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2 Great Shares to Own

There are more than 750 listed entities in Singapore’s share market. With such a huge basket of shares available, it can be a daunting affair for an investor to sift through that large pile of names in order to find great shares to own.

To help lessen the burden, investors can turn to stock screens which help filter out shares which fit certain desirable financial characteristics. And to help fill out the screen, billionaire investor Warren Buffett had actually lent a precious helping hand more than three decades ago.

A great screen

In his 1987 Annual Berkshire Hathaway Shareholder’s Letter, Buffett touched on an interesting study done by business magazine Fortune in its 1988 Investor’s Guide issue. The research dealt with the links between a company’s returns on equity, its economic characteristics, and subsequent share price performance. This is Buffett on the topic:

“Only 25 of the 1,000 companies [the 500 largest industrial companies and 500 largest service companies in the U.S.] met two tests of economic excellence – an average return on equity of 20% in the 10 years, 1977 through 1986, and no year worse than 15%. These business superstars were also stock market superstars: During the decade, 24 of the 25 outperformed the S&P 500.”

It’s easy for companies to goose their returns on equity by utilising high amounts of leverage. But interestingly, of those 25 corporate superstars, “most use very little leverage compared to their interest-paying capacity”, wrote Buffett. He then added that “[r]eally good businesses usually don’t need to borrow.”

Buffett’s words thus give us a very useful framework to help increase our chances of finding profitable investments: Companies must be able to exhibit high returns on equity (usually more than 15%) over the long-term while employing very little or no leverage.

The local examples

In line with Buffett’s thinking, I decided to find companies in Singapore which had (1) generated a return on equity of at least 15% in their last 10 completed financial years and (2) had cash on hand which is at least 50% higher than its total borrowings in those 10 years.

As it turns out, vehicle and commercial inspection firm Vicom Limited (SGX: V01) and aircraft engineering outfit SIA Engineering Company Limited (SGX: S59) are two companies which meet the criteria, as seen from the charts below.

ROE for Vicom and SIA Engineering

Source: S&P Capital IQ (for SIAEC the year 2013 corresponds to the financial year ended 31 March 2014 and so on; Vicom’s financial year coincides with the calendar year)

In their last 10 completed financial years, Vicom’s lowest return on equity had been 15.7%, while SIAEC’s had been 15.8%. Their average returns on equity over those 10 years stands at 21.9% and 20.8% respectively.

Cash and debt for Vicom and SIA engineering

Source: S&P Capital IQ (for SIAEC the year 2013 corresponds to the financial year ended 31 March 2014 and so on; Vicom’s financial year coincides with the calendar year)

As for Vicom and SIAEC’s cash and debt profile, it’s easy to see from the chart immediately above that both companies had been operating with minimal or no debt over their past 10 financial years.

Foolish Bottom Line

With such strong returns on equity on an unlevered balance sheet, it’s perhaps no surprise to find that both companies have trounced the market over the long-term. Since the start of 2003, Vicom has surged by 836% in price while SIAEC has gained some 191%; in comparison, the Straits Times Index (SGX: ^STI), Singapore’s share market barometer, has grown by just 143%.

All the above is not meant to be a buy or sell call on Vicom and SIAEC. But their corporate track records, which have resulted in market-beating returns, have been a thing of beauty. Thus, they might be worth a deeper look for investors wanting to find great shares to own.

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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 writer Chong Ser Jing owns shares in Berkshire Hathaway.