Are Expensive Stocks Always A Disaster?

I frequently come across the investing advice that investors should stick with stocks that have low valuations. The idea is that stocks with high valuations will crash down to earth, especially when the market in general is falling.

But, is that always true? I think the experience of healthcare services provider Raffles Medical Group Ltd (SGX: R01) and Singapore’s market barometer, the Straits Times Index (SGX: ^STI), can be a nice counter-example.

A year ago on 11 February 2015, Raffles Medical’s shares had a trailing price-to-earnings (PE) ratio of 26 according to data from S&P Global Market Intelligence. That’s a high valuation, especially when we consider that the Straits Times Index has had an average PE ratio of just 17 over the 37 year period from 1973 to 2010.

Over the past year, the Straits Times Index has made a loss of some 26%. Given this sharp decline, it may be easy to imagine that Raffles Medical’s shares would have done way worse given that they are expensively priced.

Share price chart for Raffles Medical Group and Straits Times Index from 11 February 2015 to 11 February 2016
Source: S&P Global Market Intelligence (click chart for larger image)

But interestingly, as you can observe in the chart above, Raffles Medical’s shares have held up remarkably well, actually gaining 0.9% in price in the same time it took the Straits Times Index to shed over a quarter of its value. And as a reminder, the starting point for Raffles Medical was the high PE of 26.

It’s worth noting too that Raffles Medical’s shares have been climbing steadily over the past five years, nearly doubling in price. So, it’s clearly not a case of Raffles Medical having fallen so hard by 11 February 2015 that it had not much room to full further.

A Fool’s take

I have admittedly cherry-picked Raffles Medical to be used here. But, the important takeaway I have from seeing the company in action is that, in some cases, stocks with high valuations can still be relatively immune to general market malaise. That’s worth keeping in mind for investors of all stripes.

And just to be clear, valuations are very important when it comes to investing – I know of no surer way of losing money in the stock market besides overpaying for a stock.

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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.