This Share Has Shown Strong Signs of Being a Quality Investment

In many different fields, checklists can be powerful tools which help users reduce errors as well as save time and effort. It’s the same with investing.

And when it comes to useful investing checklists, we can turn to Pat Dorsey, who’s currently the head of investment firm Dorsey Asset Management and previously the Director of Equity Research at Morningstar.

Dorsey’s checklist is meant to be completed in 10 minutes so that investors can effectively and quickly come up with a list of companies which are worth a deeper study. There are nine criteria in his checklist and they are shown below:

  1. The firm provides regular financial updates, has a long track record as a publicly-listed entity, and a market capitalisation that isn’t too small.
  2. It has consistently earned an operating profit.
  3. It has generated consistent operating cashflow.
  4. The firm earns a good return on equity.
  5. It has been able to grow its earnings consistently.
  6. It possess a clean balance sheet.
  7. The firm can generates lots of free cash flow.
  8. There are infrequent appearance of one-time charges.
  9. There has not been major dilution of shareholders’ stakes in the firm.

If you’d like more in-depth elaboration as to why these criteria make sense, you can check out my colleague Chin Hui Leong’s recent work. Here they are: Part 1, Part 2, and Part 3.

Using the checklist, a company that ticks off most or all of the boxes would stand a good chance of being a quality investing opportunity. With that, let’s jump to Kingsmen Creatives Ltd (SGX: 5MZ) and see why it has scored a “Yes” in most of Dorsey’s nine criteria.

Kingsmen’s in the MICE industry (Meetings, Incentives, Conventions, and Exhibitions) and its bread and butter lies in helping design, fabricate, and put in place installations for retail stores, offices, exhibitions, theme parks, and museums, amongst other venues.

It has been listed since September 2003; has quarterly earnings releases; and has a respectable market capitalisation of S$184 million.

The chart below plots Kingsmen’s operating income, net income, operating cash flow, and free cash flow for the period between 2004 and 2013. As you can see, the firm has shown consistent operating and net income and both financial metrics have been growing over the years too.

There’s some cyclicality when it comes to Kingsmen’s cash flows, but by and large, they’ve been positive and have also showed a clear upward bias in the nine year period under study.

Kingsmen Creatives' operating income, operating cashflow, free cashflow, and net income

Source: S&P Capital IQ

With the next chart below, we can see that Kingsmen has been generating great returns on equity (the company’s average return on equity between 2004 and 2013 was a phenomenal 26%). In addition, the chart also shows that the company has had a growing cash position and minimal borrowings over the years; that’s a sign of a clean and strong balance sheet.

Kingsmen Creatives' return on equity (ROE), total cash, and total borrowings

Source: S&P Capital IQ

When it comes to the prevalence of “other” charges over the nine-year block between 2004 and 2013, Kingsmen shines too given that it has hardly reported any such charges of significant amounts on its income statement.

Kingsmen Creatives' share count

Source: S&P Capital IQ

Dorsey’s last point on his checklist deals with shareholder’s dilution and this is where Kingsmen may have stumbled a little. As you can see in the chart immediately above, there was a big jump (an almost 25% increase) in share count between the end of 2006 and end of 2007. That was largely due to a share placement, which is a dilutive action.

The share placement may not have been ideal for Kingsmen’s existing shareholders, but it’s also worth pointing out that dilutive acts by the firm have been far and few between.

A Fool’s take

So, in a final tally of the scores, Kingsmen has actually scored well in all of Dorsey’s nine criteria except for the last point.

It’s important to remember here though, that the checklist is meant to help narrow the field and isn’t supposed to be used to pick investments. There are still risks to consider with Kingsmen and one cause for concern would be with the issue of leadership succession given that the company’s co-founders and leaders, Benedict Soh and Simon Ong, are already both in their early 60s.

That said, what we’ve seen with Kingsmen so far would still make it a worthwhile target for investors to take a deeper 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 Kingsmen Creatives.