Knowing how cheap the stock market currently is, can help us to simplify our investing decision.
There are two methods to find out if Singapore stocks are a steal or are in an overheated territory right now.
The first method is to compare the market’s current price-to-earnings (PE) ratio to the market’s long-term average PE ratio.
The second method is to determine the number of net-net stocks in the market.
With that, let’s check out if the local stock market is cheap or expensive.
The first method
The local stock market can be represented by the Straits Times Index (SGX: ^STI), or STI for short. It consists of the 30 biggest stocks in Singapore.
Since it is difficult to get the past daily PE ratios of the index, the PE ratios of SPDR STI ETF (SGX: ES3) can be used as a proxy. The SPDR STI ETF is an exchange-traded fund (ETF) that replicates the performance of the STI.
As of 14 May 2018, the SPDR STI ETF had a PE ratio of 11.6. Here are some of the other important PE ratios that we need:
1) The long-term average PE ratio: The STI’s average PE ratio from 1973 to 2010 was 16.9;
2) An instance of a high PE ratio for the STI: Back in 1973, the index’s PE ratio hit 35; and
3) An instance of a low PE ratio for the STI: At the start of 2009, the index was valued at 6 times its trailing earnings.
Based on the data above, it is realistic to say that stocks in Singapore are cheaper than average now.
The second method
In this method, we will look at the number of net-net stocks available in the local market.
A net-net stock is a stock with a market capitalisation that is lower than its net current asset value. The net current asset value can be calculated using the following formula:
Net current asset value = Total current assets – Total liabilities
In theory, a net-net stock is a steal as investors can get a discount on the company’s current assets, such as cash, after stripping off all liabilities. Moreover, the company’s fixed assets, such as properties, are thrown into the mix for free.
Logic holds that if a large number of net-net stocks than usual can be found in a stock market at a certain point in time, then stocks would likely to be cheap at that moment.
The following is a chart that shows the net-net stock count in Singapore since 2005:
Source: S&P Global Market Intelligence
Two things are worth noting about the chart.
Firstly, the second-half of 2007 saw the net-net stock count fall to a low of below 50. This was when the STI reached a peak before the Great Financial Crisis struck.
Secondly, the first-half of 2009 was when the net-net stock count hit a high of nearly 200. It was during this time that the STI reached its bottom during the crisis.
We can observe an inverse relationship from the chart – when the STI is at a peak, the net-net stock count is low, and when the STI is at a low, the net-net stock count is high.
As of 14 May 2018, there were 92 net-net stocks. This is comfortably between the net-net stock count’s peak-and-trough from 2005 till today.
A Foolish takeaway
We’ve walked through two ways to find out the state of Singapore’s stock market right now, and they both point to a similar conclusion. That is, stocks here are not that expensive, but they not in a deep bargain region either.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Sudhan P doesn't own shares in any companies mentioned.