“And that’s the problem, high P/E ratio fucks you upside down…”
When I buy stocks, I look at the transaction like how I approach buying a private business. I want to look at the prospects of the business and the people running the company.
More importantly, I want to look at the price I’m paying.
One simple measure of buying shares at the right price is the “price-to-earnings”, or P/E ratio.
Say a company trades at 30x P/E. This means that its shares are trading at 30 years’ worth of net earnings. If this company’s net earnings is $1 per share per year, you’re paying $30 to buy its earnings.
In other words, if you buy the entire business and if the business continues to earn as much money as it does today, it takes 30 years to get your money back.
Typically, when I look at businesses, I like to buy shares that trade for less than 30 years’ worth of net earnings.
Sometimes, people will tell me to ignore very high P/E ratio. Because these companies with high P/E ratio can grow so fast it doesn’t matter what the price means today.
But what if the market overjudges a shares’ underlying business value?
This Singapore Share Keeps Going Higher and Higher
iFAST Corporation Ltd (SGX:AIY) is one of the fastest growing Singapore-listed companies today. It grew a massive 1,072% over the last year. And hit a market cap of S$2.5 billion.
In its recent half-yearly results, iFAST continued to grow at breakneck speed. Its revenues and net earnings grew 31% and 55% respectively — producing S$106 million and S$15 million respectively.
iFAST started only during the dotcom era of 2000. And since then, it has become one of Singapore’s biggest online financial platform.
In my opinion, iFAST’s platform different from its peers. It’s user-focused, making it easy for customers to buy and sell investment products online.
And because of the “network effect” it generates, assets that iFAST advises for its customers grew to S$17.5 billion.
That’s more than doubled from a year ago.
As long as you deposit funds with iFAST to trade your shares, they are considered assets that iFAST advises.
There’s no doubt iFAST is a wonderful business.
Singapore is poised to be the next biggest financial hub in Asia, after Hong Kong. As far as I’m concerned, no other players could match iFast’s convenient online financial supermarket.
But the stock is fairly expensive.
A Singapore Share That Breaks Even After 100 Years
Just a quick look, iFast trades for 90 years’ worth of net earnings. That’s a crazy 90x P/E ratio.
Source: Yahoo! Finance
If you bought the whole iFAST business today and iFAST continued to earn as much money as it does today, you’d take close to a century to breakeven your investments.
At 90x PE, the market is expecting iFAST to grow at breakneck speed “forever”.
iFAST gains from its online financial supermarket aren’t over. But telling me that iFAST’s earnings will grow faster than 55% is unreal.
iFAST’s main revenue source comes from Singapore. But a closer look will tell you that most of its high growth regions come from Hong Kong, Malaysia and China.
It’s only last year that Singapore grew at 34%. Even then, iFAST only grew assets by 17%, 13% and 6% in 2017, 2018 and 2019 respectively in Singapore.
The stock market thinks iFAST can gather assets at hyperspeed.
Source: iFAST Corporation Presentation Slides
Here’s the other thing.
Stock Market is Sober Over the Long Run
As high growth companies continue to grow, its P/E ratio will continue to fall. This is because the rate of growth slows at some point. The stock market becomes sober over the long run.
Imagine: if iFAST grows at 55% earnings today. And the next year, its growth falls to 20%, 30%, or 40%, short of what the market wants. what would the market think?
Obviously, it’s not going to be happy. It’s human nature. People always want more.
And if they can’t get it, well, its P/E ratio falls. Even though iFAST still earns as much as it is today, its share price falls. Simple as that.
And that’s the problem, high P/E ratio fucks you upside down this way.
In the long run, strong businesses grow in an upward manner. But in the short run, it face challenges. Sometimes, it has good quarterly results. Sometimes, it has bad quarterly results.
It’s the time when the market realizes a businesses may not grow much faster than it does today. That it abandons all hope on the shares.
I call this euphoria.
I like iFAST. I think it’s a good business and should do well. It has the tailwind of Singapore as a wealth hub. But what I’m extremely careful is the crazy price I’m paying for iFast’s earnings. You only need one not so good quarter to plunge the entire share price.
Sometimes investing can be simple.
Always here for you,
Willie Keng, CFA
Founder, Dividend Titan
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