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This Share Might Be On the Cusp of Greatness

For famed investor Warren Buffett, a company’s ability to earn a good return on equity is an important distinguishing criteria between a good and a poor investment. He said as much in his 1979 Berkshire Hathaway annual shareholder’s 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.”

Then, in his 1988 shareholder’s letter, Buffett laid down six criteria he used to evaluate potential business acquisitions. This is his third criterion:

“[B]usinesses earning good returns on equity while employing little or no debt.”

With Buffett’s words in mind, here’s a share that seems on the cusp of greatness: Straco Corporation Ltd (SGX: S85). As you can see in the chart immediately below, the tourism-asset owner’s returns on equity has climbed steadily over the past decade and is now at a phenomenal 23.9% over the last 12 months; that’s remarkable especially when considering that the company has had zero borrowings since 2008.

Straco's returns on equity and balance sheet

Source: S&P Capital IQ

For some perspective, the chart below shows the returns on equity and the leverage levels (as measured by the net debt to equity ratio) over the last 12 months for the top five shares (excluding the banks) that make up the Straits Times Index (SGX: ^STI). These shares are namely Singapore Telecommunications Limited (SGX: Z74), Jardine Matheson Holdings Limited (SGX: J36), Keppel Corporation Limited (SGX: BN4), Hongkong Land Holdings Limited (SGX: H78), and Jardine Strategic Holdings Limited (SGX: J37).

Returns on equity for Straits Times Index's constituents

Source: S&P Capital IQ

It’s obvious that the returns on equity that these blue chips have earned pale in comparison to what Straco has achieved; it’s also worth noting that most of them employ significantly higher leverage).

A Fool’s take

Straco’s economic performance has improved by leaps and bounds in recent years; besides the strong returns on equity on an unlevered balance sheet, the firm’s profit has also jumped from S$6.2 million in 2007 to S$38.9 million over the last 12 months. These have been huge drivers of Straco’s market-beating share price performance: Since the start of 2007, Straco’s shares have gained some 525% while the Straits Times Index has barely increased by 11%.

But with all these said, investors should note that it’s still very important to dig into the reasons behind Straco’s results over the past few years. If it’s merely transient, and there isn’t any real competitive edge in the firm’s businesses, then Straco’s business results might just crumble easily at the first whiff of trouble – and that’s not a good thing for 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.