Yangzijiang Shipbuilding Holdings Ltd Will Become A Blue Chip Soon – Is It A Cheap Stock?

Next Monday (21 September 2015), Singapore’s stock market barometer, the Straits Times Index (SGX: ^STI), will see three of its 30 constituents change.

The outgoing trio are namely Jardine Matheson Holdings Limited (SGX: J36), Jardine Strategic Holdings Limited (SGX: J37), and Olam International Ltd (SGX: O32). In their place will be SATS Ltd (SGX: S58), UOL Group Limited (SGX: U14), and Yangzijiang Shipbuilding Holdings Ltd (SGX: BS6).

As Yangzijiang’s one of the trio that will become blue chips soon (in Singapore’s context, the 30 constituents of the Straits Times Index are known as ‘blue chips’), now may be a good time to look at how cheap or expensive it is.

A useful way of valuing a stock is to observe how its current price-to-earnings (PE) multiple compares with its own historical numbers. The following’s a chart plotting Yangzijiang’s PE ratio from the start of 2010 to today:

Yangzijiang's price-to-earnings ratio (PE ratio) from start of 2010 to 14 Sep 2015

Source: S&P Capital IQ

Based on its closing price of S$1.18 today, Yangzijiang, which – as its name suggests – builds ships for a living, is valued at 6.5 times its trailing earnings.

From the chart above, the China-based shipbuilder’s current PE ratio is a tad lower than its historical average of 7.3 over the period we’re looking at. When investing, mean reversion can be a powerful force. What this means is that below-average valuations at the moment hold the potential for above-average outcomes to occur in the future.

But, mean reversion does not guarantee a good outcome when investing. Investor Ric Dillon explains:

“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.”

Phrased another way, the future business performance of a stock has a huge role to play in how its price performs over the long-term. Yangzijiang would have to churn out growing earnings for it to be a solid investment.

But, there may be some formidable roadblocks in the company’s quest to do so. The shipbuilding industry is in a massive slump, with Yangzijiang reporting the following in its earnings release for the second-quarter of 2015 (emphasis mine):

“According to Clarkson Research, new shipbuilding orders around the globe was 13.28 million CGT [compensated gross tonnage] for 1H2015 [first-half of 2015], accounting for only 49.2% of that for 1H2014 [first-half of 2014]. The Chinese shipbuilding industry took a harder hit from the downturn, with new orders for the first half of the year decreased by 72% yoy [year-on-year].”

From a valuation stand point, Yangzijiang may be deemed to be a cheap share by virtue of its lower-than-average PE ratio. But, investors have to consider the company’s future prospects too.

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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 company mentioned.