Friday, March 21, 2008

Is there such a thing called value investing? II

What causes stock price to go up and down? I have been searching for an answer for years. Stock market is a very complex animal, hence finding an answer is not so straight forward. However, being a person like simple thing, I like simple answer.

The simplest answer in plain English that I can find is this:

Stock market return = fundamental return + speculative return = (earnings growth + dividend yield + change in PE ratio)

Consider the below written by one of the brokerage houses on Petronas Dagangan. This is a simple business, it has steady expansion, the price is governed by APM, etc. You feel good about it? Suddenly, you are wondering why the target price got hammered down by 20%? Going back to the equation, fundamental return has not changed but the speculative component has changed, they have just revised down on the PE ratio as they see the world is less rosy. A few months ago, if you believe what they valued the company at $ 12.80, you might be willing to pay up to $ 10.88 for a hope of 15% return, suddenly you got whacked!

Still scratching your head? Get used to it. I read in newspaper yesterday, Credit Suisse said that emerging markets need to correct between 20-25% down based on valuation. Does that mean the stock markets have been out of valuation for a while? I do not like use four letters word on these guys. This is the main reason I stay away from brokerage report, they can poison your minds unconsciously. I will start reading their reports now because I think chances of value being derived fairly is better.

The love for China, India, commodities suddenly evaporate? Hong Kong market got whacked now, there are people calling for 18,000 for Hang Seng Index, tested below 20,000 at the time I am writing this. Some of the S chips traded in Singapore suddenly contracted to 3 - 4 PE multiples.

Cyclical stocks should be avoided at this time because you need to do it right twice ( entry and exit ). If the fundamental of the sector is in your favor now, the depressed market sentiments will continue to depress the stock price. When the sentiments recovered, the fundamental of the sector could be on the downtrend, hence, stock price remain depressed again.

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