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The 10-Minute Screen for Successful Stock-Picking

With so many companies listed on the Main Board and Catalist stock exchanges in Singapore, where should an investor start looking?

Pat Dorsey, a former Director of Equity Research at investment research firm Morningstar, recommends that investors can do a quick-and-easy 10 minute test on the companies they come across in the public equity markets. So, what exactly should an investor be looking for?

1. Is the firm of minimum quality?

First and foremost, as Buffett once wrote, “It is better to own part of a hope diamond than to own the whole of a rhinostone,” it’s better to  focus our energy on companies that have proven quality. For that reason, companies undergoing Initial Public Offerings might be a group to pass up on as they tend to lack track records on both the integrity of management as well as the performance of their businesses.

2. Has the company been making profits?

The next check would be on a company’s profitability. Some companies can operate at a loss for a very long time. If we are spoilt for choices in a large market of publicly-listed companies, it might be wise to give those loss-making companies a pass.

On the other hand, companies that can remain solidly and/or increasingly profitable on a per-share basis could deserve more attention. An example of a company with growing per-share earnings over the years would be Dairy Farm International (SGX: D01).

3. Is the company generating positive cash flow from its operations?

A company’s ability to generate positive cash flow from its daily business activities is the next thing we look at.

For companies that have reported good earnings over the years, has their cash flow being able to tag along? This is actually a test of a company’s quality of earnings to ensure that the company’s stated-profits can actually be successfully converted to cash at the end of the day. If it doesn’t, then it could be an indication of some issues with the company’s operations or accounting process.

4. Are returns on equity at least 10% without excessive leverage?

One of the most important objectives for most companies is to produce a reasonable return for shareholders. Focusing on companies that are generating good returns per dollar of invested capital from shareholders without the use of excessive debt can help give us a stronger group of investable companies to choose from.

Super Group (SGX: S10) is one such company that has been consistently producing above average returns on equity for its shareholders even without the use of much borrowings.

5. Is the balance sheet clean?

A company with a stronger balance sheet will be in a much better position to weather through any storms.

6. Does the company produce free cash flow?

If a company is able to generate free cash flow in excess of its dividends paid, it might be an indication that its dividend is sustainable and might even be raised in the future. In contrast, a company that is not generating enough free cash flow faces the possibility of having to cut its dividend in the future.

A Final Foolish Take

Since there are roughly 800 companies listed in Singapore, it is possible for you to do the 10 minute test on all of them. If you spend just two hours every day on this, it will take you approximately 2 months to go through all the companies. By the end of it, you will have a rough idea on how attractive different companies are in terms of their investment merits.

You will then be in a much better position as compared to most other market participants when it comes to investing in Singapore. Go on, challenge yourself!

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.