Do low P/E ratios mean bargain buys?

Interesting article - I thought investors should ALWAYS look at the fundamentals? Who buys just based on PER anyway?

Jun 23, 2011
Do low P/E ratios mean bargain buys?
Stock valuations are at post-crisis lows, but investors must also look at fundamentals
By Jonathan Kwok

THE market selldown in recent weeks has left valuations of Singapore stocks at post-crisis lows.

Investors have driven the benchmark Straits Times Index down by about 7 per cent from its peak this year, on fears of Greek debt and an anaemic American recovery.

The historical price-earnings (P/E) ratio of the index is at about 10.3, the lowest since the first quarter of 2009, when the market bottomed out during the financial crisis.

Some bargain-hunters might be tempted back by the falling valuations, but analysts urge caution, saying that P/E ratios should be only a 'quick and dirty' way of selecting stocks, and that many other factors have to be studied.

Historical P/E ratio is calculated by dividing a firm's current stock price by its latest full-year earnings per share. The calculation can indicate if a share price is high or low compared with the firm's profits.

Analysts often compare a company's ratio with others in the same industry, although this is not a perfect method either, as firms can differ markedly even in the same sector, and so have different P/E valuations.

A Straits Times check showed some firms trading below the valuations of their peers.

In the agricultural sector, mushroom grower Yamada Green Resources' P/E of 1.5 is much lower than the industry P/E average of 10, excluding loss-making companies. Palm oil giant Golden Agri-Resources is at 4.3 while rubber company Sri Trang Agro-Industry is at 6.8.

Yamada could be trading cheaper because it does not grow the same products as its peers. It is also based in China and may have suffered from the lack of confidence in S-chips.

Builder UE E&C is at a P/E of 2 after falling from its 48-cent offer price in February to its last traded price of 40.5 cents.

Steelmaker Sapphire Corp, which has a significant part of its operations in China, is at a P/E of 2.3, while Chip Eng Seng is at 2.6. The average for construction firms is 7.9.

Asia Power Corp, which runs power plants in China, could also be a victim of a low appetite for mainland firms.

Its P/E of 3.6 is much lower than fellow power, gas and water firms SP AusNet and CitySpring Infrastructure Trust. Australia-based SP AusNet is at 11.2 while CitySpring, a business trust which holds assets in Singapore and Australia, is at 12.6.

The finance sector has some large divergences. Its average is 15.8 but investment firm Transpac is at 5.6, and general insurer SHC Capital is at 5.8.

It is a similar story for some restaurants and hotels. Eatery operator Inno-Pacific Holdings is trading at a P/E of just 0.9, while hotel operator Overseas Union Enterprise is at 3.6. Tung Lok, which runs Chinese restaurants, is at 6.4, compared with the sector average of 18.2.

Property stocks, including those that operate in overseas real estate markets, have an average P/E of 11.4. MacarthurCook Property Securities Fund, which invests indirectly in Australian properties, has a P/E of 1.2.

Ho Bee Investment is trading at 3.3 while Hongkong Land is at 3.5.

But analysts warned that while low P/E values could indicate that a stock could be undervalued, the issue is more complex.

'Using P/E is a quick and dirty way and we really use it only as a guide rather than as a rule,' said Sias Research vice-president Roger Tan.

'There are many companies that are now trading at a bargain looking at the P/E ratios, but investors have to really check the company's business model and fundamentals first before applying this rule.'

For instance, a company could have seen an abnormal rise or fall in profit for the past year, which would make its P/E an inaccurate indicator of its true value, market watchers said.

Mr Tan added that a low P/E could also mean that investors are sceptical about the company maintaining its profit trajectory.

Observers point out that S-chips are suffering from low P/E ratios as investors have turned wary after a series of corporate governance scandals.

In an extreme case, China Sun Biochem's P/E is just 0.8. The stock was suspended after encountering accounting irregularities two years ago, and is in the process of being liquidated.

FibreChem Technologies, also suspended from trade and another victim of an accounting scandal, has a P/E of 0.9. It is now in talks with a potential investor.

jonkwok@sph.com.sg

Musicwhiz Wrote:I thought investors should ALWAYS look at the fundamentals? Who buys just based on PER anyway?

The more "investors" I meet, the more I realize how rare fundamentals-based investors really are. Many "investors", whether retail or institutional, naive or sophisticated, large or small, look for shortcuts. Unfortunately investing IS work. But few people want to acknowledge this. Even fewer want to do the work. But those who do, will reap the rewards.

Quote:But analysts warned that while low P/E values could indicate that a stock could be undervalued, the issue is more complex.

I personally think the article would have worked a lot better if this part had come in front and the companies came later as examples of how low PEs were misleading.

As it stands, it appears the writer is pushing the low PE stocks, with a last-minute disclaimer from SIAS. Such a viewpoint is not helpful to novices (who may jump into low PE stocks and get burned) nor old hands (who are likely to laugh at the simplistic approach).

With the order of the content reversed it would read as a warning to investors to beware of amazingly low PEs, which novices would find informative, and old hands would appreciate as a reminder.

Some comments on the examples given:

Quote:In an extreme case, China Sun Biochem's P/E is just 0.8. The stock was suspended after encountering accounting irregularities two years ago, and is in the process of being liquidated.

FibreChem Technologies, also suspended from trade and another victim of an accounting scandal, has a P/E of 0.9. It is now in talks with a potential investor.

These are great examples of why one should NEVER buy based only on PE.

Quote:Property stocks, including those that operate in overseas real estate markets, have an average P/E of 11.4. MacarthurCook Property Securities Fund, which invests indirectly in Australian properties, has a P/E of 1.2.

Property company earnings are lumpy so PE is meaningless. MPSF is a fund which should be evaluated on P/B not PE.

Quote:Ho Bee Investment is trading at 3.3 while Hongkong Land is at 3.5.

Ho Bee is a developer with lumpy earnings. Hongkong Land is a landlord booking revaluation gains. Using PE is not appropriate for either company.

While fundamentals are important for investing, i think one of the key things that most "investors" miss out is understanding the management. What do I mean by that?

A lot of investors are "book smart" investors, they only looks at the numbers but rarely the qualitative aspects, such as what is the management like? The problem with numbers is that while there is auditing and all, numbers can always be fudged by a expert numbers player. This has been shown time and time again.

Each management has a particular style of running their company / organization, understanding how the management runs the company, their track record , etc helps you understand and trust the decisions they make. Some run a risky game, some are conservative, some are bottom line oriented and that's all they care about, some are employee oriented and believe through that, they can achieve more etc...etc...etc...

Ultimately, you can crunch all the numbers you want, but a bad management can in a second turn a good company into a bad one by the decisions they make and vice versa.

Agree?

Agree 100%.

PE is a quick filter of companies not likely to consider.
That's doesn't mean those with low PE should be invested.


Cory

(23-06-2011, 09:29 AM)flinger Wrote: A lot of investors are "book smart" investors, they only looks at the numbers but rarely the qualitative aspects, such as what is the management like? The problem with numbers is that while there is auditing and all, numbers can always be fudged by a expert numbers player. This has been shown time and time again.

Each management has a particular style of running their company / organization, understanding how the management runs the company, their track record , etc helps you understand and trust the decisions they make. Some run a risky game, some are conservative, some are bottom line oriented and that's all they care about, some are employee oriented and believe through that, they can achieve more etc...etc...etc...

Ultimately, you can crunch all the numbers you want, but a bad management can in a second turn a good company into a bad one by the decisions they make and vice versa.

Agree?

Hi Flinger,

While I do agree with your observations and comments, I must emphasize that assessing Management is pretty tough. I am sure d.o.g. (in his job) has access to many high-profile managers and CEOs and it's not always that obvious which are hiding fraud, which are incompetent or which are candid. I myself have been to a fair share of AGMs and met up with Management and CEOs, and also interacted with many top level people in my job capacity; all I can say is that it is hard to discern dishonesty and lack of integrity just from a few meetings. At most, you can tell if they are competent or incompetent in the way they allocate capital or conduct operations, but it's tough to gauge if Management is actually hiding something.

(23-06-2011, 02:50 PM)Musicwhiz Wrote: Hi Flinger,

While I do agree with your observations and comments, I must emphasize that assessing Management is pretty tough. I am sure d.o.g. (in his job) has access to many high-profile managers and CEOs and it's not always that obvious which are hiding fraud, which are incompetent or which are candid. I myself have been to a fair share of AGMs and met up with Management and CEOs, and also interacted with many top level people in my job capacity; all I can say is that it is hard to discern dishonesty and lack of integrity just from a few meetings. At most, you can tell if they are competent or incompetent in the way they allocate capital or conduct operations, but it's tough to gauge if Management is actually hiding something.

Hi MW,

I agree that no one would be able to gauge if management is hiding something.

What I was directing at was understanding the different styles of management and see if you are comfortable with their management style.

As I was saying earlier, some of the management are big time risk takers, while others are very conservative, and some bottom line champions.

Understanding the way the allocate capital, manage the organization and the employees , the risk they take, what they do during hard times, such as firing and then hiring, or do they streamline, etc...etc... all that information I feel helps understand the management, which in my opinion helps build trust in a management and thus willing to invest in the company.

(23-06-2011, 09:09 AM)d.o.g. Wrote: The more "investors" I meet, the more I realize how rare fundamentals-based investors really are. Many "investors", whether retail or institutional, naive or sophisticated, large or small, look for shortcuts. Unfortunately investing IS work. But few people want to acknowledge this. Even fewer want to do the work. But those who do, will reap the rewards.

I think it's interesting how few fundamentals-based (a.k.a. value) investors there are out there. Is it because of the effort and discipline required or is there some other reason? I've noticed that people seem to prefer the gaudy appeal of speculation/trading mainly because it seems like a "faster" method of getting profits. There are also people arguing that if they can get a 5-10% return in a few days, why wait one whole year for a similar dividend yield? This makes everyone seem very impatient and impetuous.

My question will be: can you ensure a consistent and steady return of XX% if you do short-term speculation? Why do so many people still seek shortcuts, or worse - a Holy Grail to trading, instead of sticking to tried and tested methods of assessing a company and the hard work involved in poring through financial statements and Annual Reports? For me, it's so much more enjoyable than looking at squiggles and blips on a screen (this is a personal opinion so TA practitioners please do not blast me!).

(23-06-2011, 09:09 AM)d.o.g. Wrote: Property company earnings are lumpy so PE is meaningless. MPSF is a fund which should be evaluated on P/B not PE.

Ho Bee is a developer with lumpy earnings. Hongkong Land is a landlord booking revaluation gains. Using PE is not appropriate for either company.

I was also surprised when the article mentioned so many property developers and quoted PER. It should have been fairly obvious to most investors (OK, probably only those on VB!) that for property companies, earnings are always lumpy so putting a PER on it is meaningless. NAV or RNAV is more appropriate and even then, it can change due to revaluations and book value adjustments, which makes valuing property companies somewhat more tricky.

(23-06-2011, 05:05 PM)Musicwhiz Wrote:

(23-06-2011, 09:09 AM)d.o.g. Wrote: The more "investors" I meet, the more I realize how rare fundamentals-based investors really are. Many "investors", whether retail or institutional, naive or sophisticated, large or small, look for shortcuts. Unfortunately investing IS work. But few people want to acknowledge this. Even fewer want to do the work. But those who do, will reap the rewards.

I think it's interesting how few fundamentals-based (a.k.a. value) investors there are out there. Is it because of the effort and discipline required or is there some other reason? I've noticed that people seem to prefer the gaudy appeal of speculation/trading mainly because it seems like a "faster" method of getting profits. There are also people arguing that if they can get a 5-10% return in a few days, why wait one whole year for a similar dividend yield? This makes everyone seem very impatient and impetuous.

My question will be: can you ensure a consistent and steady return of XX% if you do short-term speculation? Why do so many people still seek shortcuts, or worse - a Holy Grail to trading, instead of sticking to tried and tested methods of assessing a company and the hard work involved in poring through financial statements and Annual Reports? For me, it's so much more enjoyable than looking at squiggles and blips on a screen (this is a personal opinion so TA practitioners please do not blast me!).

the same reason why millions of people go gambling hoping that they can beat the house instead of working hard.

(23-06-2011, 09:09 AM)d.o.g. Wrote: Unfortunately investing IS work. But few people want to acknowledge this. Even fewer want to do the work. But those who do, will reap the rewards.

And when the rewards are not really satisfactory, the easiest excuse is to *handicap* oneself by calling it a hobby!