'Expensive' shares: Do not look at how high the share price is. It is the valuation that counts.

Quick Comment: 'Expensive' shares

Some time ago, I had a conversation with my ASX remisier based in Australia and I think some of his comments are worth sharing.

*Me refers to myself when I was speaking to him.
*Investssmart is also myself but from my point of view now.

Me: Good shares in Malaysia are expensive.
Remisier: What do you mean by expensive? When you say expensive, do you mean in absolute terms or in terms of valuation? When I say it is expensive, it normally means overvalued or fully valued. Some companies can trade at $30 but we still call them cheap.
Investssmart: This is very true. The word expensive should be used more carefully when talking about shares. The absolute value does not really count. A Mercedes for $100k is 'cheaper' than a Waja for $60k. It is the value that counts.

Me: Malaysians' perception is that the higher the share price is, the more it can drop.
Remisier: That happens all the time. It is important to remember that we should look at the movements in terms of percentage. If a $50 company can drop to $5, a $5 company can drop to 5c as well. The important thing is to fix the absolute amount you invest. Purchasing 100 shares in a $50 company is the same as purchasing 1000 shares in a $5 company. If both rise by 10%, you will still earn the same amount of $500 no matter which company you invest it. 
Investssmart: We should not be put off by the share price. It is the valuation that we should worry about. The chances of IRIS to drop from 90c to 20c is higher than the chances of BKAWAN dropping from $7.80 to $2. But somehow, if you give investors just these two choices, many would rather invest in IRIS because they think it is 'cheaper'!

Remisier: Do you remember me recommending you Rio Tinto ($30), BHP ($15), Woodside ($20) and Cochlear ($25)? You did not purchase any either! Perhaps, this changed your view on 'expensive' stocks!
Investssmart: These four stocks have skyrocketed since his recommendation. They are now about $75, $30, $45 and $50 respectively. Never say that upside of highly priced shares are limited. There is no such thing. Upside of overvalued/expensive shares is limited but upside of highly priced shares is not. Although I did not purchase these shares, it was not because I was scared of the high prices. It was mainly because I did not have the strong confidence in the commodity bull and sadly, I was proven to be wrong. Could have made tonnes more from the ASX. Nevertheless, in a bull market, almost everything on the ASX rose.


Me: I did not buy those few but I still bought some highly priced ones. What would I be trading if I don't buy any highly priced shares? I don't remember you ever recommending me any penny stocks!
Remisier: Good stocks are normally highly priced because the demand for good stocks is very strong. Lowly priced shares are normally those that are speculative or not performing. 
Investssmart: It is strange but true to a certain extent. Of course, it does not apply to all company shares.

Strange but could be true: I don't think it is a coincidence that most of the true blue chips throughout the world are trading at high prices. Most of these blue chips have been there for ages. It had to start off somewhere as a smaller company and it takes time to reach where it is today. If the company was trading at $1 ten years ago, it will probably trade at $10 today to be considered a top performer. Otherwise, it would not be considered a blue chip.

Fundamental based investors always look at companies that have excellent track records and therefore, end up investing in highly priced shares. That is because it is very rare that we can get such companies at low prices as share prices should have risen as companies perform well over the years. I doubt fundamental based investors would be interested in companies that trade at low prices over the last few years because that means that they probably do not have a good track record. Of course, this does not apply to all shares but I believe that it is true to a certain extent.



Conclusion: Do not look at how high the share price is. It is the valuation that counts.

http://investssmart.blogspot.com/2006_04_01_archive.html

Every person who owns shares in a company wants it to grow

Every person who owns shares in a company wants it to grow

When investors talk about "growth", they're not talking about size.  They're talking about profitability, that is, earnings.

It means the profits are growing.  The company will earn more money this year than last year, just as it earned more money last year than the year before that.

• A company doubling its earnings in 12 months can cause a wild celebration on Wall Street, because it's very rare for a business to grow that fast.
• Big, established companies are happy to see their earnings increase by 10 to 15% a year, and
• younger, more energetic companies may be able to increase theirs by 25 to 30%. 

One way or the other, the name of the game is earnings.  That's what the shareholders are looking for, and that's what makes the stocks go up.

People who buy shares are counting on the companies to increase their earnings, and they expect that a portion of these earnings will get back to them in the form of higher stock prices.

This simple point - that the price of s stock is directly related to a company's earning power - is often overlooked, even by sophisticated investors. 

The earnings continue to rise, the stock price is destined to go up.  Maybe it won't go up right away, but eventually it will rise.

And if the earnings go down, it's pretty safe bet the price of the stock will go down.  Lower earnings make a company less valuable.

This is the starting point for the successful stockpicker.  Find companies that can grow their earnings over many years to come. 

It is not an accident that stocks in general rise in price on average of about 8% a year over the long term.  That occurs because companies in general increase their earnings at 8% a year, on average, plus they pay 3% as a dividend.

Based on these assumptions, the odds are in your favour when you invest in a representative sample of companies.  Some will do better than others, but in general, they'll increase earnings by 8% and pay you a dividend of 3%, and you'll arrive at your 11% annual gain.


Stock Price Watchers

The ticker-tape watchers begin to think stock prices have a life of their own.

• They track the ups and downs, the way a bird watcher might track a fluttering duck.
• They study the trading patterns, making charts of every zig and zag.
• They try to fathom what the "market" is doing, when they ought to be following the earnings of the companies whose stocks they own.

"Expensive Shares"

By itself, the price of a stock doesn't tell you a thing about whether you're getting a good deal.


You'll hear people say: "I am avoiding IBM, because at $100 a share it's too expensive." 

• It maybe that they don't have $100 to spend on a share of IBM, but the fact, that a share costs $100 has nothing to do with whether IBM is expensive. 
• A $150,000 Lamborghini is out of most people's price range, but for a Lamborghini, it still might not be expensive. 

Likewise, a $100 share of IBM may be a bargain, or it may not be.  It depends on IBM earnings.

• If IBM is earning $10 a share this year, then you're paying 10 times earnings when you buy a share for $100.  That's a P/E ratio of 10, which in today's market is cheap. 
• On the other hand, if IBM only earns $1 a share, then you're paying 100 times earnings when you buy that $100 share.  That's a P/E ratio of 100, which is way too much to pay for IBM.

'Expensive' shares

Quick Comment: 'Expensive' shares
Some time ago, I had a conversation with my ASX remisier based in Australia and I think some of his comments are worth sharing.

*Me refers to myself when I was speaking to him.
*Investssmart is also myself but from my point of view now.

Me: Good shares in Malaysia are expensive.
Remisier: What do you mean by expensive? When you say expensive, do you mean in absolute terms or in terms of valuation? When I say it is expensive, it normally means overvalued or fully valued. Some companies can trade at $30 but we still call them cheap.
Investssmart: This is very true. The word expensive should be used more carefully when talking about shares. The absolute value does not really count. A Mercedes for $100k is 'cheaper' than a Waja for $60k. It is the value that counts.

Me: Malaysians' perception is that the higher the share price is, the more it can drop.
Remisier: That happens all the time. It is important to remember that we should look at the movements in terms of percentage. If a $50 company can drop to $5, a $5 company can drop to 5c as well. The important thing is to fix the absolute amount you invest. Purchasing 100 shares in a $50 company is the same as purchasing 1000 shares in a $5 company. If both rise by 10%, you will still earn the same amount of $500 no matter which company you invest it.
Investssmart: We should not be put off by the share price. It is the valuation that we should worry about. The chances of IRIS to drop from 90c to 20c is higher than the chances of BKAWAN dropping from $7.80 to $2. But somehow, if you give investors just these two choices, many would rather invest in IRIS because they think it is 'cheaper'!

Remisier: Do you remember me recommending you Rio Tinto ($30), BHP ($15), Woodside ($20) and Cochlear ($25)? You did not purchase any either! Perhaps, this changed your view on 'expensive' stocks!
Investssmart: These four stocks have skyrocketed since his recommendation. They are now about $75, $30, $45 and $50 respectively. Never say that upside of highly priced shares are limited. There is no such thing. Upside of overvalued/expensive shares is limited but upside of highly priced shares is not. Although I did not purchase these shares, it was not because I was scared of the high prices. It was mainly because I did not have the strong confidence in the commodity bull and sadly, I was proven to be wrong. Could have made tonnes more from the ASX. Nevertheless, in a bull market, almost everything on the ASX rose.

Me: I did not buy those few but I still bought some highly priced ones. What would I be trading if I don't buy any highly priced shares? I don't remember you ever recommending me any penny stocks!
Remisier: Good stocks are normally highly priced because the demand for good stocks is very strong. Lowly priced shares are normally those that are speculative or not performing.
Investssmart: It is strange but true to a certain extent. Of course, it does not apply to all company shares.

Strange but could be true: I don't think it is a coincidence that most of the true blue chips throughout the world are trading at high prices. Most of these blue chips have been there for ages. It had to start off somewhere as a smaller company and it takes time to reach where it is today. If the company was trading at $1 ten years ago, it will probably trade at $10 today to be considered a top performer. Otherwise, it would not be considered a blue chip.

Fundamental based investors always look at companies that have excellent track records and therefore, end up investing in highly priced shares. That is because it is very rare that we can get such companies at low prices as share prices should have risen as companies perform well over the years. I doubt fundamental based investors would be interested in companies that trade at low prices over the last few years because that means that they probably do not have a good track record. Of course, this does not apply to all shares but I believe that it is true to a certain extent.

Conclusion: Do not look at how high the share price is. It is the valuation that counts.

Disclaimer: This report is brought to you by Investssmart, an unlicensed investment adviser. Please exercise your own judgment or seek professional advice from your remisiers. By law, they are the experts. I am not responsible for your investment decisions.

http://investssmart.blogspot.com/2006_04_01_archive.html