This article was recently published on Felix Leong's blog and is republished with permission.
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1) Net Cash Position
Like my core holdings Semb Corp Industries and Challenger Technologies, I generally prefer companies that have little to no debt. That is also the reason why I usually avoid industries such as commodities, properties and shipping.
With little or no debt, the company cannot go down under as long as its profitable. It also does not have to worry about the increase of interest rate costs (since rates are expected to hit 4% in 2017). In general its just much safer to hold as compared to other stocks that highly geared. Avoiding mistakes is a highly important element towards long term success in investing.
2) High Returns On Equity (ROE)
A stock that generates 10% ROE would be average in my view, I would prefer to hold stocks that have a ROE of 12% or much higher. When a company with high ROE retains its earnings, it would compound a higher long term return to owners.
Example a stock with $10 in assets earnings $1 with an ROE of 10%, if it retains the $1 in earnings, the company is likely to generate an additional $0.10 in earnings next year, bringing next year's earnings per share to $1.10
However a stock with $10 in assets earnings $1 with an ROE of 30%, even if it pays half the earnings as dividends and retains the other half is likely to generate an additional $0.15 in earnings next year, bringing next year's earnings per share to $1.15! This is often why high ROE companies usually trade at a few times their book value.
Among the list, only Genting Singapore has an ROE of below 10%. Its Casino business generates a very high ROE but overall performance is dragged down by its property and hotel segment (That is also why I dislike investing in properties because of the low ROE, something like 5% on average).
Like what I mentioned about Semb Corp Industries, I believe a lot of value can be unlocked via a spin off. Especially if they strip out their properties and list it as something like Genting Properties. By removing the low ROE segment, they can focus more on their higher return core business.
3) Track Record of Profitability
Mostly importantly is that the company has to show that its able to maintain or increase earnings per share, year after year (at least over 3 year sample but best is 5-10 years track record). I would often take a deep look at their annual report during years where there was a recession so if it holds well during bad times (example during SARS and the global financial crisis)
Dividend policy is also very important as a consistent payout is one of the best ways for management to reward loyal shareholders. Companies that do not pay dividends at all are the ones that I would avoid. I'm not an accounting expert, as the companies report record or growing earnings I'm not able to tell if it true or not, so the best way for me to verify is by receiving say one third or half the earnings as cash dividends! Accounting earnings can be faked but cash that goes into my bank, its definitely real.
Conclusion
These are the 3 important criteria that I look for when screening for potential stocks to add into my portfolio, but depending on industries there are other factors that I also consider.
In general I am comfortable holding only 3-5 stocks in my portfolio at any give time, this style of investing may not apply well to other investors, who may feel more comfortable being diversed (say 10-30 stocks or more)
At the end of the day which ever the method, what is most important is sticking to what you know best and is comfortable for you. Sometimes its also not how much you know about stocks, but how much you know about yourself.
"Intelligent investing is not complex, though that is far from saying that it is easy. What an investor needs is the ability to correctly evaluate selected businesses. Note that word "selected": You don't have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital." - Warren Buffett (right)
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