Evaluating a company
In this post, I will share with you my approach in evaluating companies whose stocks are listed on the Malaysian stock exchange.
My method for evaluation is based on what I have read from a few books, mainly:
1. The Intelligent Investor - by Benjamin Graham
2. How to Make Money from Your Stock Investment Even in a Falling Market - by Ho Kok Mun
3. Secrets of Millionaire Investors - Adam Khoo and Conrad Alvin Lim
I invest in Malaysian stocks for the long term and for dividends. I do not use a trading approach.
To hold for the long term, it is important that the company has good financial strength and profitability.
I use the following criteria to determine financial strength, which can be calculated based on the data from the latest quarterly report:
1. Current ratio > 1.5
where current ratio = Net current assets / net current liabilities
2. Working capital - LTD > 0
where Working capital = net current assets- net current liabilities
and LTD refers to long term debts or non-current liabilities
3. DE ratio < 0.5
where debt-to-equity (DE) ratio = non-current liabilities / shareholder equity
4. LTD/PAT < 3
where LTD means long term debts or non-current liabilities
and PAT means profit after tax ( I use the net profit attributable to shareholders, rolling over the past 4 quarters )
5. cash/debt > 0.3
where cash is the "cash and cash equivalents" in the balance sheet and debt = total liabilities (current and non-current)
The more of these criteria are fulfilled the better it is.
For profitability, I would prefer the following:
1. No deficit in last 5 years i.e. the company did not have a loss in the past 5 years
2. Annualized earnings growth of over 15%.
I would look at the earnings for the past 5 years. If there is a year or two when the profits dipped (e.g. due to the global financial crisis), that is alright, as long as the overall trend is increasing profits. I tend to avoid companies with cyclical earnings.
3. Increasing operating cash flow
Next, I will also look at the companies average return-on-equity (ROE) and return-on-revenue (ROR) of the past 5 years. I prefer the company to have better ROE and ROR compared to its peers in the same industry. According to Benjamin Graham, it is advisable to have ROE of over 15%.
For dividends I prefer the company pays out dividends every year. I would keep a few stocks that have a track record of paying dividends higher than FD rate for every year in the past.
Finally, if I think the company is good to buy based on my evaluation, I will then check the annual reports of the company for the past few years. I will try to understand the company's business and products, it's business segments and markets, it's director's compensation and it's shareholders. This part is rather subjective and I am still learning.