Why is one company profit increase by only 10 to 20%, yet the share price rises but another company profit increase by 100% yet the share price not much change?
Why some companies are trading at 20 to 30 PE but some companies trading below 10 or even below 5 PE?
I’m painting a picture of 2 companies. Both company started off share price at $1.00, EPS=10cts, PE=10, 50% profit pay out as dividend = 5cts/share. (For easy understanding)
Company A – Resilence business, revenues & profit able to increase by 20% yearly.
Company B – Secure a project or contract for 2 years, profit increase by 100% for each year for the 2 years.
Company A
1st yr: EPS=12cts – Div=6cts – SP=$1.20
2nd yr: EPS=14cts – Div=7cts – SP=$1.40
3rd yr: EPS=16cts – Div=8cts – SP=$1.60
Sold off after 3 years @ $1.60 plus dividend received = 60cts + 21cts = 81cts
The total return for 3 years = 81% or 27% yearly
Company B
1st yr: EPS=20cts – Div=10cts – SP=$1.30
2nd yr: EPS=20cts – Div=10cts – SP=$1.20
3rd yr: EPS=10cts – Div=5cts – SP=$1.00
Sold off @ $1.00 add on dividend = 0cts + 25cts = 25cts
The total return for 3 years = 25% or 8.3% yearly
Note: B company even thought profit & dividend increased by 100% share price increase by 30cts That is extra 5cts for dividend plus 25cts factor in share price. (Unless the 100% increased are recurring profit the 100% profit increase is only extra EPS of 10cts)
For 2nd year extra 5cts dividend & 15cts (Share price drop by 10cts if there is no visibly contract or project secure)
For 3rd year back to square one if no new contract or project.
Conclusion:
Company A is able to growth its profit yearly at 20% should hold for long term investment. Its important for a company to grow stable recurring profit yearly so that share price can be sustained. Share price will naturally increase if the companies are able to grow its top & bottom lines yearly. An establish company with good track record will able to command a much higher PE ratio than a young upcoming growth company.
Company B is good for short term investment as share price will have to factor in new contract or project secure.
The above illustrations are just to paint a picture for easy understand why some companies are trading at higher PE than others. Companies trading at low PE may not be cheap if the future of its business is uncertain. These illustration may be helpful for us to stock-pick the right companies, the right business to growth out nest egg.
Investors will have a better understanding why some stocks share price increase at a small percentage than another stock even though the profit may increase by 100%. Some stocks are trading at 20 to 30 PE ratios as compare to another trading a at single digit PE ratio. Many companies are trying to build up a strong recurring profit base. Project & contract secure will help to growth the companies faster.
The answer for company to perform is to grows its recurring profit.
To receive 3% dividend from a growth company is still better than bank interest of 0.1% or CPF interest of 2.5%.
PS: These illustrations do not take into consideration of market condition for easy understanding.
CORDLIFE
Vested 20%. – A promising growth stock. Dividend of more than 3% is still worth investing. A potential perpetual dividend raisers.
BONVEST
Vested 5% - Company holding solid prime asset, major shareholders holding more than 80% but dividend payments is reducing over the years. Dividend received is still much better than bank interest. Good candidate for this stock to unlock value but management is too conservative.
STAMFORD LAND
Vested 5% - Company with many hotels & properties down-under. Dividends yield of more than 5%. Good opportunities of company to unlock values.
STRACO
Vested 3% - Company growth about 10%, no debt and generating positive cash-flow. A Potential perpetual dividend raisers stock. Over the year dividend increased from 0.5cts to 1.25cts.Will increase holding on price weakness.
OUE
Vested 5% - OUE is property company with good quality hotel & office properties. Company is restructuring & building up recurring revenue. I see this stock future looks promising.
BIOSENSORS
2% vested – This stock is back on my radar now. The company 2nd generation stents business is growing fast. A good take-over target. So far company not ready to pay dividend. I’ll go slow on this stock because cost of holding. (Depend only on capital appreciation but no dividend)
SECOND CHANCES
Vested 3% - 2nd Chances is more a property company, paying out dividend of more than 7%
Hehe...I also have Biosensors. Currently I don't consider it a cheap stock but I recognise that its GP margins are really solid.
I have good news for you -- they are paying a final dividend for the first time.
"The Company has recommended a final dividend of US$0.02 per share for the financial year ended 31 March 2013 amounting to US$34.5 million, subject to shareholders' approval."
Thanks Garl for highlighting Biosensors final dividend of US$0.02 to me. I'll be accumulating this stock gradually when its price is nearer to $1/- up to 5%-10% of my holding. This stock being resilence in its business, gaining market shares and good profit margin suit my investment profile.
I would like to share my understanding regarding to wsisdom to the Nextinsight readers below.
I'm puting forward 3 questions for Nextinsight readers to reflect on.
The acticle posted today : 90-Year-Old Chinese Investor Shares Trade Secrets, written by Andrew Vanburen (China Correspondent) is also very helpful for Nextinsight readers to ready and reflect on their investment stretegy.
WISDOM
Like king Solmon, seek wisdom not riches. Wisdom will help you make wise decision. Seeking riches will cloud our thinking and end up making foolish decision. I have few questions to ask that may help us in our investment decision.
1. If a company cash holding is more than the share price, is it logical to loan more money for its business paying so high interest between 12.5% to 30%?
2. Do we believe a great company share price is going downhill rather than uphill over the years?
3. Do we believe a great company share price only going up and down like waves over the years?
Seek Wisdom & not riches is the answer to Sound Investment.
