Growth investors are investors who aim to invest in companies that are able to grow their businesses at high rates in the future.
In a previous article, I had pointed out reasons why growth investors may find local supermarket operator Sheng Siong Group Ltd (SGX: OV8) an interesting candidate for further research. But, the company also has negative traits that investors should be aware of; in this article, I want to discuss two such traits.
A high valuation
Ideally as investors, we should always buy a stock at less than its actual economic value.
One way to gauge whether Sheng Siong has a high, fair, or low valuation is to compare its price-to-earnings (PE) ratio to the market. I will be using the SPDR STI ETF (SGX: ES3) as a proxy for the market, since the SPDR STI ETF is an exchange-traded fund that tracks the fundamentals of the Straits Times Index (SGX: ^STI).
With a stock price of S$0.97 now, Sheng Siong has a PE ratio of 21. This is significantly higher than the SPDR STI ETF’s PE ratio of 11.4. Generally, it’s very difficult to find growth companies that are trading at a PE ratio that’s below the market’s. But, we still need to make sure that the price we pay is fair in order to give us a better chance at earning a reasonable return.
In the case of Sheng Siong, investors have to decide whether paying an 84% premium to the market average is reasonable. Personally, I find the price a little too steep.
Declining growth rates
In my previous article on Sheng Siong that I mentioned earlier, I pointed out that the company has demonstrated a positive track record of growth. But, investors should also pay attention to the company’s growth trend over the years. See the table below:
Source: Sheng Siong’s annual reports
Although Sheng Siong has displayed consistent revenue growth in the last few years, the growth rate has been declining. This raises an important question: “Will the declining growth rates continue in the foreseeable future?”
If the answer is yes, then it will get to a point where Sheng Siong’s top-line stops growing. And if that happens, the company’s PE ratio might compress to a level that’s a lot more similar to the market average as compared to the current situation.
A Foolish conclusion
There are things to like about Sheng Siong from the perspective of a growth investor, such as its track record of growth, and a robust balance sheet. But, Sheng Siong also has a high valuation, and declining growth rates. These are risks investors should be aware of.
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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 Lawrence Nga doesn’t own shares in any companies mentioned.