Here is another case study.
There is a stock that was trading at around S$ 11 a share in 2019. Then, its price had fallen by 20%-25% to S$ 8+ a share in 2020. Now, as I write, we could see in the price chart below that its stock price had recovered to S$ 11+ a share. So, in this case, why was there a rebound in the price for this stock?
Source: Google Finance
Well, to answer this, we need to assess its fundamentals and valuation over the long-term. This assessment is important as it helps investors to identify genuine bargains and avoid value traps or panic selling in the stock market.
So, let’s begin.
First, in terms of fundamentals, this stock had delivered consistent growth in its earnings, up from S$ 743 million in 2008 to S$ 2.48 billion in 2019. So, we could see that the 20%-25% drop in stock price is not reflective of its earning abilities. Rather, I felt that this fall has reflected a pessimistic outlook on the stock due to the COVID-19 pandemic, which is an external event.
In other words, the stock price decline has little to do with the stock’s business.
Figures adjusted to conceal identity of the stock
Second, let’s talk about valuation. Here, I would calculate its valuation based on its earning abilities, which was S$ 2.48 billion in 2019. In that year, it reported a total of S$ 1.127 in earnings per share (EPS). Hence, based on the stock price of S$ 8.50-S$ 9.00, its current P/E Ratio at that time was 7.5-8.0.
Now, if I compare this with the stock’s past historical P/E Ratio, it is obvious that its current P/E Ratio was at its lowest, thus, indicating that it is undervalued. So, in this situation, it would be unwise to sell off the stock. Rather, you may view it as an opportunity to accumulate more shares of this stock at S$ 8+ a share. This would be the essence of value investing.
Personally, that’s what I did.
I invested in this stock at S$ 8.69 a share on 15 October 2020.
Fast forward to today, this stock made S$ 2.48 billion in earnings in 2021. This is a recovery to its true earning ability in 2019. Its EPS was S$ 1.105 in 2021 which is a bit lower than S$ 1.127 in 2019, arising from a small increase in the number of shares. Based on its current price of S$ 11.71 per share, the current P/E Ratio of this stock is 10.6, which is close to its range in 2011-2019.
Figures adjusted to conceal identity of the stock
Hence, by assessing a stock’s fundamentals and valuation for the long-term, we can see that a price rebound in this stock is warranted and justifiable.
So, what are some key takeaways from this case study?
1. Focus intensely on the stock’s long-term fundamentals and valuation.
2. A price rebound is likely for stocks that have the ability to increase earnings.
3. Never sell fundamentally good stocks panicky. They could be value buys.
If you wish to learn more about value investing:
Dividend Investing: How to Build a Stock Portfolio that Pays Increasing Dividends?
Growth Investing: How to Make Massive Profits from Stocks Safely?
