview that was released in the book Benjamin Graham: Building A Profession, Benjamin Graham spoke about the importance of history. Graham’s widely considered to be the grandfather of the discipline of value investing and is a well-known mentor of billionaire investor Warren Buffett. These are Graham’s words:

“And if you say, as people have said, that the past is no longer relevant, the thing they forgot was that if the past is not relevant, what is? What do we know? If you cannot base your investment policy on the past, I think you have no basis for it at all.”

I couldn’t have put it any better than Graham.

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.