You finally decided to start your investing journey after reading a few investment books and tons of financial articles on websites (hopefully, we are one of them!).
You were enthusiastic about investing, until you saw a list of over 700 companies under the Singapore Exchange (SGX). You realise you never even heard of 80% of these companies before. So how are you going to identify your hidden gems?
The best way to identify these hidden gems will be to first know what kind of stocks you are looking for to fit into your portfolio. Value stocks are one of the three main types of stocks (besides growth and yield stocks) that you can consider.
Think of value stocks as companies that are trading at a discount to their fundamentals (earnings, book value etc). The concept of looking for stocks that are undervalued is called value investing. This investment strategy is widely used by many investors including Warren Buffett.
But how do you find good undervalued stocks in Singapore? Here is a 3-step process that you can consider using.
# 1 Stock Screening – Your Criteria, Your Industry
You can use stock screeners such as the one from SGX to filter stocks that fits your criteria.
Source: SGX StockFacts
Other than these 5 common criteria, investors can also set other criteria which they deem fit.
After setting a list of criteria (maximum of 5 for SGX), you can start doing due diligence on the industries that you are familiar with. It can be an industry that you are working in or an industry that you have been following.
By investing in industry that you already know, it gives you better insights into the industry. You will be more sensitive to the key drivers of the businesses.
Think of it as shopping. The more familiar you are with a product range, the more likely you would know if a good deal presents itself. The same logic applies to stock investing.
Investment Opportunities In Small Market Capitalisation (Small Cap) Stocks
According to Ibbotson Associates, an investment-consulting firm that tracks long-term market data, small caps stocks (market cap of < $2b) tend to perform better than that of larger caps stocks. Since there is lesser analysts’ coverage on these not so well known companies, the lack of information and visibility in the market creates more upside opportunities.
In investing terms, it basically means that markets are less efficient for smaller cap stocks.
In other words, it might take a longer time for the market to react to a small cap company with a positive earnings announcement, or a promising business expansion plan, hence giving you a higher chance of entering the stocks at undervalued prices.
# 2 Diving Into The Numbers – Financial Ratios
Financial ratios are numbers derived from the financial statements, mainly, the income statement, statement of financial position and cash flow statement. These statements act as indicators to the performance or the health of the company.
Not all financial ratios are created equally, some ratios are more important than others in certain industries. For instance, inventory turnover ratio is an important ratio for retail industry and less so for service industry. Hence, it is important for you to look out for the key financial ratios within the industry.
It is important to also remember that these ratios should be compared relative to the stock’s peer competitors. This means that the ratios should only be compared within the same industry. If you don’t know which ratios to look out for, it’s probably a sign that you do not know the industry well enough in the first place.
In addition, use a few relevant financial ratios to confirm your investment decision.
Here are some commonly used ratios for value investors:
Price-To-Earnings (PE) Ratio
PE ratio can be defined as the closing price of the stock, divided by the averaged earnings per share for the past 12 months. If the PE ratio is 10, it means that you are paying $10 for every dollar generated in earnings. This ratio reflects the investors’ future expectation of the stock, a higher PE implies that investors are confident (or overconfident) that the future earnings will exceed their initial investment.
Price/Earnings to Growth (PEG) Ratio
It is defined as the PE ratio divided by the forecasted growth rate of earnings for a specified time period. PEG ratio provides a more complete picture than the PE ratio, telling you a different story. For instance, the PEG for a technological company must be lower than the PEG of a slower growth company, even if PE may be higher.
Price-to-Book (PB) Ratio
It refers to the stock’s market value to book value. Book value refers to the amount in which company is worth should it cease operation today and simply sell off all its assets and pay its debt. If the PB is 0.5, it means that investor are paying $0.50 for every $1 of asset that the company owns, which could suggest that a company is undervalued.
The use of PB ratio is more relevant for companies which are asset-heavy such as the manufacturing industry, and less so for asset-light companies such as technology industry.
For example, we take a look at TTJ Holdings Limited, a company that specialises in the design, fabrication and erection of structural steel work in Singapore. The company current has a PB ratio of about 1, and a PE ratio of about 5. This indicates that the company is relatively profitable for the price it is currently trading at, while the asset it owns is sufficient by itself to justify the current value of the company.
Source: SGX StockFacts (TTJ)
Given that the company’s 5-year beta is 0.67, it is also safe to say that the company can be considered a defensive stock. If you are familiar with the construction and steel industry, you may be interested to look further into this company.
# 3 Looking Beyond Numbers – Growth Story That You Trust
No matter how attractive the financial ratios look, many of them (i.e. PEG and forward PE) are derived from the forecasted values. Thus, it is important to choose a company with a future growth story that you strongly believe in. For instance, you will probably not buy stocks that seem to be undervalued (low PE and PB) but who are in sunset industries like manufacturing of CD-ROM or floppy disks.
There are however some traditional companies that could have growth opportunities that could be exciting to be looking out for.
An example would be ISOTeam limited. Even if you don’t know them, you probably would have seen their projects around you all the time. The company takes on HDB upgrading projects such as repainting of flats, and other improvement works to housing estates.
With a 5-year beta of 0.34 (Source: SGX StockFacts), it is can be seen as a company that isn’t really affected much by the boom or decline of the Singapore economy. This comes as no surprise, since the supply of HDB upgrading projects in Singapore is generally quite consistent regardless of how the economy is faring.
The interesting story here however is how the company is entering the handyman market by offering handyman services such as plumbing, electrical and painting services for individual homeowners through their subsidiary ISOHomecare. If you are bullish for this area of growth, then you may want to look more deeply into this company.
Looking For Companies
Investing is both an art and a science. Investors should look at both the quantitative and qualitative aspect of a company before investing.
To be a value investor, it isn’t enough to buy “cheap” stocks; you have to hold them long enough till the market recognise them for what they are worth. That is why you need to take into consideration your investing duration (or opportunity cost), as it may take some time for the stocks that you have shortlisted to emerge from their undervalued position.
All the best for your investment journey!
How can you choose winning stocks in Singapore? Join us on 16 November in our next 90-minute series: Guide To Choosing Winning Stocks, as we discuss some of the key elements to look at when choosing stocks to invest in. Top Image