I often revisit my older articles to see if I?ve gotten things wrong or right because they can serve as important lessons and help me hone my skill as an investor.
On 13 January 2015, I wrote and published an article titled Why You Should Proceed With Caution with the Cheapest Oil Stocks. The article singled out the five oil & gas stocks in Singapore?s market that carried the lowest price-to-book ratios back then. They were JES International Holdings Limited, Swiber Holdings Limited (SGX: BGK), Hoe Leong Corporation Ltd (SGX: H20), EMAS Offshore (SGX: UQ4), and Ezra Holdings Limited…
I often revisit my older articles to see if I’ve gotten things wrong or right because they can serve as important lessons and help me hone my skill as an investor.
On 13 January 2015, I wrote and published an article titled Why You Should Proceed With Caution with the Cheapest Oil Stocks. The article singled out the five oil & gas stocks in Singapore’s market that carried the lowest price-to-book ratios back then. They were JES International Holdings Limited, Swiber Holdings Limited (SGX: BGK), Hoe Leong Corporation Ltd (SGX: H20), EMAS Offshore (SGX: UQ4), and Ezra Holdings Limited (SGX: 5DN).
Over two years have passed since my aforementioned article was published, so I think it’s a good time to come up with some definitive conclusions from the experience of the quintet.
Travelling back in time
Stocks with low valuations often make for desirable bargains. And the five oil & gas stocks, with their incredibly low PB ratios of between 0.18 and 0.37 at that time, looked really cheap on the surface.
But, I also warned in my January 2015 article (as the title may suggest), that “bargain hunters ought to step in with their eyes wide open and be fully aware of the risks involved [with the quintet].” That’s because most of the five companies had two big problems – they were unable to generate cash flow from their businesses and their balance sheets had a tonne of debt.
Here’s a table showing how the stock prices of the five companies have changed from 13 January 2015 to today:
Source: S&P Global Market Intelligence
Turns out, I was right to have warned investors to beware the risks involved – all five companies have been disasters for their shareholders. JES International’s shares are currently suspended from trading. Swiber has gone bankrupt. Meanwhile, Hoe Leong, EMAS Offshore, and Ezra’s stock prices have collapsed by between 56% and 97%; Ezra, as some of you may be aware, is also at risk of going bankrupt right now.
The crucial lessons
There are three big lessons to draw from this two-plus year episode.
Firstly, cheap stocks can go on to become even cheaper. The low valuations the five stocks carried back in January 2015 offered no protection to their investors whatsoever.
Secondly, the presence of large amounts of debt in a company can be a big, big problem for its shareholders. The late Walter Schloss, an investor with a fantastic long-term track record, once said, “I like to look at the balance sheet and I don’t like debt because it can really get a company into trouble.”
Back then in 13 January 2015, Swiber, Hoe Leong, EMAS Offshore, and Ezra had net-debt to equity ratios of 131%, 120%, 100%, and 85%, respectively. Those are really high ratios and pointed to how weak their balance sheets were. JES was somewhat of an anomaly as it had a net-debt to equity ratio of ‘just’ 44%; but even so, it had more debt than cash and that is a source of risk.
Thirdly, companies with businesses that depend on commodity prices can see their stock prices move in very dissimilar ways to the prices of their associated-commodities. To this point, the price of WTI Crude Oil is currently around 10% higher compared to 13 January 2015.
A Foolish conclusion
Statistically cheap stocks with debt-laden balance sheets can be legitimate bargains. But, it is important that we invest in them with our eyes wide open, fully aware of the risks involved. Meanwhile, it can be a fool’s errand (lower-case ‘f’) to invest in commodities-related companies simply based on an analysis of the movement of the prices of commodities.
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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.