Warren Buffet once said: “Do not depend on a single income. Invest and create a second/third source of income”. His advice suggests that savings alone aren’t enough to keep your finances secure. Instead, one of the best ways to make your money work harder is through investing.
The number of investors entering the market has been on the rise, especially for account holders aged 25 years and below. This age group has seen a 50.9% increase in the number of new Central Depository System (CDS) accounts from 2015 to 2017.
However, the majority of CDS account holders in Malaysia are those between the ages of 46 and 55 years, which means despite efforts being made to educate younger generations on the benefits of investing, very few know how or even where to start. It also points to the fact that many of the younger generation feel that they cannot afford to invest yet.
If you’re new to investing, it can be challenging to figure out where to start and what sort of stocks to look out for. But if there’s another lesson to take from Buffet, it’s that buying stocks that are undervalued is a key component to his value investing strategy.
What are undervalued stocks?
An undervalued stock is one that is selling at a discounted price, relative to its ‘intrinsic value’. Looking for undervalued stocks is part of a strategy called value investing. Value investors look for undervalued stocks in the hopes that they will eventually rise to reflect their intrinsic value.
How to find undervalued stocks
The challenge is figuring out which stock is undervalued. Value investors typically look at a company’s financial statements and analyse its fundamentals, such as cash flow, return on assets, profit retention and capital management, to determine its stock’s intrinsic value. However, different investors have different valuation methodologies to calculate intrinsic value.
Nevertheless, there are a few key indicators you can use to determine if a stock is undervalued:
| Valuation | Best Used For | Calculation |
|---|---|---|
| Price-to-earnings (P/E) | Determining if a stock is undervalued | P/E = share price ÷ earnings per share (EPS) |
| Price-to-book (P/B) | Valuating asset-based companies such as banking or property stocks | P/BV = share price ÷ book value per share |
| Price-to-earnings growth (PEG) | Assessing a company's growth | Price earnings growth = price-to-earnings (P/E) ÷ growth rate |
| Return on equity (ROE) | Measuring how effectively a company is using its assets to generate profits | Return on equity = net income ÷ average Shareholders’ equity |
| Dividend yield | Determining how much a company pays out in dividends | Dividend yield = annual dividend ÷ current stock price |
a) Price-to-earnings (P/E) ratio
Out of these valuations, the most commonly used to figure out if a stock is undervalued is the P/E ratio. Price over earnings is used to indicate how far the stock price is compared to its earnings. For example, a P/E of five means that the stock price is 5x times the company earnings, which means an investor will likely break even after 5 years given the same earning every year. Generally, a stock is considered undervalued if its P/E is below 15.
b) Price-to-book (P/B) ratio
The P/B ratio compares a company’s market capitalisation to its book value. In other words, this ratio shows you how much investors are paying for each dollar of the business’s net assets.
Typically, a P/B ratio of under one indicates an undervalued stock, although some value investors also consider stocks with a value of under three.
c) Price-to-earnings growth (PEG)
The PEG ratio builds on the PE ratio by factoring in the expected earnings growth. A PEG ratio of less than one is considered to indicate an undervalued stock, while a PEG ratio of more than one could mean that the stock is overvalued.
d) Return on equity (ROE)
The ROE is a measure of how effectively a company is using its assets to generate profits. A higher ROE denotes higher efficiency.
e) Dividend yield
While a stock’s dividend yield is less commonly used to screen out undervalued stocks, it’s nonetheless a useful metric. A stock with a high dividend yield can be due to a drop in share price, thereby pushing yield rates up – this drop in prices can indicate potential undervalue.
Having regular dividends can also be useful to a value investor, as it provides consistent income while the investor waits for the stock to move up in price.
A high dividend yield isn’t always a good thing, however. If a company does not have a consistent history of earnings, or has just taken on huge debt, it could have trouble sustaining its dividend yield. It could also indicate that a company is not reinvesting enough cash to grow the business, but instead paying it out to investors.
5 potentially undervalued stocks in Malaysia
Jerry Lee, a research analyst from iFAST Capital Sdn Bhd, suggests comparing the current P/E ratio of the market against the fair P/E ratio assigned to the particular market. Both earnings growth and dividend yield also play important roles in determining the level of attractiveness of a market.
Ian Tai, the founder of BursaKing, says his way of defining if a stock is undervalued is if their P/E is below 10 and it gives a dividend of around 6% and above.
Taking into consideration both suggestions, we’ve screened out a few stocks based on these metrics:
- P/E < 10
- P/BV < 3
- PEG < 1
- ROE > 10%
While we are listing stocks that may be undervalued based on several key metrics, you should not treat this as a recommendation to buy any particular stock. It’s important that you do your own research when investing in the stock market.
Focus Lumber Berhad is engaged in the manufacturing and sale of plywood, veneer and laminated veneer lumber, and investment holding. Its subsidiaries are engaged in the generation and sale of electricity.
Its operating profit dropped in 2016 and 2017, but has rebounded again in 2018. Its dividend yield for the past 12 months currently stands at a high 10.51%.
Interested investors should be aware, however, that most of the company’s revenue is derived from exports to the US market, and almost half (45%) of its revenue in 2018 was from a single customer, Ihlo Sales & Import Co.
This REIT’s portfolio includes 15 properties that span across retail, industrial, hotels, education and office sectors:
- Vista Tower, The Intermark
- Contraves, Cyberjaya
- Deluge Factory, Nusajaya
- Toshiba Tec Malaysia, Shah Alam
- Wisma Comcorp, Shah Alam
- Selayang Mall, Selayang
- Gurun Automotive Warehouse, Gurun
- AIC Factory, Shah Alam
- SEGi University Kota Damansara
- SEGi College, Subang Jaya
- Holiday Villa Langkawi
- Holiday Villa Alor Setar
- Dana13, Dana 1 Commercial Centre Petaling Jaya
- Block A & B South City Plaza, Seri Kembangan
- HELP University Jalan Semantan
AmanahRaya REIT’s after-tax earnings dipped in 2015 and 2016, but has shown positive growth in the past two years.
If you’re looking for an investment with a diversified property portfolio and a relatively high dividend yield, this may be the REIT for you.
MBM Resources Berhad’s two core businesses are motor trading (distributorship and dealership of major international vehicle brands of vehicles in Malaysia) and automotive parts manufacturing.
Its P/E ratio of 6.2 is considered low when compared to the larger automobiles and auto parts industry, which currently stands at an average of 13.9.
MBM Resources also has a 20% shareholder’s stake in Perodua, so investors looking to get exposure to Malaysia’s largest car manufacturer could consider this stock.
Poh Huat manufactures office and home furniture, and is one of the leading furniture exporters in Southeast Asia. Its main export markets are North America, India, United Kingdom, Middle East, and Southeast Asia.
Poh Huat could stand to profit from the ongoing US-China trade war, as US importers turn away from Chinese exports, presenting opportunities for Poh Huat to gain market share.
GDB Holdings is principally involved in the provision of construction services, focusing on high-rise residential, commercial and mixed development projects.
Its after-tax profit has consistently grown from the years 2014 to 2018. It has also steadily grown its assets in the past five years. At the moment, its dividend yield is an attractive 6.78%.
However, a key risk that the company faces is the oversupply of residential properties, particularly in the Klang Valley. This may dissuade property developers from undertaking new launches, making it difficult for GDB Holdings to acquire new contracts.
Are undervalued stocks really worth it?
The stock market moves in cycles, moving from low to high over time. This cyclical nature of the market often holds no prisoners, meaning good stocks also are up for grabs once in a while.
So as the market declines, stocks as a whole become undervalued simply because people are pessimistic over their value, pushing them down to extreme levels. It’s during this time where investors have the opportunity to buy stocks at low prices; and because stocks can rise back up as the market cycles, these stocks can potentially produce long-term profits. The only problem here is there is no precise way to know when a decline will end, so you might face further downside risks.
However that shouldn’t deter you. Like all investing ventures, the first thing you need to do is thoroughly research the stocks you want to put your money in.
Second, spread your risk. You can do this by diversifying your investments into different assets, instruments, and industries.
Third, start now. Don’t wait for the next market crash to start investing, as time in the market is more effective than timing the market. If you’re young, you’ll also want to take advantage of your long time horizon, as a longer horizon gives your portfolio more time to grow.
This article was originally published on January 11, 2018.
