Buy Low, Sell High: It’s Not That Simple

Foreword from ShareInvestor

This article “Buy Low, Sell High: It’s Not That Simple” by Lorna Tan was first published in The Sunday Times on 13 Jul 2008 and is reproduced in this blog in its entirety.

The general rule of thumb in stock investing may seem straightforward, but it is not as easy as it sounds. Lorna Tan asks experts for their investing strategies and tips

Every stock market investor knows the old adage: Buy low, sell high. It sounds easy but in reality, most will agree that it is not always possible to catch stocks at their lows and their highs.

Even seasoned investors are caught in a bind when markets head south and there is negative news all around.

Since the start of this year, the Straits Times Index has slipped about 15.5 per cent.

One burning question that pops up often: When does one buy and when should one exit the market?

With the current volatile market exhibiting unclear signs on where it is heading, experts like Ms Carmen Lee, head of research at OCBC Investment Research, advocate investing in blue-chip stocks.

On the other hand, Mr Winston Chong, a director of financial advisory company Life Planning Associates, prefers undervalued stocks as they tend to be under-researched and overlooked by analysts and thus result in great bargains.

Selling at the right time is also crucial. Mr Dennis Ng, an avid stock investor and founder of mortgage consultancy portal, is sitting on a 300 per cent gain over four years after he sold 80 per cent of his stocks last year. Now flush with cash, he is stock fishing.

Here are some investing strategies recommended by experts:

Photo Illustration: Mike M Dizon and Ng Sor Luan

Buying Strategies

Target And Hold Blue Chips

For investors without the luxury of time to constantly monitor the market, it is best to stick to investing in core blue chips with good fundamentals, profitable track records and strong management.

Said Ms Lee: “In these uncertain market conditions, we advocate a stock pick strategy of investing in quality stocks, which may still be subject to the present weak market conditions, but are better positioned to post good long-term growth.”

So if you are already invested, re-examine your holdings. If your investments are quality stocks, hold on to them and look to buy more if prices ease further. This is because such stocks are traditionally the first to move up in any uptrend.

In addition, most blue chips in Singapore offer fairly decent dividend yields which will also support interest in these stocks at lower levels.

Bank On Promising Business Models

Mr Ben Fok, chief executive officer of Grandtag Financial Consultancy, will buy a share if he likes the business model of the company.

“I will hold on to a share as long as I still believe the business model will still work in the future,” he said.

That is why he is still invested in water-treatment company Hyflux. “Water treatment is a specialised area and there is a high entry barrier to the industry,” he explained.

He had first bought Hyflux shares in 2004.

However, if you had bought technology stocks during the tech bubble in 2001 and are still hoping for a recovery, Mr Fok cautioned that it is unlikely to happen. This is because the upsurge then was built on promised earnings potential that did not materialise.

Aim For ‘Turnaround’ Companies

Ignored by most investors, investing in companies that are turning around is one of Mr Ng’s favourite strategies.

The trick is to look for companies which have a history of incurring losses for a couple of years.

By studying the developments of such companies in detail, you may find some that are about to “turn the corner” and become profitable again.

This was what led to his purchase of MediaRing two years ago at 17 cents per share and China Aviation Oil (CAO) at $1.50 a share a few months ago.

An additional factor to consider before buying into turnaround companies is to ensure that they are not buried in debt.

“For MediaRing and CAO, I bought them after previous debts were settled through debt-restructuring deals,” he said.

Mr Ng sold his MediaRing shares and some CAO shares at 30 cents and $2.50 respectively last year.

Look Out For Bad News

Another buy strategy is to rely on bad news.

For example, some share prices decline because of poor earnings for a particular quarter. Mr Fok said that if this is likely to be a temporary phase the company is going through and that its earnings may go back to being robust in the next few quarters, it may be worth it investing in the company.

An exception to this is when the company is in dire financial straits which may lead to insolvency.

Tip: Study the bad news first.

Spot Undervalued Stocks Using PE Ratio

You can use the price-earnings (PE) ratio as a tool to find undervalued stocks.

For instance, spot a stock which is selling at low PE ratios and heading for robust earnings growth. This way, your downside risk is likely to be smaller and your upside potential promising.

PE ratio is the ratio of the current stock price to its earnings over the last 12 months.

For example, a company trading at $21 a share and with earnings over the last 12 months of $1.20 a share would have a PE ratio of 17.5. The PE is also known as the earnings multiple or price multiple, as it shows how much investors are willing to pay per dollar of earnings.

A high PE for a company generally implies that investors expect it to have high earnings growth.

Singapore Exchange vice-president for private investors Stephen Tan noted that PE ratios should be used to compare against those in other companies in the same industry or against the company’s own historical PE.

It would not be useful to compare companies in different industries as their prospects are very different, he said.

Identify Bargain Buys Using PB Ratio

Stocks that trade at a discount to their historical book value are prime candidates for an investor looking for undervalued firms.

A low price-book (PB) ratio means that you would be buying the business at a bargain as it would be worth more if broken up and sold piecemeal, said Mr Tan.

The book value or net tangible assets of a company are usually calculated using this formula: Total Assets-(Intangible Assets + Liabilities).

When Mr Ng bought Metro shares at 78 cents in September 2006, it was trading at a 44 per cent discount to its net tangible asset figure.

But this strategy applies mainly to property and finance companies which depend largely on their assets to make money. For the former, their main assets are properties while for finance companies, their main assets are the loan portfolios they hold.

Selling Strategies

Mr Ng and Mr Fok agree that the decision to Mr Ng and Mr Fok agree that the decision to sell is often more difficult than to buy.

Mr Fok noted: “Greed and fear always come in.”

For him, the best time to sell is when you need the money, when the price has reached your target, or when the stock has failed to re-invent itself.

“For those who understand technical analysis, when the charts show heavy volume and the stock declines in value, it shows that something is not right. In this case, supply exceeds demand, hence price will fall,” he said.

“I will also sell when the big boys are selling.”

Mr Ng said that he would typically sell if the company’s PE ratio is above 20. That was what prompted him to sell his Osim shares in 2006 after holding them through four years of impressive profit growth.

[To be continued: Second part of this article on the Pitfalls To Avoid When Investing In Stocks]