What Good Stocks Have In Common

How to find your next winner

For many people, finding the right stock is reading about it from the newspaper/analyst reports, or hearing about it from someone who made money off it. Think of it as a MANGO sale, if you heard about it from someone else, by the time you get to the shop you might have to rip the last piece off the sales person.

Warren Buffett has always looked for a few inherent strengths within the company he is look to invest in.

Companies that stand out from the crowd with unique products or services

If 10 companies sold the same product. Well, 9 of them must be stupid and 1 a genius. Either way, a price war is unavoidable and this leads to companies undercutting each other. There are many companies with unique products like Coca cola and Kraft. For some local examples. maybe Tiger Beer (which got bought over) and Singapore Press Holdings (which have little competition. If you think of bread, you think of Breadtalk. Macdonald's is the first to come to many when they think of fast food. These companies command high margins as they can pretty much charge whatever they want to consumers.

Low cost buyer and seller of commonly used products and services

These are companies that offer products that are used regardless of an economic boom or recession and do not have to spend alot of capital to redesign their products. You are have to eat and buy groceries during a recession, see the dentist and take public transport. (Think cold storage, Sheng Shiong, Q&M, SMRT) These companies operate with smaller margins but more than make up for it with volume of sales.

While I'm not asking you to purchase the above shares, think about why you invest in a company before you buy the stock. Does it have some kind of advantage over the competition.

Companies with a competitive advantage

This segment will require some financial knowledge which can be found under Education.
These companies with significant advantages (also know as economic moats)

1. Command higher margins as they do not have to engage in price competition
2. These companies consistent make a profit while managing to keep costs low consistently and avoid getting into debt
• Low % of expenses to gross profit <70% or thereabouts
• Little need for capital expenditure (CAPEX <50% of Net Profits)
• Little to no interest expense on loans (Interest expense to operating income <15%)
• Consistent upward trend in earnings, net profit margins(>20%) and earnings per share (EPS)
3. High cash flow generation with no debt
• Able to pay off total debt with annual earnings within 4 years
• Debt to equity ratio of less than 0.5 or low compared to the sector average
4. High Return on Shareholders Equity (ROE)
• ROE > 20%

With such companies, you would have no problem holding them for 10years plus, earning dividends yearly along with capital gains.

Singapore T-Bills and Bonds

What are Singapore Treasury Bills and Bonds

Singapore Treasury Bills (T-bills) and bonds, collectively know as Singapore Government Securities (SGS), are offered by the Singapore Government to the public and institutional investors. You can think of Bonds and T-bills as a loan from the Singapore Government to the public. Bonds are widely accepted to be safe haven for cash as they are backed by the issuing government.

• The government will pay the holders of SGS a fixed sum of money on the maturity date
• You cannot cash in your SGS before the maturity date
• These SGS can be traded in the open market

 

Treasury Bills

 

1. These are short term securities that mature in a year or less from their issuing date

• 3 months, 6 months, 12 months

2. They are bought at a discount to the par value and upon maturity, holders are paid the par value.

• For eg, You purchase a $1000 T-bill for $970 and you will get back $1000.
• Your earnings of $30 will reflect a yield/interest rate of 3%

3. T-bills are sold in denominations of $1000 via auction

4. Interest earned is tax exempt

5. Can be bought under CPF Investment Scheme

6. Held via the Central Depository (CDP)

7. The different issue codes are listed below

Bonds 

 

1. They are long term securities that mature more than a year from their issuing date

• 2, 5, 10, 15, 20, 30 years

2. Interest rate earned is via a fixed coupon rate

3. Semi annual repayments to the bond holder

4. Bonds are sold in denominations of $1000

5. Interest earned is tax exempt

6. Under CPF Investment Scheme

7.Held via the Central Depository (CDP)

Calculating your bond Returns 

 

Current bond yield is a reflection of the annual coupon interest to its current price

• If you bought a bond at a fixed coupon rate of 4% your fixed return annually on a $1000 bond will be $40 (0.04 x $1000).
• If the price of your bond was to increase to $1200, your current yield would decrease to 3.3% ($40/$1200 x 100%)
• If the price of your bond was to decrease to $800, your  current yield would increase to 5% ($40/$800 x 100%) 
• Bond yield move together with interest rates

Total Bond Return

•  If you bought a bond at a fixed coupon rate of 4% your fixed return annually on a $1000 bond will be $40 (0.04 x $1000).
• If you sold your bond at a price of 1020, your total return would be 6% ($60/$1000 x 100%). Annual repayment of $40 + Appreciation of bond price $20
• If you sold your bond at a price of $980, your total return would be 2% ($20/$1000 x 100%). Annual repayment of $40 - Depreciation of bond price of $20.

From the above, it is important to note that

• Bond price is affected by interest rates
• As the interest rates increase, bond yield would increase
• As your bond yield increases, its market price would decrease

Useful links
SGS Issuance Calendar
Daily and Historical Prices
Bond Yield Calculator

How to read Financial Statements Part 3

Part One

Part Two

"There is a huge difference between the business that grows and requires lots of capital to do so and the business that grows and doesn't require capital."

-Warren Buffett

Understanding the Cash Flow Statement

The cash flow statement, as the name suggests, is the record of the movement of cash in and out of a company during a particular period of time. If you were to keep a cash flow, it would consist of cash flowing in from your salary and cash flowing out from your expenses and repayment of debts.

There are 3 parts to the Cash Flow Statment

1. Cash flow from Operating Activities
2. Cash flow from Investing Activities
3. Cash flow from Financing Activities

Cash Flow from Operating Activities 

 

 

It will always begin with Net Income and then adds back in depreciation and amortization. Although these are actual expenses, they do not eat up any cash because they represent cash that was eaten up years ago. For our supermarket, it made $3,300 in net profits for the year. However, $300 was deducted in total for depreciation and amortization. After adjusting for these expense, its actual cash flow from operations would be $3,600.

Cash Flow from Investing Activities

 

Our supermarket might have to spend money on a new store or more factories to produce more products in order to grow the business, in this cash $900 (Capital Expenditure).
Cash flow from investing therefore is usually negative as it reflects how much a company spent to produce future income.

Cash flow from Financing Activities 

This usually includes any dividends paid to share holders, cash used to buyback their shares and repayments on any long term debts.

Net Change in Cash 

 

If we add the Total cash from operating activities, together with the decrease in cash from investing and financing, we will get the Net Increase(or decrease) in cash for the year. The total cash at the end of the year will be derived after taking into consideration the company's cash position at the beginning of the year.

Key things to note with the cash flow statements

1. Is the company generating healthy amounts of cash. Excess cash can be used to payout dividends to reward shareholders or to expand company operations
2. Can the company keep its capital expenditures under control and are they funding their capital expenditure through internal cash flow or debt.
• What % of a company's earning is being used for Capital Expenditure
• Capital Expenditure/Net Earnings x 100%
3. Consistent Share buy backs can indicate a company with healthy cash positions and generates greater value for shareholders
4. Does a company have a fixed dividend policy to reward shareholders.

Note: This is only meant to give investors a brief overview of the main components of a the Cash Flow statement. Actual statements have more variables but if you apply the basics principles and practice reading them, it will become easier with time.

How to read Financial Statements Part 2

Part 1

Warren Buffett does not believe in leverage. If you are smart, you won't need to borrow money. if you are not smart, then you won't do the right thing with it. Well most of us aren't Warren Buffett.

Understanding the Balance Sheet

 

Think of a company's balance sheet in the same way that you think about your own finances. How much money do you have in your bank account (Assets) and do you owe any money to the bank (Liabilities). Your net worth (Equity) is what remains after you have subtracted your liabilities from your assets.

A company's balance sheet is a snap shot of its financial position on a particular date. The three segments will always be Assets, Liabilities and Equity. It is named the balance sheet because it has to be balanced.

Assets = Liabilities + Shareholder's Equity

Using our previous example in Part 1 of a supermarket, here's what a simplified balance sheet will look like.

Assets 

Current Assets is made up of "cash and cash equivalents", "inventories" and "receivables". They are referred to as current because they are cash or can be converted to cash within a year. They have around $5000 cash to purchase new products to sell, has $3000 worth of products (inventories) to sell and is currently owed $1000. Cash is used to buy Inventories, which is then sold to vendors and becomes Receivables or Cash.


As you can probably guess, Non Current Assets are assets that cannot be converted to cash within a year. Property Plant and Equipment (PPEs) are assets that are vital to a company's operations. For our supermarket, they may include its physical shop and factories that it may own. Note that PPEs depreciate over time and hence its value decreases with each passing year. Other assets and investment can include various other investments and for the sake of simplicity, will not be covered here.

Total Assets = Current Assets + Non Current Assets

Liabilities

As with current assets, current liabilities are debts and obligations that are due within a year.
Using our supermarket again, when it purchases products to sell, they do not have to pay for it immediately (Trade and other payables). For the supermarket to operate efficiently and expand, it may have to borrow money from the bank and pay the interest (Short Term Debt).

Non current liabilities are not due within a year and include the total debt the company owes to the Bank (long term debt).

Total liabilities = Current Liabilities + Non Current Liabilities

Equity

You are only worth as much as all your assets and liabilities combined.

Net Worth/Shareholder's Equity = Total Assets - Liabilities

Shareholder's equity is the amount that the supermarkets owners and shareholders have initially put in and left in the business to keep it running. Share capital is the portion of a company's equity that it sold to shareholders in exchange for cash to fund its operations. When a company has profits, it can either pay them out to shareholders, use it buy back their shares or keep it to grow their business (Accumulated Profits). Accumulated profits are added each year to the total accumulated profits from prior years and are reflected as a growth in net worth or equity year after year.

Key points to note on a Balance Sheet

1. Current Ratio is the measure of a company's ability to repay its short term debt
• Current Ratio = Current Assets/Current Liabilities
• A current ratio of >1 indicates a company is able to pay off its short term debts.
2.  Debt to Equity Ratio is a measure of a companies debt to its total equity
• Debt to equity ratio = Total Debt/Total Equity
• A debt to equity ratio of 0.5 means that a company is 50% leveraged
3. Does the company have a healthy cash stockpile to expand and weather recessions.

I will post more in depth analysis on Balance Sheets in the future.

Note: This is only meant to give investors a brief overview of the main components of a Balance Sheet. Actual balance sheet have more variables but if you apply the basics principles and practice reading them, it will become easier with time.