Thursday, 22 December 2016

Some basic metrics and investing tools

Some of you who are new to investing just like me may initially be puzzled by all the different metrics used by seasoned investors. Below are a few basic ones (share price, market capitalisation, and price-to-earnings ratio) which I believe are useful.

Share price

Basically this is the cost of owning one unit of a share in a company.
Note that a hefty share price may not necessarily mean that a company is expensive as the company may have many shares on issue. A better way of determining whether a single share is cheap or not may be the Price to Earnings Ratio Metrics which is covered below.

Market Capitalisation

This is the total number of shares issued, times the price of each share. Effectively, this gives a valuation to how much a company is worth.

For example:
In the case of Singapore Telecommunications Limited (Singtel):
Shares on issue: 16329 million (= 10^6)
Current share price: $3.65
Market Capitalisation = 16 329 000 000 x 3.65 = $59.60 billion (= 10^9) approximately.

Why is this important?
A big company may indicate "stability". Logically thinking, it may be nearly impossible for a large corporation with a market capitalisation of $50billion, with a longstanding history to collapse (well, at least not in a single day), but this may actually happen with a  $10million dollar company in a speculative industry (e.g. diamond mining, even though I do not believe there is such a listed company in the SGX at the moment).

Price to Earnings Ratio (P/E)

Effectively this tells you how much of a "bargain" the share is. This is the cost of each share, divided by the average earnings per share.

As you may have guessed it by now, a LOW P/E suggests that the share is currently cheap, and a HIGH P/E suggests that the share is currently expensive.

Although this metric gives you a quick insight as to how cheap each share is, it does NOT take into consideration a number of things, which include:

- Bumper earnings
e.g. a company can report higher earnings in the past year due to a divestment (selling) of a subsidary business. As a result earnings seem greater than what it usually is for the past year. As you can expect, there is no way a company can sustain its operations in the long term by constantly selling their assets, hence watching out/reading carefully a company's earnings report for bumper earnings which creates a false image of a company's P/E ratio is important.

- Falling share price
A company's P/E may be low as a result of share price previously plummeting due to a bad earnings forecasts, broker's downgrade, etc. Such reasons must be investigated first before concluding that a share with a low P/E is actually cheap.
For example, some companies may provide update on their operations/earnings, and they could predict a "bad" year ahead due to adverse trading conditions. For example, a property developer could forecast poorer earnings the following year due to an oversupply of properties in the property market, or even due to a change in regulations; such as one which increases restrictions on individuals borrowing to invest in a property.

Why are there "Differing P/Es"???
It must be noted that although share price may be current, earnings can be "trailing" or "forecasted". Trailing earnings are earnings that have come to pass, and are often earnings by the company in the last financial quarter/year etc. However forecasted earnings are often used by analysts who predict how much a company will be earning in the upcoming year/years.

For example;
in FY2016,
A company may have a share price of $1
Trailing Earnings per share: $0.10
P/E (trailing) is therefore = 1/0.10 = 10

Analysts may forecast the company to have an earnings per share of $0.15 in FY2017. FORECASTED P/E would therefore be 1/0.15 = 6.67

Hence a share may be trading on a seemingly "unreasonably high" TRAILING P/E ratio, such as Raffles Medical Group (with a P/E of about 36), but the share price could very well be sustainable as many holders/potential buyers believe that the future earnings of the company would increase substantially. For example, if they were to predict that earnings were to double by FY 2019, that is equivalent to saying that Forecasted 2019 P/E would be only 18. Seems cheaper right?


An acquaintance who is also a more experienced investor once said to me "growing companies never come cheap" and I eventually came to believe so. On a side note, I will be talking about some of my investments (albeit tiny ones due to my finances) in companies which I believe have significant potential ahead in a separate post.

This post may be boring to the seasoned investors here, but I am putting this out as I feel that there may be many others who may be slightly more unfamiliar with these investing terms. I hope that everyone has enjoyed this post.😁

Best Regards,

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