Personal Investing by OOI KOK HWA
This first of a two-part article looks at the criteria for selecting the right stocks
Q: I don’t know how to select the right stocks for long-term investment. Do you have any systematic way for stock selection?
Lately, readers have asked us whether there are basic, systematic ways to select stocks for long-term investment. We find that it’s quite difficult to answer this question as there are many ways to pick stocks. Different fund managers have different methods of picking the right stocks for their funds.
Even though there are no short cuts in screening stocks, we can broadly group our selection according to seven criteria, namely SGPDBHM. “S” stands for sales, “G” – growth, “P” – price-earnings ratio (PER), “D” – dividend yield, “B” – book value, “H” – health and “M” for management.
In this article, we will look at the first four criteria: sales (S), growth (G), PER (P) and dividend yield (D).
S – Annual sales of at least above RM500mil
Our first criterion is to select companies that have total annual sales of RM500mil and above. The main purpose for this is to select big companies for investment. Normally, a company with total sales of above RM500mil is considered well established and is less dependent on its owner.
In most instances, it will be one of the market leaders commanding a certain market share in its industry. Although we are not saying that companies with annual sales of less than RM500mil are not good for investment, less established companies face stiffer competition and have more uncertainties in their future compared with more established companies.
This explains why the majority of our research houses prefer big companies to small companies. At present, if you are holding shares in a lot of small companies (although they have good fundamentals), the majority of them are not performing in terms of stock prices despite the current high stock market valuations.
This may be due to the same worries as well as analysts not paying much attention to those stocks.
G - growth in sales
We need to select stocks with strong sales growth. Higher growth in sales implies that a company is expanding fast.
According to Benjamin Graham in his book entitled “Security Analysis”, a growth company’s business can move faster than its stock price.
Given that our returns depend only on capital gain or dividend income, if a stock never pays any dividend, we need to make sure that we can get capital gains from the stock.
Unless we are able to catch them at cheap prices, we need to make sure that the company has very strong sales growth.
Higher sales will contribute to higher profits and higher stock prices.
P - Low PER stocks
To get a high margin of safety (MOS), we need to find stocks with low PER. For a stock that has a PER of 20 times, you would need to wait 20 years to get back your money, assuming that it can achieve the same earnings per share (EPS) over the next 20 years.
Hence, we should select stocks with low PER, especially lower than the overall stock market or its own industry average.
Given that the current market PER is about 15 times, if you can find a stock that is selling lower than 15 times, we can say that it is selling at a cheaper valuation than that of the overall market.
D- dividend yield of at least equal to fixed deposit rate
A good company needs to pay dividend. We believe this is the best way to rewards shareholders.
There are some listed companies that are making good profits but refuse to reward their shareholders with high dividends as they claim that they need to retain the profits for future expansion.
However, we believe “a bird in the hand is worth two in the bush”.
There are cases where companies are able to generate good returns from every dollar that they retain, but in most cases, some fail in their expansion programmes. To retail investors, there are too many uncertainties over returns from these investments.
We believe that companies that are unable to reward their shareholders with good dividend need to reward them with higher stock prices.
According to Warren Buffett, this is called the one-dollar premise, whereby every dollar that the company retains needs to translate into one dollar in stock price.
Given the present weak stock market, if a company is able to provide a dividend yield that is equal to the fixed deposit rate of 3.7% will attract investors to put their money into their stock instead of in the bank.
Ooi Kok Hwa is a licensed investment adviser and managing partner of MRR Consulting.
The Star
This first of a two-part article looks at the criteria for selecting the right stocks
Q: I don’t know how to select the right stocks for long-term investment. Do you have any systematic way for stock selection?
Lately, readers have asked us whether there are basic, systematic ways to select stocks for long-term investment. We find that it’s quite difficult to answer this question as there are many ways to pick stocks. Different fund managers have different methods of picking the right stocks for their funds.
Even though there are no short cuts in screening stocks, we can broadly group our selection according to seven criteria, namely SGPDBHM. “S” stands for sales, “G” – growth, “P” – price-earnings ratio (PER), “D” – dividend yield, “B” – book value, “H” – health and “M” for management.
In this article, we will look at the first four criteria: sales (S), growth (G), PER (P) and dividend yield (D).
S – Annual sales of at least above RM500mil
Our first criterion is to select companies that have total annual sales of RM500mil and above. The main purpose for this is to select big companies for investment. Normally, a company with total sales of above RM500mil is considered well established and is less dependent on its owner.
In most instances, it will be one of the market leaders commanding a certain market share in its industry. Although we are not saying that companies with annual sales of less than RM500mil are not good for investment, less established companies face stiffer competition and have more uncertainties in their future compared with more established companies.
This explains why the majority of our research houses prefer big companies to small companies. At present, if you are holding shares in a lot of small companies (although they have good fundamentals), the majority of them are not performing in terms of stock prices despite the current high stock market valuations.
This may be due to the same worries as well as analysts not paying much attention to those stocks.
G - growth in sales
We need to select stocks with strong sales growth. Higher growth in sales implies that a company is expanding fast.
According to Benjamin Graham in his book entitled “Security Analysis”, a growth company’s business can move faster than its stock price.
Given that our returns depend only on capital gain or dividend income, if a stock never pays any dividend, we need to make sure that we can get capital gains from the stock.
Unless we are able to catch them at cheap prices, we need to make sure that the company has very strong sales growth.
Higher sales will contribute to higher profits and higher stock prices.
P - Low PER stocks
To get a high margin of safety (MOS), we need to find stocks with low PER. For a stock that has a PER of 20 times, you would need to wait 20 years to get back your money, assuming that it can achieve the same earnings per share (EPS) over the next 20 years.
Hence, we should select stocks with low PER, especially lower than the overall stock market or its own industry average.
Given that the current market PER is about 15 times, if you can find a stock that is selling lower than 15 times, we can say that it is selling at a cheaper valuation than that of the overall market.
D- dividend yield of at least equal to fixed deposit rate
A good company needs to pay dividend. We believe this is the best way to rewards shareholders.
There are some listed companies that are making good profits but refuse to reward their shareholders with high dividends as they claim that they need to retain the profits for future expansion.
However, we believe “a bird in the hand is worth two in the bush”.
There are cases where companies are able to generate good returns from every dollar that they retain, but in most cases, some fail in their expansion programmes. To retail investors, there are too many uncertainties over returns from these investments.
We believe that companies that are unable to reward their shareholders with good dividend need to reward them with higher stock prices.
According to Warren Buffett, this is called the one-dollar premise, whereby every dollar that the company retains needs to translate into one dollar in stock price.
Given the present weak stock market, if a company is able to provide a dividend yield that is equal to the fixed deposit rate of 3.7% will attract investors to put their money into their stock instead of in the bank.
Ooi Kok Hwa is a licensed investment adviser and managing partner of MRR Consulting.
The Star
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