Valuations, valuations, valuations:
Based on the P/B chart, the STI is cheap – trading not too far off the lows of 2016.
The banks now have really driven valuations lower as we talked about in our recent webinar on banks.
About the Straits Times Index:
The FTSE Straits Times Index (STI) is a capitalisation-weighted stock market index that is regarded as the benchmark index for the Singapore stock market. It tracks the performance of the top 30 companies listed on the Singapore Exchange.
What’s Price-to-Book?
The price-to-book chart (P/B chart) is a useful complement for investors trying to understand how cheap or expensive a certain sector or country is.
In the case of Singapore, the Straits Times Index is dominated by many traditional businesses such as the three banks (UOB, OCBC, DBS) and the P/B chart is a decent proxy for investors to assess how expensive or cheap the market is.
iShares MSCI Singapore Index
More on the Price-To-Book Ratio
The price-to-book ratio is a useful valuation metric that allows us to understand a company’s valuation by comparing its price relative to its net asset value.
Net asset value can also be known as book value or shareholder equity.
P/B ratio = price per share / book value per share
OR
market capitalization (i.e. market cap) / shareholder equity
whereby market capitalisation is simply the number of shares x price
Book value = assets – liabilities
Book Value or Net Asset Value or Shareholder Equity
Book value or shareholders equity is essentially what is owned by the shareholders of the company.
Using a simple analogy, imagine you bought a flat that was worth $1,000,000.
Property asset value: $1,000,000
Your own cash: $200,000
Bank loan: $800,000
Your Equity: $1,000,000 – $800,000 = $200,000
Even though you now control an asset that is worth $1,000,000 – what is actually yours still remains the same. If the property is liquidated, the cash proceeds would go to pay off the bank loan and the reminder which is $200,000 would returned to you.
In the context of a company, the same principle applies.
All companies possess assets and liabilities. Shareholder equity simply represents what is owned by the shareholders once you net off the company’s liabilities.
This value can be a proxy in the case that a business liquidates itself although in practise, this rarely happens for large stocks. Also, it is worth mentioning that asset values are dictated by accounting practises and do not necessarily represent actual market prices.
For example, a car which has been depreciated on a straight-line basis may not actually fetch that value if sold because of its actual condition.
When we talk about liabilities, it doesn’t just refer to bank loans but could include other things such as accounts payables (i.e. money owned to other people), preferences shares and so on.
Tangible assets vs intangible assets
Companies were traditionally valued based on their “tangible assets” – think things you can see, touch and feel. However, intangible assets (for example intellectual property) play a much bigger part in many companies these days.
For example, in the case of Microsoft, the real value of the business does not lie in its buildings or equipment. Rather, it lies in its intellectual property like its operating system and Microsoft Office.
Still, many businesses in Asia are still quite traditional in nature and using net asset value is a decent proxy especially when it comes to businesses such as banks and property firms.
PS: We’ve recently launched our free mini online course for readers covering the core principles of the investing framework of Warren Buffett, the worlds most successful investor. Sign up to find out more about it!
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