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Investing in Raffles Medical Group.

Monday, June 18, 2018

I revealed earlier in the year that I have a few hundred drafts in my blogging account, these are blogs which I started and did not finish.

It is terrible, I know.

There were always so many things going on in my mind and I am sure they contributed to my sleeping problem in the past.

Things have improved for me on the mental health front as I try not to think too much these days.

Anyway, this blog on Raffles Medical Group (RMG) was one of those drafts. 

It was more than a year ago when I started this.

OK, enough rambling.

When I looked at RMG together with Healthway Medical many years ago at around the time of  the Global Financial Crisis, RMG's historical PE ratio was 21x.

That provided a guide for me as to what might be a fair price to pay for a stake in RMG today if there has not been any major changes to its business.

With a PE ratio of about 33x in early 2017, I decided that RMG definitely wasn't cheap.

I thought if its share price should decline by a third, we would see a price movement approximately to its mean.

At the time in early 2017, RMG was trading at about $1.50 a share.

So, a one third decline in share price would give me a target buy price of $1.

Pay $1.50 a share?

Not for me.

Investors who invested in RMG at a PE ratio of 30x or higher had to expect RMG to register phenomenal growth in earnings year after year.

Otherwise, why would they value RMG so highly?

Personally, I could not see phenomenal growth in RMG's earnings happening especially with all the capital expenditure (CAPEX) and also the expected increase in operational expenditure (OPEX).

As RMG's share price plunged over time, I received emails from some readers who asked me to talk to myself but I declined.

They should talk to themselves and ask why did they invest in RMG at higher prices?

Were they investing for growth or were they speculating?

Believing that RMG would deliver phenomenal growth in earnings and accepting a very high PE ratio, they should understand that if growth should falter, Mr. Market could go into a depression.

This is a key risk factor when paying prices which reflect high expectations for growth and this is usually represented by a high PE ratio.

Of course, Mr. Market's optimism could create opportunities for investors of the more patient variety who prefer getting more value for money.

After all, the swing from optimism to pessimism could be quite dramatic and we really should be buying when Mr. Market is feeling pessimistic.

Don't blame the analysts, professional or amateur (including bloggers).

Good or bad, they probably had their plans.

Ask what is our plan?

The truth is RMG is facing some challenges.

With medical tourism in Singapore facing stiff regional competition and ongoing CAPEX with attending start up costs to be seen in their new Chinese hospitals through 2018 and even 2019, earnings at RMG would probably take not one but several hits.

It would, therefore, be a good idea to demand a bigger margin of safety which, of course, means demanding a lower entry price, everything else remaining equal.

Although RMG has a good track record of growing value for shareholders over the years, if we want a better outcome for our investment, it would make sense to pay a more reasonable price.

What is a more reasonable price?

Regular readers know that one method I use is to compare with crisis valuation to help determine if a stock is cheap.

RMG's lowest PE ratio was about 14x. This was during the GFC (2009). So, assuming earnings bottom at 4c a share, at about 56c a share, RMG would hit crisis valuation.

Not expecting another GFC, I decided that paying anything below its historical mean (21x) is probably a bargain.

So, paying anything below 84c a share should provide me with a good starting point.

In September 2017, when RMG hit $1.03 a share, I thought it was still expensive. 

Assuming an EPS of 4c, PE ratio was almost 26x.

Of course, Mr. Market didn't care what I thought and RMG saw its share price recovered.

I decided then that perhaps I should not wait for 84c and that I could nibble if it should ever touch $1 a share (i.e. PE ratio of 25x)

A PE ratio of 25x is significantly lower than 33x but, to be honest, I would still be buying into the expectation that RMG's Chinese investments would do well and lift earnings in a spectacular fashion in future.

If nothing goes terribly wrong, perhaps, the year 2020 is when earnings would improve more meaningfully for RMG.

So, investing in RMG now is to invest in growth but expectations should be realistic.

At $1 a share, dividend yield is about 2%.

So, it probably wouldn't appeal to the purist income investor. 

I got my foot in the door by paying $1 a share but unless the price goes lower from here, I am keeping my investment relatively small.

Related post:
Investing philosophy is timeless.


csky said...

Hi AK,

Have you looked at Singmedical? Seems like there is some value there but not sure why price got hammered down with the recent rights issue. Market price is actually lower than rights price. EPS for FY17 was 1.99 cents, that was excluding earnings from several acquisitions they made in FY17. EPS for Q118 was 0.74 cents, if we annualized that, we will get EPS of 3cents. But even if we conservatively estimate EPS at 2.5 cents, at current price of $0.46, PE is about 19x. Would that be considered undervalued for a medical stock?

Management include Tony Tan who previously sort of started Parkway. CEO and Chairman each hold >10% and have committed to fully subscribe to their share of the rights.

AK71 said...

Hi csky,

My preference is for RMG because it has a long and strong track record.

I think I will stick with what I am more familiar with here. ;)

K said...

Hi AK,

Is there a free website to find historical PE ratio of a particular counter? Thanks.

AK71 said...

Hi K,

You can try Yahoo!Finance but I think doing our own numbers would be more accurate.

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