Understanding price returns in share investing

PHOTO: Understanding price returns in share investing

Investor generally invest for two reasons.

First, they attempt to cash in on the price returns, which are reflected in the rise in the market price of the specific share upon liquidation.

Second, they benefit from the potential earnings that are periodically paid out to shareholders, otherwise also known as dividend returns.

A good investment opportunity should entail both strong price and dividend returns. However, some investors tend to focus on potential price returns with little regard for dividend returns, or vice versa.

In this second issue of the Mind Your Money Series, we will look at the concept of price returns and the factors that drive the growth and decline of market prices of different stocks.

Next month, we will explore dividend and total returns.

What influences price returns

From most investors' point of view, parting with cash to purchase a company's stocks serves one purpose: wealth accumulation in the future because the investors believe that there are potential price gains to be reaped.

So it follows that the price of a stock not only indicates a company's current value, but also reflects the growth that investors expect in the future.

An investor can choose to invest in blue-chip stocks, which are those of well-established companies with stable cash flows and strong management teams, as outlined in the Securities Investors Association (Singapore) Investment Guide Book.

Typically, blue chips pay regular dividends and would have had considerable long-term price returns in the past.

Otherwise, the investor can also consider growth stocks, which are shares of rapidly growing firms. Such companies typically plough back their earnings into the business, and hence their shares tend to experience more price fluctuations.

What sort of price returns have Singapore stocks showed in the past?

Consider the Straits Times Index (STI).

Like every stock market in the world, Singapore's stock market has a key stock market index - the STI.

In the same way the consumer price index (CPI) measures how much prices of goods and services have moved during a certain period, the STI is a barometer of how much the Singapore stock market has moved over a certain time.

The CPI is made up of a basket of certain goods and services. Similarly, the STI is made up of a basket of stocks of 30 companies.

If one were to look at the current STI stocks that have been listed for at least five years, it is clear that many have performed creditably.

Of the 30 stocks comprising the STI, 27, or 90 per cent, were listed more than five years ago.

Over these five years, the 30 stocks have shown price movements ranging from a 5 per cent fall for Singapore Airlines to a 270 per cent rise for Genting.

If the price movements were arranged from the lowest to the highest, the median (or statistical middle) of the price moves of the 27 stocks would be a 68 per cent rise by Noble Group.

Do remember, though, that past price movements of stocks do not mean they will behave in the same way in future.

In other words, past performance is not a guarantee of future returns.

Suppose an investor wants to start investing in stocks. How can he start?

A good way is to undertake a regular and long-term investing strategy by using regular share savings plans, which was covered by this column last month.

Using the Price-to-Earnings Ratio (P/E Ratio)

Apart from considering the price moves of a stock over time, investors also may want to review its price-to-earnings ratio, or P/E ratio.

The P/E ratio of a company is calculated by taking the price of one share and dividing it by the earnings per share.

The P/E ratio of a company can be compared with the P/E ratio of another company to determine whether one is higher- or lower-priced compared with the other if their earnings were the same.

If the P/E ratio of company A is higher than that of company B, then one may surmise that company A is higher priced than company B for their respective earnings.

The P/E ratio of an entire industry can be calculated by averaging the P/E ratios of all companies within that sector.

P/E ratios may vary vastly when comparing one market with another, or one industry with another.

While it is a useful measure, it is not the be all and end all when it comes to investment decisions. As investors, we should always try to obtain as much information as possible before investing.

The writer is a market strategist at Singapore Exchange.

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