Today, in this write-up, I would like to touch on capital appreciation.
Understandably, capital appreciation is often the key reason for many people to invest in stocks. Many prefer to experience rising stock prices, after buying their shares in the stock market. Who likes to buy a stock and experience a decline in its stock price shortly after?
Here, I would not share how to achieve capital appreciation each time we buy a stock. That is not practical. Stock prices could move up, down, or sideways after purchasing them and it is best for investors to acknowledge this, prior to buying stocks in the stock market.
Instead, I would like to pen down 2 types of capital appreciation and I will share their differences and the type of capital appreciation which I will personally aim for as a value investor:
Type #1: Investor-Backed Capital Appreciation
What does it mean?
First, we need to understand that if a business is good (ie. a business that grows its earnings consistently for the long-term), its valuation should grow in tandem with its long-term growth in earnings. In other words, if the price of a stock had appreciated in line with its earnings growth, I’ll view this capital appreciation to be backed or supported by genuine long-term investors.
Let me illustrate this concept with Public Bank Bhd (PBB).
I have prepared a table of PBB’s Closing Stock Price, EPS, and P/E Ratio below:
From 2010 to 2019, we can see that PBB’s:
a. Stock price increased by 49.3% from RM 13.02 in 2010 to RM 19.44 in 2019.
b. EPS had increased by 62.8% from RM 0.872 in 2010 to RM 1.420 in 2019.
This means, its stock price had appreciated more or less in line with its earnings growth in that 10-year period. If you noticed, PBB’s P/E Ratio averaged at 14.90, ranging between 13.45 to 17.15. This means, investors are valuing PBB at about 14-15 in P/E Ratio for most periods throughout 2010-2019. So when:
a. Stock price rises in tandem with stock earnings over the long-term.
b. The stock’s P/E Ratio had remained stable over the long-term.
I would view this capital appreciation to be supported by genuine investors.
Type #2: Trader or Speculator-Fueled Capital Appreciation
I believe some of you already have an idea of what I’m talking about.
Yes, this type of capital appreciation is often fueled by hype and good news of a certain stock. They include something like:
‘A Bhd is believed to benefit from a change in political leadership.’
‘B Bhd is rumoured to be securing a multi-billion project in 2-3 months’ time.’
‘C Bhd’s business would be massively impacted as a result of COVID-19.’
‘D Bhd should do well as the USD had strengthened against the MYR.’
‘E Bhd would be impacted by a slowdown in the oil & gas industry.’
and so on and so forth.
The above ‘news’ are things that traders and speculators crave for. They tend to buy and sell stocks ad-hocly, emotionally, and irrationally, based on these news.
The rise in stock price is not backed by its fundamentals.
Normally, stocks that are experiencing rising stock prices that are mainly fueled, mainly by traders and speculators, are often less sustainable. What does up fast can come down very fast too. This is because they are focused on gains that are short-term. These people are not Warren Buffett, who buys stocks upon studies on their annual reports, does his valuation and intends to hold onto stocks for a very long time. All these people want is to make a quick buck in the market.
Conclusion: Which Type of Capital Appreciation Do I Prefer?
Needless to say, I prefer the first one.
Capital appreciation is more sustainable if the stock has solid fundamentals and is attractive among genuine investors who intend to keep it for the long-term. It is a type of capital appreciation that is more logical and justifiable.
The second type of capital appreciation is usually driven by irrational behaviour. Thus, they add to the unpredictability of the stock market. They are instances in the stock market where we find the rise in stock prices are fueled by insanity. In our case, once this sort of insanity is detected, we can avoid buying the stock or choose to sell it off to realise a handsome capital gain, if we happen to own it.
Alright, that is it for this week.
If you have any questions / feedback, please post them to firstname.lastname@example.org.
Stay tuned for my latest next week.