Q: I have been waiting for the stock market to correct for sometime so I could not find the opportunity to buy stocks at good price because the market always recovers quickly every time it falls. Now that the index has gone above 6,500, I am afraid if there are still good stocks to buy at this level. Can you advise me? – Lory Filomeno by e-mail
A: It may indeed be a little bit challenging to pick a good stock now as share prices at the moment are already very high. In fact, the Philippine market P/E average now is at 21x, making it one of the most expensive in Asia. But it doesn’t mean that you can not invest anymore. For as long as the stock market continues to enjoy strong investment demand and liquidity support, there will always be opportunities to make money.
You can take advantage of the current bullish momentum in the market by buying stocks that have not reached their fair values yet. The question is how you look for that opportunity. You need to look for stocks that are still undervalued.
There must be some stocks that may have underperformed compared to others because investors have either ignored them in favor of more active stocks or they have not yet recognized their true potential.
Start screening stocks in the PSE universe by doing P/E ratio comparisons. Although it can be difficult at this stage to find really cheap stock by P/E valuation, you can search for stocks that still offer good discount to market P/E. If investors are willing to pay at 21x P/E, then use this as your temporary benchmark until market sentiment has changed. But be aware that not all stocks with low P/E are good. There are some stocks that trade at low P/E because investors simply do not expect so much growth from the company.
P/E ratios do not tell you about the financial position of the stocks. Two stocks with similar P/E ratios may not have the same balance sheet. One stock may be conservative and use less debt, but the other one may be highly leveraged and more complicated. P/Es also do not tell you the quality of the company’s management. Get to know the people behind the company by reading the annual report. Evaluate the prospects of the business. How stable is the company? How sustainable is the company’s growth rate? How firm is the company in achieving its earnings target this year?
Once you have filtered the list of candidates, you can further fine tune it by comparing each stock’s price-to-book value ratio, price-to-cash flow ratio and price-to-sales ratio against industry and overall market average. You can easily access this data for free from your broker or data provider in the Internet.
Your stock does not need to top in all criteria but use this only as margin of safety for reference. The more ratios in the criteria the stock is able to compare well against others, the better. When you have already identified the stocks that you plan to buy, set your target price and timetable. At what price do you want to sell the stock if it were fairly valued? How soon do you think you can sell it at your target price?
Normally, you would expect the stock to outperform in the next six to 18 months, but with the current bullish market, it may be faster and you have to act fast too.
Last week, we have seen some few stocks that have started to move up quite actively on strong buying. One of these is SM Development Corp. This stock has been declining steadily since 2011, losing about 40 percent from a high of P9.49 to a low of P5.72 in late 2012. Investors had been selling this stock apparently due to disappointing lower earnings per share in 2012, which went down by 11 percent year on year, making the stock expensive at that time.
But a closer look at the latest income disclosure by SMDC to PSE last year shows that earnings were not that bad. In fact, total comprehensive income of SMDC went up by 38 percent year on year. Total sales for the last nine months in 2012 were also up by 42 percent compared to previous year.
The reason for the decline in earnings per share was due to the series of stock rights offerings the company did which increased the total number of shares outstanding. SMDC was trading at only 10x P/E or P6 two weeks ago before it caught the attention of the market. The stock is now trading at P8.85, up by 47 percent and has a current P/E of 15x, still cheap at current valuations. If we are going to apply the market P/E of 21x as benchmark, this stock should be trading at P12.
Ayala Land or ALI is currently trading at 47x P/E. If we are going to assume only half of ALI’s valuation as reference for other property stocks, the target P/E of SMDC should be 23x or P13 a share.
The case of SMDC is one of the examples that there are still undervalued stocks in the market today. These stocks may have been avoided by the market in the past for many reasons but these should have already been discounted in the share price by now.
Looking at the P/Es, there are few more stocks that are worth looking at. Some of these include Megaworld (14.8x), PLDT (16x) and Globe Telecoms (14x). When you buy a stock at this level in the market, even though the stocks that you buy are promising, try to always keep a level of flexibility. When you know that you have made a mistake in the process, be firm to recognize it and cut your losses.
Henry Ong is a Registered Financial Planner of RFP Philippines. To learn more about financial planning and how to become RFP, attend FREE personal finance talk on Mar 7, 7pm at PSE Center Ortigas. To reserve, e-mail at firstname.lastname@example.org