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Sanity ALWAYS prevails when investing - EVENTUALLY

by , 04 September 2019
Sanity ALWAYS prevails when investing - EVENTUALLY
Sometimes the stock market behaves inexplicably.

Quality companies trade at unbelievable discounts. Or they sell at prices so high that you might flinch.

What makes this difficult to muster is the fact that these ‘discrepancies' tend to keep going on for much longer than you'd think possible.

One such share was Curro Holdings.

The company listed in July 2011 and investors could pick shares up at R5 each easily. By January 2016 the share price hit R58 - more than a 1,000% return for investors.

And when it pulled back to around R38 in September 2017 analysts told investors ‘Curro is a growth story'. And that it warranted high PE ratios because it had high growth potential.

 
But, as I told investors in a September 2017 newsletter paying for growth at all costs ends up in heartache.
 
Today, Curro trades at R19, a 50% drop from my warning and a 67% drop from the share’s high point. What’s caused the market darling to crash like this? And how could you have spotted it?
 
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High PE’s mean high expectations
 
In my 2017 warning to investors I said that Curro was a high quality business. But that it was going to drop because of high expectations.
 
You see, at the time the share sat on a PE ratio of 68.27.
 
Investors were paying R6.95 for every R1 of revenue Curro generated.
 
My guestimate was that if Curro managed 30% growth in earnings per year for three years it would reach a PE of 31 – and that’s if its share price stayed the same.
 
Simply put – the share would stay expensive even if it reached high growth consistently and its share price didn’t increase for THREE years.
 
This led me to one conclusion – Curro was priced way too optimistically.
 
Any slight blip and Curro would crash…
  
Curro’s growth just couldn’t deliver on its ‘priced to perfection’ shares
  
In December 2017 Curro announced 22% profit growth and 10% growth in earnings per share to 48.1cps (from 43.9cps).
 
Then in December 2018 it announced further profit growth of 19%, with earnings per share increasing 23% to 60.1cps.
 
December 2019 figures will be higher. The company’s June 2019 interim results shows it grew six-month profits from 34.8cps to 50cps. So let’s say it keeps this up for the entire year, earnings would come in at 100cps, up 66%!
 
But at 100cps earnings Curro’s PE at its current share price is still 19.36!
Considering a R38 share price of 2017 it’s PE would’ve been 38!
 
So, if you’d bought Curro shares in 2017 its earnings has grown around 100%, but its share price has halved!
 
And that’s simply because it was WAYYYYY too expensive to start out with.
 
But that’s the thing with the markets – for close to a year I simply sounded like an ‘alarmist’ for say the share is too expensive. Some said that I simply couldn’t gauge the growth potential of the company…
 
But history has proven over and over again – crazy valuations never last. They just last longer than you’d expect them to!
  
________________________________________
 
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What you should look out for before buying the next HOT GROWTH SHARE
 
So what should you look out for before buying the next hot growth share?
 
Is it simply looking for a high or low PE ratio?
 
Nope. Whilst the PE ratio tells us a lot – we should consider a couple of items:
 
Overvalued share warning sign #1 – a high price to sales ratio
 
Take the share price of a company and divide it by the revenue per share. If the answer is below 1 it means the company makes more than R1 revenue per R1 of its share price.
 
If it is above R1 it means that investors pay more than R1 in share price per R1 revenue the company produces. Whilst R2 in share price per R1 in revenue isn’t out of the ordinary anything worse than that becomes a question mark.
 
Curro’s 2017 figure was 6.95 – that means investors paid R6.95 for every R1 the company made in revenue. Or in other terms – revenue had to grow nearly 700% to play catchup with the company’s market value!
 
Overvalued share warning sign #2 – An over optimistic forward earnings figure
 
In September 2017 the consensus was that Curro’s December 2019 earnings would come in at R1.38 per share. That’s 156% growth.
 
Yes, companies grow that much, in as short time periods. But if the share price is already so high that investors REQUIRE this kind of growth to materialise in order to justify the share price you should know there’s trouble…
 
At present it looks like Curro will reach 100cps earnings. That’s still 85% earnings growth. But its less than investors expected – especially since they were paying PE ratio’s of 68 and higher for the share.
 
The fact is that expectations this high means it is VERY easy to disappoint. And even a small disappointment could mean a large drop in share price.
 
Overvalued share warning sign #3 – ‘Experts’ saying the share will continue its upward trend ‘forever’
 
In 2017 broker’s reports stated Curro’s share price will head back up, simply because it was going up in a straight line for the preceding six years.
 
That’s crazy – and you should recognize it as such.
 
A share price doesn’t continue heading up just because it went up rapidly in the past.
 
I can remember the last time people said things like “prices can only go up and won’t go down’ and ‘growth in these prices is a sure thing’.
 
That was just before the 2008 financial crash, and people were saying that ‘because property prices kept going up, they would continue going up’.
 
Think of Cryptocurrencies, people said the same thing before Bitcoin’s massive crash…
 
In short – sanity will prevail on the stock market.
 
Quality shares don’t stay low forever without reason. And companies that are priced for perfection can NEVER live up to hyped up expectations.
 
So keep your wits and never get carried away by sentiment!
     
Here’s to unleashing real value,
Francois Joubert,
Editor, Red Hot Penny Shares 


Sanity ALWAYS prevails when investing - EVENTUALLY
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