The goal is to find companies with extraordinary price returns, either positive or negative, as larger share price movements are more likely to skew the disparity between a company’s price and value. Using the free stock screener available on the Singapore Exchange (SGX), we can filter companies that have experienced the largest price changes over a four-week, 13-week, 26-week, or 52-week (one-year) period.
For companies with market capitalisation above $500 million, the company with the greatest change in share price over one year is Addvalue Technologies, which designs and develops communications technologies and products. Due to the substantial increase in share price, the company’s price ratios all indicate that it is strongly overvalued. For example, its price-to-earnings (P/E) ratio is a whopping 87.5 times, while its price-to-book (P/B) ratio is a massive 25.1 times.
At the other end of the spectrum, the company with one of the largest negative changes in share price over one year is Singapore Post (SingPost). SingPost is a national postal service provider in Singapore. Unlike Addvalue Technologies, SingPost’s price ratios indicate an undervalued company, with a much lower P/E ratio of 13.9 times and a P/B ratio of just 0.5 times.
The question is, are these companies truly overvalued or undervalued? Or is the share price movement not reflective of a change in value or fundamentals of the company?
See also: Investing what-ifs: Conducting a scenario analysis
2. Determining value
The next step is to define and determine what constitutes the company’s “value”. One way is to examine the company’s fundamentals, including all three main financial statements. From the income statement, the revenue and net income can be used. From the balance sheet, the total equity can be used. Operating cash flow (OCF) and free cash flow (FCF) can be used from the cash flow statement.
A weighted blended “value” can then be used, incorporating all five of these fundamentals. For the sake of illustration, let’s use 10% for revenue, 15% for adjusted net income, 20% for total equity, 25% for FCF and the remaining 30% for OCF.
See also: Understanding yields in stock investing
3. Comparison
The comparison to be made is between price growth and the company’s weighted value growth. This should be done over multiple periods, for example, over a one-year, three-year, five-year and 10-year period, if available. The average price and value movement over all these periods should also be compared.
If price growth exceeds weighted value growth in any period, it indicates the company is overvalued. Conversely, if the weighted value growth exceeds the share price growth over the period, it implies that the company is undervalued.
4. Important parameters
The biggest question investors would probably have is whether the starting point of comparison is valid. This method assumes that the starting point, either one year or 10 years ago, is when the company is fairly valued. If the company was already undervalued or overvalued one year ago or 10 years ago, investors would need to account for it by adjusting the company’s weighted value.
For example, let us say that 10 years ago, the company was undervalued by 10%. The price change over the past 10 years was 10% and the weighted value change over this period was also 10%. However, because the company’s starting point is undervalued, the adjusted weighted value change would be 10%+10%, for a total of 20%. Hence, the company is undervalued, as its 10% price growth is lower than the adjusted weighted value growth of 20% over the 10 years.
To determine by how much a company’s starting point is undervalued or overvalued, investors can use the mean or average price-related ratio for the period. For example, if a company trades between 0.5 and 1.0 times P/B over a period, then a mean of 0.75 times P/B can be used as the value indicating the company is fairly valued. If a company’s starting point P/B is 0.9 times, then it is overvalued by (0.90–0.75)/(0.75)=20%.
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Hence, if we say the price growth for this company over that period is 25% and its weighted value growth is 30%, then its adjusted weighted value growth would be 30%–20%, which is just 10% due to its starting-point overvaluation. Since its price growth of 25% exceeds its adjusted weighted value growth of 10%, the company is overvalued for that period.
5. Examples
Chart 1 shows price growth versus value growth for SingPost over five periods. The examined periods are one-year, three-year, five-year, 10-year and 15-year. The average is the key metric for determining whether the company is undervalued, fairly valued or overvalued in this analysis.
Based on the chart, SingPost appears to be slightly undervalued, as the average price growth over the periods is slightly below the average weighted value growth over the same periods. Table 1 shows the individual values for price growth versus value growth, where the company’s weighted value growth exceeds its price growth over 10-year and one-year periods.
This is a basic way of conducting this analysis. Additionally, investors may add features that incorporate factors affecting the variables used to determine the company’s value. This would then result in the “adjusted average weighted value”, as seen in both the chart and table, and discussed previously in point 4.
For SingPost and this example, first, an adjustment is made to the starting point to assess whether the company is overvalued, fairly valued, or undervalued at the start of the period. Price-related ratios, such as P/E, P/B, EV/Ebit and EV/Ebitda, were used to determine this. Secondly, the data used to determine the weighted value is tested for consistency and positive performance. A discount is applied for each period in which SingPost experiences declining revenue, negative net profit, declining total equity, negative operating cash flow (OCF) and negative free cash flow (FCF).
Investors may add or remove variables if they can rationalise and justify them. Based on the adjusted weighted value, however, SingPost appears fairly valued, as its average value growth is very close to its average price growth over the periods examined.
Chart 2 shows Addvalue Tech’s price-to-value growth, and the company is slightly overvalued based on the price-to-value analysis.
Investors should note that any valuation method used in isolation is unlikely to reflect the company’s overall valuation.
To address this, investors can utilise other valuation methods, such as margin-of-safety analysis, discounted cash flow analysis, yield analysis, and more. Although one method may indicate that a company is undervalued, others may give the opposite conclusion.
Hence, the best approach is to use multiple analytical methods to gain greater confidence before deciding to invest in a company. Investors can also use a scoring table that incorporates multiple valuation methods and sets a minimum passing score.
Separately, singular methods, such as this price-to-value analysis, may be useful as an initial filter for investable companies. It is a great way to save time by shortlisting companies that are potentially undervalued.
Finally, the analysis methods mentioned are mainly quantitative. Investors should attempt to understand and rationalise businesses qualitatively before deciding to invest in them.
Disclaimer: This article is strictly for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy or sell stocks, including the stocks mentioned. Any personal investments should be made at the investor’s discretion and after consulting licensed investment professionals, at the investor’s own risk. The author of this article does not hold or own any stock featured in this article or have a vested interest in it at the time of writing.
