How You Can Pick Winning Shares like Investing Greats

Earlier today, my colleague Chin Hui Leong shared how the investing principles of the legendary investor John Neff can be applied by individual investors here in Singapore to find winning shares. Neff’s investing methods were detailed in his own book, John Neff on Investing.

Here’s a brief recap of what Chin wrote:

a) Low Price-to-Earnings (PE) ratio

Neff preferred shares which have a PE ratio lower than the overall market’s as that generally provided excellent upside while giving solid downside protection.

The current price-to-earnings ratio for the SPDR STI ETF (SGX: ES3) is 13.6; the ETF (exchange-traded fund) tracks Singapore’s market barometer, the Straits Times Index (SGX: ^STI). Therefore, our first criterion for the screen would be a PE ratio lower than 13.6.

b) Fundamental growth in excess of 7%

In his second principle, Neff demanded persistent increments of earnings growth of between 7% and 20%. He felt that growth rates higher than 20% carried too much risk and might not be sustainable. With persistent increments in mind, we can use the historical five year annualized EPS [earnings per share] growth in that same range as our second criteria.

c) Yield protection

One of the defining approaches of Neff’s investing style was his insistence on a dividend. As he saw it, “a superior yield at least lets you snack on the hors d’oeuvres while waiting for the main meal”. The current yield for the SPDR STI ETF is 2.6%. Thus, our third criteria will be a yield that is higher than that.”

I have great admiration for Neff, and in the spirit of sharing even more useful tools which investors can use, I wanted to expand upon Hui Leong’s work to include another of Neff’s criterion we can use to help sieve out possible investing opportunities.

More useful tools

Besides wanting to find growing companies with low valuations and healthy dividend yields, Neff also wanted a business with strong fundamental support. On that note, one of the measures he looks at would be a firm’s return on equity. This is how Neff describes it in his book:

“Return on equity (ROE) furnishes the best single yardstick of what management has accomplished with money that belongs to shareholders.”

And while Neff did not mention what’s considered a good ROE figure to look at, anything above 15% (provided the company’s not heavily leveraged) is actually a sign of quality. With this in mind, I’d like to add onto Hui Leong’s three criteria with a fourth of my own: A return on equity of 15% or more with a balance sheet that has more cash than debt.

The candidates and a Fool’s take

I built a screen with all four criteria in hand and King Wan Corporation Ltd (SGX: 554), Hour Glass Ltd (SGX: AGS) (SGX: E5P), and Valuetronics Holdings Limited (SGX: BN2) were some shares which filtered through.

Important financials for King Wan, Hour Glass, and Valuetronics
Source: S&P Capital IQ

From their numbers alone, the trio have had decent earnings growth, carry a cheap valuation, deliver a high dividend yield, and seem to have businesses with desirable economic characteristics.

But crucially, investors can’t just stop there. Neff’s criteria is meant to help narrow the field to ease constraints for the individual investor, and not pick investments. As such, investors would still have to study these shares carefully and ascertain if their businesses can still remain strong as they did in the past.

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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 doesn’t own shares in any companies mentioned.