Equities or stocks as spoke about previously, usually represents an ownership in the company. It denotes the real value of one’s stake in an investment as investors who purchase stocks in a company are usually vested in their own personal equity in that company. This personal equity is represented by the amount of shares they own. Owning shares in a company should ideally yield capital gains for the shareholder over time, as well as receive potential dividend gains. I will be using Religare Health Trust as our example today.
A little introduction on RHT Health Trust (SGX: RF1U), formerly known as Religare Health Trust, is the first business trust listed on the Singapore Exchange Securities with India-based healthcare assets. They invest primarily in medical and healthcare assets and services in Asia, Australasia, and emerging markets in the rest of the world. The Company has a portfolio of strategically located Clinical Establishments and 2 Operating Hospitals. RHT Health Trust Manager is the trustee-manager of the Company. As at time of writing, its NAV stands at $0.875, PE: 27.05, PB: 0.95, Yield: 8.43% and market capitalization is $709.57 million.
Value Investing Principles
The essence of value investing is the process of identifying companies that are fundamentally and financially sound, but whose stock is trading substantially below the genuine, intrinsic value of company shares. This is definitely not the same as buying cheap stocks. Now that we know the business trust’s current price, let’s work out how much growth the market’s expecting the trust to achieve.
In this example, we’ll be using a simple dividend growth model also known as the Gordon Growth Model to determine the intrinsic value of a stock based on how much growth the market is expecting from the trust’s future dividend distributions. The below sets to find out the market value of the trust’s share price for the past 5 years.
|Share price ($)||0.855||1.085||0.965|
|Return on Equity (%)||5.84||5.08||5.76|
|Dividend per share (¢)||8.19||7.32||7.72|
|Earnings per share (¢)||5.25||4.72||5.46|
|Dividend Payout Ratio||1.56||1.55||1.41|
Since unsystematic risk can virtually be eliminated in a well-diversified portfolio, the only risk affecting that portfolio is systematic risk. As such, investors like us would need a return for that risk. Since the Capital Asset Pricing Model (CAPM) is most widely debated in the empirical financial literature, let us use it to estimate the required rate of return for Religare Health Trust. The formula for CAPM is as follows:-
Ri = Rf + [β(Rm – Rf)]
Where Ri = required rate of return
Rf = risk free rate
Β = company beta
Rm = market rate
The risk free rate is normally taken to be the 10-year government bond yield; currently this yield on a 10-year Singapore government bond is 2.35%, and that will be our risk free rate.
Beta is a measure of a stock’s volatility in relation to the market. A beta of less than 1 means that the security is theoretically less than the market while a beta of more than 1 implies that the security’s price is theoretically more than the market. In the case of RHT, data taken from ShareInvestor has the beta pegged to 0.484, assuming that investors are adopting a longer term position of more than 500 days.
The market return is simply the long-term return of the stock market as a whole. In this example, I will be using the long-term return of the SDPR STI ETF (SGX: ES3), an exchanged-traded fund which tracks Singapore’s market barometer, the Straits Times Index (SGX: ^STI). Since its inception in April 2002, the SDPR STI ETF has generated an annual total return (inclusive of reinvested dividends) of 6.48%.
Plugging in all the figures, Religare Health Trust would have a required rate of return of 4.34%.
Next, we assume that Religare Health Trust would continue to grow at a constant rate in perpetuity. The formula for the Gordon Growth Model is as follows:-
P = D1 / (R – G)
Where P = stock value
D1 = Expected dividend per share one year from now
R = Required Rate of Return for Equity Investor
G = Growth Rate in Dividends
Religare Health Trust’s annual distribution for its fiscal year ended 31 March 2016 (FY2016) was 7.72 cents Singapore per unit. The distribution in the first half of FY2017 came in at 3.60 cents Singapore per unit. Thus, we can assume the trust’s distribution for FY2017 to be at 7.20 cents Singapore per unit.
With that, we can expect to see a share price of approximately $1.01 for FY2017. From the current share price of $0.875, standing at 07/12/2016, RHT’s share price is said to be slightly undervalued as compared to the above calculation. Of course, investors should note that there have been assumptions made to derive this. If you expect RHT to grow its dividends faster than -2.81% annually, then the trust is undervalued at $0.875. Otherwise, if you expect dividends to shrink further, you might want to wait a little longer before coming to a decision.
Disclosure: I do not have any positions in any Religare Health Trust stocks at time of writing and have no plans to initiate any positions within the next 72 hours. I wrote this article myself and the calculations made are my own and are not intended as investment advice. I am not receiving any paid compensation for it and I have also no business relations with any company whose stock is mentioned in this article.