4 Risks to Look Out for While Bargain Hunting During a Market Slump

“Wake me up when September ends” – Green Day (rock band)

September’s been a rough month for the Singapore stock market to say the least.

After peaking at 3,550 points in April this year, the Straits Times Index (SGX: ^STI) then gradually started to fall. The descent intensified over August and September, culminating in the index closing at 2,791 at the end of the latter month. That level represents a decline of 21.3% from the April high and had put the Straits Times Index into bear market territory.

The index has since made up some ground, but at yesterday’s close of 2,962, there’s still a long way to go before the peak in April can be reached again.

While the big slide in the stock market so far may be gut wrenching, it may also be an opportunity to pick up some bargains. But, it’s important to be aware of any risks which may be present before we invest.

Here are four risks to note.

Risk No. 1: Watch the balance sheet – click here

Risk No. 2: Industry Risk – click here

Risk No. 3: Growth Risk – click here

Risk No. 4: Valuation Risk

A downturn in the stock market can bring lower stock prices and lower valuations. But a cheaper price tag may not always turn out to be a good investment. If a stock is selling at a “cheap” valuation, you might want to ask why.

My colleague Chong Ser Jing made this point recently as well. He used the example of commodities trader Noble Group Limited  (SGX: N21) and shipbuilder Cosco Corporation (Singapore) Limited (SGX: F83). Both companies traded at a price to earnings (PE) ratio of less than 5 on 1 January 2009.

On the surface, the valuation of the companies look cheap and they were thus a bargain. But it was not to be.

The fall in earnings in the years that followed dragged down shares of Noble and Cosco by 38% and 61% respectively from 1 January 2009 to 1 October 2015.

It goes to show that what’s cheap can get cheaper. It may thus make sense to pay attention to a stock’s underlying business along with its valuation before committing any money to it.

A Fool’s take

Buying shares when they’re cheap can pay off down the road, but we should still be aware of the risks. Considering the company’s balance sheet, industry developments, future growth, and valuation (along with the business) may be a good place to start in assessing risk.

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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 contributor Chin Hui Leong doesn’t own shares in any companies mentioned.