Felicia Tan Thu, Jun 23, 2022
Are stocks worth their valuations in their current dip?
While the world is battling global inflation — with the US Federal Reserve (Fed) seeking to raise interest rates to combat the decades-high figures — investors are facing another set of issues with the markets.
For the month of May, US consumer prices spiked to 8.6%, making this the highest since 1981. The figures, which were revealed on June 10, heightened expectations that the Fed will prioritise fighting inflation with aggressive rate hikes than seeing that more easy money is available for market players to punt.
On June 13, the US markets reacted, with the NASDAQ Composite falling by 4.7% to close at 10,809.23 its lowest level since September 2020. The S&P 500 fell 3.9% to end at 3,749.81 points, or over 20% below its record high since January. The Dow Jones Industrial Average (DJIA) fell 2.79% to 30,516.74 points, down 17% from its record high. Cryptocurrencies also slid, with Bitcoin declining as much as 10% on June 14 to below US$21,000 ($29,072), the lowest level since December 2020.
With most of the sectors and counters in the red, is now a good time to buy into the dip?
Goola Warden, The Edge Singapore’s executive editor and technical chartist, says there is still some room to go before the share prices bottom out. “I don’t think we’re at the bottom yet,” she says. ”Bottoms are characterised by little or no action, disinterest in the market, low volume and stocks moving in very narrow ranges.”
“We can use the negative cross area of the 50- and 100-day moving averages (MAs) near around 3,290 points by now although it’s far away as resistance. The closest is the 200-day MA at 3,224, which could act as a resistance line” Warden adds. Resistance levels are the equivalent of layers of sellers waiting to dump shares.
Focus on the fundamentals
Beyond the technical aspects, investors should be diving deeper into the value these counters offer, instead of solely focusing on their share prices.
“The share prices alone should not be a trigger to buy or sell stocks,” says The Edge Singapore’s senior analyst Thiveyen Kathirrasan. “If a company’s share price has gained or dropped significantly over a short period of time, then it is a call for investors to relook at the company’s fundamentals and valuations.”
Investors should attempt to look at the stock without focusing solely on its price. “Simply put, just pretend the charts do not exist and look at the business for itself,” says Kathirrasan.
He also suggests investors should ask themselves: Is the business worth buying, and will it be there in the long run? More importantly, investors should do their research and determine how much they think the business should be valued at or what is a fair price for the business based on the research.
“The stock price is actually one of the several things you should be looking at, to compare what you think it’s worth against what it is currently trading at,” he says. “Once you’ve determined that the business is worth it, you’ll have to look at the business fundamentals. Is the business doing well? Is there growth, and does it have a lower-than-average P/E ratio compared to its peers, for example?”
Kathirrasan also says the metrics that matter are: Profit, cash flow, revenue growth, financial ratios and debt. However, investors should note that different metrics for different companies in the various sectors may carry more weight than the other.
“For instance, cash flow may be more important in some companies, and order books may be more important for other companies,” he says. “For some tech companies, investors should be looking at their revenue growth, competitive advantage and how many users or subscribers said company has. For example, the more users on its proprietary platform, companies like CrowdStrike will benefit.”
American cybersecurity technology company CrowdStrike uses data analytics and artificial intelligence (AI). “Therefore, the more people use its proprietary platform or the company’s module offerings, the smarter the data at CrowdStrike gets, which is a positive catalyst to the company’s fundamentals and it’s worth,” says Kathirrasan.
“With companies like Facebook, the more users they have, the more revenue they can obtain through the number of advertisers, for example,” he adds. “For companies that are in the waste management business like waste management, some metrics investors could include in their analysis are population growth, as the higher the population, the more waste gets generated.”
Ultimately, Kathirrasan has a simple piece of advice for investors: “Understand the business you’re looking to invest in, use common sense to see what works for them and do your research”.
“If you know the business, you’ll know what numbers are important to the company.”
Share price analysis
Once you have studied the business and determined that it is worth putting money into, that is when you look at the share price. If it is lagging, it could be due to a few reasons, says Kathirrasan.
There could be insider trading, or the stock is just being punted on, he adds. “Has the counter piqued a great deal of interest by a small group of investors who control the share price or a large group that can move the share price like GameStop?”
If that is not the case, look at the company’s numbers and see if they appear sketchy and read the auditors report if you are in doubt. In The Edge Singapore’s top 10 global portfolio picks in 2020 (Issue 917, Jan 24, 2020), Kathirrasan selected Hainan Meilan International Airport as one of the counters within the portfolio. Meanwhile, large Chinese conglomerate HNA Group is a company that went through a lot of financial trouble previously, including defaulting on its creditors.
In doing his research, the senior analyst found that a bulk of the company’s stock was owned by the Hainan state government as opposed to the troubled HNA Group, which bears the same name. The company’s P/E was at 4.0x at the time, compared to an average P/E of 30x to 50x for airports around the world.
Upon a closer look, he found that the airport’s earnings yield (the reciprocal of P/E) and operating cash flow (OCF) yield are at 19.8% and 39.0% respectively, well above the benchmark Chinese risk-free rate of 3.1%.
Kathirrasan’s research eventually paid off, with his 2020 portfolio hitting returns of 98.1%, thanks to Hainan Meilan’s return of 661.9% over a 12-month period.
