A reader, Dexter Choo, asked me how did I value SembCorp Industries and determine a "safe price of entry"? Before I go on, I must establish that if we believe that valuation exercises are subjective and this is something I have blogged about many times before, then, it follows that "safety" is also relative.
So, with that in mind, I am going to share in this blog my approach in this instance. Now, please note that I am not saying that this is the right or best approach. It is simply something that makes sense to me and that I am comfortable with. After all, what we do should have a strong connection to our motivations.
For a while now, in view of rising interest rates in the not too distant future, I have been looking to increase my investment in companies which:
1. Are net cash or have very low net gearing.
2. Are able to generate stable earnings.
3. Pay out a good portion of earnings as dividends.
If we look at SembCorp Industries' numbers for the 5 years to 2013, we see that it is generally a net cash company which generates stable earnings. It is also a company with growing NAV/share from $1.86 in 2009 to $2.93 in 2013. Now, as an income investor, the fact that they also pay consistent and meaningful dividends of at least 15c a share (DPS) is important to me.
Now that we have some numbers, we might ask what would be a sensible price to pay for the stock? Depending on the valuation technique we use, we would get different answers.
Personally, in this case, I use a very simple metric, PE ratio (TTM). This looks at the price of the stock today and the earnings in the last 12 months. I might also discount earnings a bit to be more conservative but if by annualising the earnings in the last 6 months I would get a more conservative estimate anyway, I would use that. So, what is a reasonable PE ratio for SembCorp Industries?
Given more normalised circumstances without considering the effect of the Global Financial Crisis in 2008 and the Fiscal Cliff panic in 2011, Mr. Market seems quite happy to pay a price that has a PE ratio of about 11.4x to 13.6x for SembCorp Industries.
Based on an estimated 40c EPS for 2014 and my entry price of $5.04 a share, I got in at an estimated PE ratio of 12.6x. Is it undervalued? Not by a long shot, I don't think so. Then, why did I buy?
Well, apart from the fact that it ticked all my boxes, I reminded myself of an idea by Warren Buffett:
"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
A buy price of $5.04 a share is not fantastic but I believe that it is fair enough.
As an investor, I am also informed by Technical Analysis (TA) which tells me that what price Mr. Market is willing to pay often has to do with sentiments and not fundamentals. So, I also look at charts in an effort to time my entries at prices more reasonable. Of course, we have to remember that TA is about probabilities and not certainties. So, there is no guarantee that prices would not go lower.
I will end by saying that there could always be "safer" prices at which to buy a stock. So, buying SembCorp Industries' stock at the depths of the Global Financial Crisis, for example, at a PE ratio of 7x would have been much safer but that is all I dare to say.
Related posts:
1. When to BUY, HOLD or SELL?
2. SembCorp Industries: A nibble.