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These 2 Shares Might Be Great Shares to Own

When it comes to pruning the universe of listed-companies to make it easier to find interesting investing opportunities, billionaire investor Warren Buffett had given some very useful hints more than 27 years ago.

A useful tool-kit

In his 1987 Berkshire Hathaway Annual Shareholder’s letter, Buffett wrote about a study conducted by Fortune Magazine for its 1988 Investor’s Guide issue. The study, which covered 500 of America’s largest industrial companies and 500 of the largest services companies, had looked at each firm’s returns on equity and subsequent market returns. This is how Buffett describes Fortune’s findings:

“Only 25 of the 1,000 companies 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 [an American share market index].”

Buffett also added that of those 25 outperformers, “most use[d] very little leverage compared to their interest-paying capacity.” He then followed up with the thought that “[r]eally good businesses usually don’t need to borrow.”

Finding great shares locally

With Buffett’s words as a guide, it thus makes sense for investors to look for shares with a history of generating high returns on equity while using very little leverage. The criteria shared by Buffett – shares with an average return on equity of 20% in their last 10 years and with no year worse than 15% – is great. But, it might be too stringent in Singapore’s context given our much smaller pool of shares to choose from (there are only around 750 listed entities in our local market).

Due to the constraints, we could perhaps look at shares which had (1) generated an average return on equity of at least 15% over their last 10 completed financial years; and (2) held more cash on hand than total borrowings in at least eight out of their last 10 financial years.

A quick screen on local shares, built with the two criteria mentioned just above, sees Raffles Medical Group Ltd. (SGX: R01) and Super Group Ltd. (SGX: S10) filter through amongst others. The former is a provider of healthcare services predominantly in Singapore while the latter makes instant beverages (mainly coffee) and other beverage ingredients for sale throughout Asia.

Returns on equity for Raffles Medical Group and Super Group

Source: S&P Capital IQ

From 2003 to 2013, Raffles Medical Group’s lowest return on equity is 8.4% while that for Super Group is 10.9%. Their average returns on equity over that decade stands at 15.1% and 15.7% respectively.

Cash and debt levels for Raffles Medical Group and Super Group

Source: S&P Capital IQ

Coming to both companies’ balance sheet, they’ve for the most part, been very conservatively financed – both have had way more cash on hand as compared to total borrowings in nine out of the 10 years between 2003 and 2013.

A Fool’s take

As a likely result of their stellar corporate performance in the past decade, Raffles Medical Group and Super Group have both been great long-term market beaters. Since the start of 2003, the former has gained some 1,424% in price while the latter’s up by 847%. In contrast, Singapore’s market barometer, the Straits Times Index (SGX: ^STI), has grown by a relatively measly 146% to its current level of 3,301 points.

To be clear, all the above isn’t meant to be a buy or sell call on both shares. After all, companies with great track records do stumble at times, sometimes permanently so (Super Group, for one, has been having a very tough 2014 with declining sales and earnings). But, their corporate histories have been excellent and if only for that reason, they might be worth a closer look.

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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, Raffles Medical Group, and Super Group.