Stock selection process

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#1
Hi All....Good to see this forum up. Smile

Lets see if we can start a discussion on how we select stocks in the Singapore market. The aim is to write down and quantify the steps used. As methodically and objectively as possible. Writing things down and discussing helps to clarify what we are thinking... Rather than to say...oh, I bought some shares because I like their product, their sales girls dress nice and their annual report is glossy...

These are my stock selection criteria. They are loosely based on the old 'Wallstraits 8' criteria, used for evaluating companies for their future earnings (or FCF).

Lets start with the first.

Sustainable Competitive Advantage

Important when buying a company for its future earnings. To try and ensure that these earnings don't dry up, and the value stock you bought doesn't become cheaper and cheaper...until zero.

What is a competitive advantage?

The most important criteria is *market share*. Ideally, we want a company with the largest market share, among a fragmented pool of small competitors. In time, the largest player should gain an advantage (eg: through economies-of-scale, network effect) and be able to squeeze out or buy over the smaller competitors. Once they reach a certain market share, they gain pricing power.

Avoid situations where the company will also be a price-taker:
- a small player in a fragmented market. Worst case is where you have hundreds of players, each with a negligible (< 5%) market share, and you're company is one of them (eg: unifood. Many SGX S-Chips are like this, the bigger ones all seem to be in HK).
- a company which is in third or 4th place but vastly dwarfed by larger competitors (eg: Chartered vs TSMC).
Don't buy these companies, no matter how low the PE. Every time you're tempted, look at a 5 year chart of Chartered or Unifood. At every step of the way, someone thought it cheap.

We also don't want a company with too dominant a market share - means they have no room to grow (eg: Microsoft).

This is from Porter's five forces (Rivalry and Barriers to entry).

What it not a Competitive Advantage?

Branding: This is subjective. What is good branding to me may be different to you, your wife or your 5 year old kid. Effective branding will show up as high gross margins.... but practically, as a (part time) retail investor in the Singapore market, I've never found a case where comparing gross margins is useful.

Other crap: Every company says they are a 'leading player' in their industry and all their competitors are second rate. Every IPO and annual report boasts of their company's 'experienced' management team. Perhaps they think their competitors are all run by kindergarten children?

How I use it

Since 90% companies listed on the SGX (or anywhere else) will not have any competitive advantage, I use this as a preliminary tool to decide which companies are suitable for further study.

For me, companies fall into 3 categories:
A) Leader: Large market share, lots of small competitors ready to be gobbled up.
B) Significant player. Probably is a large company, and among the top 10 in its industry. May have some larger competitors, but none of them dominate. If the company is well run and profitable, we can conclude that they will still be around for the foreseeable future. SIA Engineering and Venture are examples.
C) Small player in fragmented market. Usually hundreds of competitors, with some significantly larger ones. Will never have pricing power.

Most companies I investigate are are B's. A's are rare. I ignore C's.

Any thoughts? Does anyone have any variations on this?
I wait until there is money lying in the corner, and all I have to do is go over there and pick it up.
Jim Rogers
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#2
Hi Blackcat,

Great to see you back on this forum too! Thanks for your sharing and I think this is a very good thread to start. Smile

Well, in order not to be too long-winded (which some people have complained of me), I will try to put down a few short points on this.

1) Competitive Moat - High Barriers to Entry meaning a lot of capex, expertise and skill is needed to replicate the success of the incumbent. Good competitive moat may not just be limited to capex and size of company, but also scale and skill set of employees (e.g. Kingsmen has the scale to handle large projects which smaller players may not be able to, despite the industry being low barriers to entry).

2) Numbers - Of course these are important. In the interest of brevity, all I will say is - focus on Cash Flow and Balance Sheet first; then Profit and Loss later. ROE and FCF are more important to me than EPS and Net Profit (which can be manipulated due to accounting adjustments and one-off items).

3) Stable Industry - Stable meaning it is not too tighly regulated (e.g. Airlines) and is not in its infancy (e.g. genetically modified foods, solar panels). This will ensure most of the players are mature; and there are no sudden "shocks" to upset profits and cash flows.

4) Management - Good point on all listco saying they have an 'experienced' management team. The way to judge this objectively is to look at what Management said a few years back, and compare it to what they have achieved today. Did they deliver on promises? Did they execute their strategy flawlessly? How did they steer through rough waters? These signs all point to truly outstanding Management. Oh yes, and look for Management who are candid and frank; and not afraid to admit mistakes. A good example would be Boustead's CEO Mr. FF Wong who continually admits he slipped up here and there, but the point is that he learns from it and it makes him a wiser businessman.

5) Dividends - This stems from good FCF and low capex. If a company has a stable and good historical payment history, chances are this will continue if the business continues to grow steadily and do well. High growth companies which require tons of capex (example companies in the O&G support sector like Swiber, Ezra and Falcon Energy) will continually be raising money instead of paying it out. I learnt this the hard way....

Just my 2-cents; will add more if I think of more points!
My Value Investing Blog: http://sgmusicwhiz.blogspot.com/
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#3
For me... ...

I try to use the following methods,
1) 50% of funds - Using STI as guide, Buy SG blue chips with SOLE licences to operate. (SGX..SPH..SMRT..etc)
They have good risk management board.

Others 40% of funds,
2) Good management
3) Net cash flow / Zero or low debt
4) Dividend payouts are consistent over 5 yrs or more.

Remaining 10% of funds,
5) High growth / New biz / turn-around / special cases... etc

: )


1) Try NOT to LOSE money!
2) Do NOT SELL in BEAR, BUY-BUY-BUY! invest in managements/companies that does the same!
3) CASH in hand is KING in BEAR! 
4) In BULL, SELL-SELL-SELL! 
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#4
My stock selection process:

a) Good balance sheet. In short, avoid those with high debt (except real estate stocks, since I guess banks are more willing to lend to real estate firms given that they have better quality collateral).

b) low PER or P/B (for real estate stocks only)

c) high percentage of stocks owned by key stakehoders

d) avoid cyclical industries at their peak, unfamilar industries and low margin businesses (low margin may imply lack of moat).

e) look at the downsides, upsides and catalysts before invest.

f) prefer stocks with purchases from management.
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#5
A few more:

- Liquidity. I want fund mgrs to be able to buy. Someone once told me a mkt cap of 200m was the minimum required. I look at the chart and free float...a small cap like Eu Yang San would be the smallest I would consider.

- More for industry:
* Tech is unpredictable. eg: Hi-P, who know if blackberry is even going to be around in 5 years?
* No REITS. Forever dependent on Debt. Some of them would be good long term investments if they paid less dividends and reduced debt instead.
* Prefer regular income vs lumpy income.

- For *investment*, I wait for bear markets or recessions to buy. 2-3 quarters of contractions will drag down revenues, earnings and compress PEs....ready to spring back when the recovery unfolds. Bonus points if you manage to pick a small cap that turns into a large cap. Anyway, I may be waiting another 5 years Sad
I wait until there is money lying in the corner, and all I have to do is go over there and pick it up.
Jim Rogers
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#6
Many multibaggers started from less than $200 million mkt cap....

Osim
Viz Branz
Sing Lun
Fragrance
Design Studio
Advanced holdings
Food Empire
Kingsmen

Dividend distributed not included Tongue
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#7
hi all, i am super new to this forum. and new to investing too.

i have no idea if my content is enuff to be posted here online, but i'll give me a try. Big Grin

for picking companies listed on sgx, i start from alphabet Z to A. 1 by 1.

1) P/E lower than 15.00
2) ROE higher than 10.00
3) Long and Consistent positive Cash flow from operating activities.

4) read their annual report. ( most imprtant step )

5) using a method from the book "profit from panic" by adam khoo, to calculate the intrinsic value of the share.
taking the history of Cash flow from operating from XXXX to current year, get the growth rate, and project the number for the next 10 years. SUM of all divide by total outstanding shares will be the intrinsic value.

these are my stock selection procress at least for now. ( lazy me still doing the filtering part of all the stocks listed on sgx.)
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#8
(22-10-2010, 10:08 PM)jianjian Wrote: hi all, i am super new to this forum. and new to investing too.

i have no idea if my content is enuff to be posted here online, but i'll give me a try. Big Grin

for picking companies listed on sgx, i start from alphabet Z to A. 1 by 1.

1) P/E lower than 15.00
2) ROE higher than 10.00
3) Long and Consistent positive Cash flow from operating activities.

4) read their annual report. ( most imprtant step )

5) using a method from the book "profit from panic" by adam khoo, to calculate the intrinsic value of the share.
taking the history of Cash flow from operating from XXXX to current year, get the growth rate, and project the number for the next 10 years. SUM of all divide by total outstanding shares will be the intrinsic value.

these are my stock selection procress at least for now. ( lazy me still doing the filtering part of all the stocks listed on sgx.)

Hi ! First of all, let me extend a warm welcome to you on joining Value Buddies! Here, we analyze companies in detail and use value investing techniques to pick gems which are considered undervalued. I hope you enjoy your stay here. Smile

To comment on what you had said, is there a reason why you used PER lower than 15x? 15x under normal circumstances would be considered "high" unless you are looking at blue chip or monopoly companies. Note that each class of company (small caps, mid-caps or large caps) may have a PER which is deemed "reasonable", and this also depends on each individual company's characteristics, growth profile and unique fundamentals.

As for ROE>10%, this is actually not too tough; but it must be consistently above 10% for 5-10 years at least. A more stringent criteria I use is >20%; and it must NOT be debt-fuelled. To give a good example, Ezra (which released results today) has an ROE of 12% but most of it was due to an increase in gearing.

The aim of reading the annual report is to ascertain the business model of the Company and also to read about their prospects and plans, so this is definitely something an investor should do. In fact, read 10 years of their annual reports if possible (I do that); and if possible too, get the competitors' annual reports as well!

I have an issue with Adam Khoo's technique (actually, I have an issue with Adam Khoo but that's another story haha). If we take historical operating cash flows and project this into the future, we end up with a distorted and unrealistic discounted cash flow value for the company, as future cash flows are extremely uncertain past the third year. Even the discount rate is notoriously hard to determine, although most books use 10% for conservatism. So before using any DCF method, do note its limitations and do not place too much emphasis on the value you obtain. The number which you eventually get is NOT the intrinsic value; it's just the discounted cash flow valuation using predicted future cash flows. Intrinsic value's definition is to take into account ALL salient aspects of the Company, quantitative and qualitative; and to use these factors as the basis for making an informed investment decision.

Ok I shall stop here.....or I can ramble on and on. Haha.

Hope this helps....!
My Value Investing Blog: http://sgmusicwhiz.blogspot.com/
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#9
hi musicWhiz, thx for the warm welcome, i do read your blog often Tongue

thanks again for all the feedback. i will try to improvise and add in more criteria for stock selection as i proceed from here.

i can say that value investing is reallyREALLY a tough job! but i actually find enjoyment in it.

blame it on the first book i read on investing Sad its about value investing not TA investing. Angry
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#10
(22-10-2010, 10:37 PM)jianjian Wrote: hi musicWhiz, thx for the warm welcome, i do read your blog often Tongue

thanks again for all the feedback. i will try to improvise and add in more criteria for stock selection as i proceed from here.

i can say that value investing is reallyREALLY a tough job! but i actually find enjoyment in it.

blame it on the first book i read on investing Sad its about value investing not TA investing. Angry

You're most welcome! Value investing is a continuous learning process. Since I started in 2007, I can say I've learnt a huge lot; and most of it from dydx and d.o.g. on this forum (well, it used to be called Wallstraits). I also read books on value investing to get more ideas; my current read is "The Business of Value Investing" by Sham Gad.

It's a tough job but at the end of the day, it's rewarding both for the mind and for your pocketbook. Big Grin
My Value Investing Blog: http://sgmusicwhiz.blogspot.com/
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