17 August 2012

Buy Shares Based on Book Value or Earning Power?

For some investors who are more on fundamental analysis, they would sometime confused with the methods of identifying undervalued stock. Basically the market tries to separate the investment methods to two main categories - Value Investing or Growth Investing.

For Value Investing, majority of the indicators was Price Multipliers, such as Price/Earnings, Price/Book or Price/Sales ratios. All of these give hints to the investors to purchase the stocks when the price drops below the average price multipliers level and sell the stock when the prices are at high range level. Those stocks which fall into this category normally are due to unpopularity. Reasons could be in unfavourable industry, or the company is having structural changes, or because of the unexpected loss. 

In contrast to Value Investing, the investors would love to purchase stocks with high and consistent growth perspective. They do not mind to buy a company with higher growing power at higher price, as long as the company can grow bigger in term of revenue and net profit to certain size. I believe that most of the younger investors would prefer Growth Investing, due to the reasons of the potential EPS growth in near futures.

Of course, above are just the summary of the fundamental analysis. Should we really segregate or put ourselves in to just one category? In my own opinion, I would prefer to combine both in my investment strategy.

For most of the time, I prefer smaller market size listed companies for some reasons:
  • Smaller size listed company normally controlled by majority shareholders / management
  • Lesser interest from fund houses / research analysts due to some constraints set by the fund houses itself
  • It could be a multi-bagger if the stocks you selected could grow in PE when the earning grows bigger and market size become bigger and attract spot lights from the analysts 
Of course the cons could be higher premium paid due to illiquid volume and smaller size of the company. If we do more homework by understanding the business model and how the company reacts during difficult period ('Integrity' plays a big part here), we stand a higher chance to earn more in the stock market.

I too prefer low price multiplier stock with high growth prospect. But it seldom occurs in the market. So what we can do is to be patience, and wait for the opportunities to come.

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