Lately, I received a question and let me reword it as follows:
I bought Top Glove at around RM 6 a share for I believe that Top Glove is a good company and it is undervalued. Why did its stock price fall to RM 2.75 per share today? What are your thoughts on it and what should I do?
Before I begin, let me state the following:
1. I do not own shares of Top Glove or any other glove stocks.
2. I do not intend to tell anyone what to do with their Top Glove shares.
3. You are encouraged to make independent decisions on investment matters.
Thus, my purposes for this write-up are:
1. Share my thoughts of this whole episode of Top Glove in 2020-2021.
2. Expound on the advanced application of P/E Ratio when valuing a stock.
3. Impart 5 lessons that we could all learn from this amazing story of Top Glove.
As such, let’s begin:
#1: Top Glove Before COVID-19
Top Glove is a highly profitable company even before COVID-19. In 2015-2019, I discovered that Top Glove has generated around RM 350 million on average per year in shareholders’ earnings. So, before its bonus issue in 2020, Top Glove has made an average of 14.4 sen in Earnings Per Share (EPS) and paid an average of 7.2 sen in Dividends per Share (DPS) in that 5-year period.
#2: Top Glove’s Valuation in March 2020
Before the rapid increase in its stock price that began in March 2020, its P/E has been rising in 2015-2019. In March 2020 (MCO 1.0), when Top Glove was at RM 6+ per share (before bonus issue), its P/E Ratio was at 40-45 based on EPS 2019 and its dividend yield was around 1.2% per annum based on DPS 2019.
#3: Why Top Glove Spiked Up So Rapidly in 2020?
There was an expectation of substantial rise in profits from glove stocks with an acute rise in demand for gloves, especially from the healthcare sector globally.
Top Glove and the other glove stocks appeared on headline news. They became the in-thing as they were expected to do well while others were expected to be embracing a difficult operating environment in 2020 due to COVID-19. Hence, it had attracted many people to start buying shares of Top Glove.
But, my question at that time was this, ‘Who are these buyers?’
1. Are they value investors?
2. Do they buy Top Glove for dividends?
3. Are these buyers investors who read Top Glove’s annual reports?
4. How long would these buyers hold onto Top Glove’s shares?
#4: Let the Party Began
Defying logic and common sense, the Top Glove party began.
Top Glove rose rapidly from RM 6+ to RM 10, RM 15, RM 20, and eventually RM 28+ a share in August 2020. Many firmly believed that it could possibly climb to as high as RM 30 to RM 40+, RM 50+, RM 60+, and even RM 100+ a share.
For this discussion, let’s just keep it to RM 28+ a share.
At RM 28+ a share, Top Glove was trading at a P/E almost 200x its EPS in 2019.
Let me illustrate what that really means.
Let’s say I have an apartment where I collect RM 1,000 per month in rent. Thus, I make RM 12,000 per annum in rental income. A P/E Ratio of 200x would mean that my apartment could be sold for a price of RM 2.4 million, which is 200x my annual rental income.
Would you pay RM 2.4 million to buy my apartment to collect RM 12,000 a year in rental income?
If you think this example is absurd and ridiculous, think Top Glove.
#5: But, Wouldn’t Top Glove Increase its Profits Substantially?
Also, from the person above who bought Top Glove at RM 6 (after bonus issue), the person believed that the purchase was ‘undervalued’ as its P/E Ratio at that time was at its all-time low. Okay, before I offer my views, we need to understand:
1. On 7 September 2020, Top Glove issued 2 bonus shares for 1 existing share.
2. Thus, the stock price was adjusted downwards to reflect its bonus issue.
3. If one bought 1 share at RM 18, he will have 3 shares at RM 6 a share each.
So, I believed that the person bought his Top Glove somewhere from December 2020 to February 2021. At that time, Top Glove had reported the following:
At RM 6, that person may have thought that he bought it at P/E Ratio of 12 as it is based on Top Glove’s latest 12-months EPS of 50.23 sen.
Whether or not he is conscious, that person had based his P/E Ratio Calculation on Top Glove’s ability to generate RM 4+ billion per annum for perpetuity. Thus, the question is this: ‘Do you think Top Glove can earn RM 4+ billion per year in the long-term?’
It is not about making RM 4+ billion in 1 year.
The focus is about making RM 4+ billion every single year that matters.
#6: What’s Your Assumption in Using P/E Ratio?
As I write, Top Glove’s stock price is RM 2.75 a share.
Its current P/E Ratio is 2.79. This is calculated based on its latest 12-month EPS:
If your reasoning for buying Top Glove is due to its current P/E Ratio of 2.79, are you assuming that Top Glove could earn RM 7.9 billion in earnings every year in the future (like the next 10 years)?
So, this is where investors should think and reflect independently. My own view or opinion on Top Glove’s ability to generate profits is irrelevant.
We have to know the context of the P/E Ratio calculated and not use it blindly.
#7: What To Do If I Have Top Glove Shares?
Once again, I wouldn’t tell you what you should do with your Top Glove shares.
You are free to decide what you should be doing with them.
But, if you had bought Top Glove at RM 3+, RM 4+ … RM 28+ a share during the 2-year period in 2020-2021 and are disappointed that it fell to RM 2.75 today, it would be helpful for you to reflect on the following:
1. Did you buy it as an investment or did you intend to trade or speculate it?
2. Did you read its annual report before buying shares of Top Glove?
3. What was your P/E Ratio when you bought Top Glove?
4. Did you compare its current P/E Ratio with its past P/E Ratio averages?
5. What were your expected dividend yields from Top Glove?
6. How long did you intend to hold onto shares of Top Glove?
7. Before buying, did you have a plan in place if Top Glove’s stock price falls?
#8: 5 Lessons We Can Learn from the Top Glove Episode
You may incur some capital loss from Top Glove. What was done is done.
Now, don’t lose this golden opportunity to learn some valuable lessons from it.
Otherwise, you would lose your capital in vain. Personally, I believe the key lessons that we could learn are as follows:
1. A good company is not a good investment if the price is overvalued.
2. Don’t chase spikes. What goes up quickly will come down as quickly.
3. Be long-term minded. Invest based on their earnings consistency.
4. Understand your assumptions when using P/E Ratio and Dividend Yields.
5. It’s okay to make a mistake. Take time to learn from it and not waste it.