Let’s assume you bought a stock at RM 6+ a share in 2021.
Today, its stock price is RM 5.06 a share. Thus, you are in a 15%-20% capital loss position. So, the question is, ‘Should you cut your losses or should you buy back the same stock at a lower price?’.
Source: Google Finance
Once again, the answer is crystal clear if we reassess the stock based on its long term fundamentals and valuation. We would consider adding more shares, if its fundamentals and valuation are attractive. Otherwise, we would sell it off. Over here, for this stock, I had discovered the following:
In terms of fundamentals, the stock has delivered consistent growth in earnings in 2010-2022. In 2021, it recorded RM 118.5 million in one-off gains. This ‘gains’ had contributed to the stock’s substantially high earnings in 2021. Hence, after I accounted for the ‘gains’, its earnings in 2022 has normalized to around RM 300 – 350 million a year as attained in 2018-2020.
So in short, I find that the stock’s fundamentals are still intact.
Figures adjusted to conceal identity of the stock
But, the fundamentals of a stock is just one-half of the equation.
The other half lies in its valuation. For this stock, its past historical P/E Ratio had increased from 18.75 in 2012 to 55.78 in 2022. Thus, it means that its growth in stock price was much faster as compared to its earnings growth in that period. I could see that this stock was most overvalued in 2022 due to its high P/E Ratio.
At present, this stock’s latest 12-month earnings per share (EPS) is 14.80 sen. At RM 5.06 a share, its stock price is valued at 34.19 which is close to its long-term average of 33.67 (fair valuation). Here, if you had purchased this stock at RM 6+ a share, it is likely that you bought yours at P/E Ratio between 40-50. As such, it is possible for you to have purchased yours when it was overvalued.
Your first purchase was a mistake.
Now, the question is, ‘Would I buy this stock at RM 5.06 a share today?’.
Personally, I would say nope. This is because I find that there are stocks that are much better in fundamental qualities which are trading at P/E Ratio below 30 in the present. Here, I believe a disposal of this stock in exchange for stocks which have better fundamentals at P/E Ratio of 15-25 is worth considering.
So, what are the morals of this case study?
1. You can incur capital loss from overpaying for fundamentally good stocks.
2. Don’t go beyond P/E Ratio of 30. (Many good stocks have P/Es of 15-25).
3. Use valuation. Never decide on a stock based on its stock price movements.
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?
