Let me ask you a question.
You have two stocks to choose from. Stock A is trading at RM 1 a share. Stock B is trading at RM 10 a share. So, is Stock A a better investment than Stock B?
Is your answer an absolute ‘Yes’? If so, is it because you believe that Stock A is cheaper than Stock B?
If that’s you, pardon me. My views are different from yours.
I believe, stock price alone does not determine whether a stock is cheap or expensive. It is a misconception to think that Stock A is cheaper than Stock B. This misconception alone has caused some sincere investors to buy overpriced stocks, believing that these stocks are cheap. This led to poor investment returns, leaving investors confused and disappointed.
In contrary, I think it is possible for Stock B to be cheaper than Stock A.
Seriously? Are you joking?
Nope. I’m positive about it.
Let me explain.
First, we have two stocks.
As I write, Dialog Group Bhd (Dialog) is trading at RM 1.61 a share. Meanwhile, Aeon Credit Service (M) Bhd (Aeon Credit) is trading at RM 15.90.
In a glance, stock price of Aeon Credit is nearly 10 times the stock price of Dialog. So, which of the two stocks do you prefer? Is it 1,000 shares of Aeon Credit? Or, is it 10,000 shares of Dialog?
Personally, it depends. As a value investor, I would compare prices of both stocks with their respective earnings. It’s really simple.
Let us start with Dialog. In 2016, Dialog has made RM 0.057 in earnings per share (EPS). At RM 1.61, the current price is a multiple of 28.25 of Dialog’s EPS in 2016. Thus, the current P/E Ratio for Dialog is 28.25. In other words, for every RM 1 Dialog is making, I’m willing to invest RM 28.25 if I buy Dialog.
Dialog’s Current P/E Ratio
= RM 1.61 / RM 0.057
Meanwhile, in 2016, Aeon Credit has made RM 1.490 in EPS. At RM 15.90, the current price is a multiple of 10.67 of Aeon Credit’s EPS in 2016. Thus, the current P/E Ratio for Aeon Credit is 10.67. In other words, for every RM 1 Aeon Credit is making, I’m willing to invest RM 10.67 if I buy Aeon Credit.
Aeon Credit’s Current P/E Ratio
= RM 15.90 / RM 1.490
Therefore, Aeon Credit is cheaper than Dialog as Aeon Credit’s P/E Ratio is lower. It is a classic example where investors have misconceived price and value. It is an erroneous belief to think that they are the same. Price and value are different. Their difference is stated below:
Dialog is more affordable than Aeon Credit.
Aeon Credit is cheaper than Dialog.
I believe, you’re getting the picture. Price is about affordability. Value is about determining whether an investment is cheap or expensive. Thus, let us be absolutely clear about it as this alone should help you to avoid:
Stocks that incur losses. (P/E Ratio is not available).
Stocks with inconsistent profits (High fluctuations in P/E Ratio)
Stocks that are overpriced (High P/E Ratio)
This helps you to enhance your success in investing by focusing on stocks that are profitable and have low P/E Ratio.
This article is posted by Ian Tai, creator of Bursaking.com.my. It’s a website that empowers retail investors to build wealth through ownership of fundamentally solid stocks in Malaysia.
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Disclaimer: This article is intended to be educational. It’s not intended to promote / discredit the investment potential for both Aeon Credit and Dialog Group. The author and publisher of this article hereby disclaims any reward or liabilities derived from the direct or indirect usages of the writings above.