This Might Be a Great Share to Own

When it comes to hunting for investing opportunities, great managers and businesses with strong economics can be a wonderful winning combination for investors. But, what is ‘great’ and what is ‘strong’? For that, we can turn to the advice of billionaire investor Warren Buffett.

This is him expounding on what traits to look out for in great business leaders in his 1979 Berkshire Hathaway annual shareholder letter:

“The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share.”

In his 1987 shareholder letter, Buffett shared a study conducted by Fortune Magazine on 1,000 of America’s largest industrial and services companies (500 industrial companies and 500 services companies were involved). The following are Buffett’s words about 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].”

From these, we can tell that a company’s returns on equity can be a great gauge of three things: 1) The quality of its management; 2) the quality of the economics of its businesses; and consequently 3), the attractiveness of its shares as a possible investment.

Keeping all the above in mind, a company like Kingsmen Creatives Ltd. (SGX: 5MZ) seems to have ticked the twin boxes of having great managers and great economics.

Kingsmen Creatives' returns on equity , cash, and borrowings

Source: S&P Capital IQ

In the decade ended 2003, Kingsmen’s lowest return on equity had been a rather pedestrian 10.7%. But for the most part, the company had delivered great returns on equity with the average for those 10 years coming in at an impressive 25.0%.

What’s even more remarkable is that Kingsmen has managed to earn these returns without having to resort to undue leverage. As you can see from the chart above, the company has consistently carried more cash than debt on its balance sheet and has also been growing its cash hoard while its borrowings remained negligible.

For some perspective, the SPDR STI ETF’s (SGX: ES3) top 10 holdings, which accounts for 58% of the ETF and includes the big blue chips like Oversea-Chinese Banking Corp. Limited (SGX: O39) and Keppel Corporation Limited (SGX: BN4), have an average return on equity of just 10.4% currently. The SPDR STI ETF is a close proxy for Singapore’s market barometer, the Straits Times Index (SGX: ^STI).

A Fool’s Take

As a likely result of Kingsmen’s stellar financials over the past decade, the company’s shares have been a significant market-beater, having gained 419% in price to S$0.935 since the start of 2004. In comparison, the Straits Times Index has delivered a relatively anemic 89% in gains in the same time period.

All the above isn’t meant to be a buy or sell call on Kingsmen’s shares as even companies with great track records are not infallible in the future. But, given its history of excellence thus far, the company might be a worthy candidate for a deeper study by investors.

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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 and Kingsmen Creatives.