This 1 Blue Chip May Be a Quality Investment

In Singapore, the blue chips – the 30 components of Singapore’s market benchmark, the Straits Times Index (SGX: ^STI) – are often highly regarded by the investing public.

But faith in the quality of the blue chips as good investments can be misplaced at times. Just ask shipping outfit Neptune Orient Lines Ltd (SGX: N03). The company was part of the revamped Straits Times Index that was launched on 10 January 2008 but got kicked out almost five years later on 24 September 2012.

During that four-plus year block of time, Neptune Orient Lines saw its share price decline by two-thirds as its bottom-line shrank from a profit of US$523 million in 2007 to a loss of US$412 million in 2012.

Neptune Orient Lines’ experience goes to show that what ultimately counts is a company’s business performance, not its status due to it being part of an exclusive club or index.

Keeping this thought in mind – that it is the business that matters – what are some of the current blue chips that do have the potential to be a quality investment?

To answer the question, we can turn to an investing checklist created by Pat Dorsey. Dorsey, who’s currently the head of investment firm Dorsey Asset Management and previously the Director of Equity Research at Morningstar, had meant for the checklist to be a quick tool for investors to use.

The checklist is designed to be able to be completed in 10 minutes so that investors can effectively come up with a list of companies worthy of a deeper look. There are nine criteria in the checklist:

  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 some 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.

A company which scores a “yes” response to most or all of the criteria would stand a better-than-equal chance of being a quality investing opportunity. With that, let’s jump to transport provider ComfortDelGro Corporation Limited  (SGX: C52) and see just why it’s a blue chip that might really deserve the blue chip moniker.

ComfortDelGro is a global land transport giant that counts the operation of bus services, rail services, and taxis as its main bread and butter. The firm has Singapore as its largest geographical market, but it also has a sizeable presence in the United Kingdom, Australia, and China.

The firm’s corporate predecessors have been around for decades and the ComfortDelGro we know of today has had at least a decade’s worth of history as a publicly-listed company. Along with a noteworthy market capitalisation of S$5.95 billion, these characteristics will give ComfortDelGro a “yes” for Dorsey’s first criterion.

The chart below shows how ComfortDelGro has been consistently generating operating income, net income, operating cashflow, and free cashflow over the decade ended 2013.

And as you can see, the firm has even managed to eke out some growth in operating cash flow, operating income, and net income; criterion 2, 3, 5, and 7 get a clear pass as a result.

ComfortDelGro's operating income, operating cashflow, free cashflow, and net income

Source: S&P Capital IQ

Coming up next is a chart which plots ComfortDelGro’s returns on equity and key balance sheet figures over the same 10-year period as above.

As the chart paints, ComfortDelGro has been generating a healthy return on equity over the years (it’s certainly not a great figure, but an average return on equity of 13.4% between 2003 and 2013 is also nothing to sneeze at as well); as of the end of 2013, the transport outfit’s return on equity sits at a comfortable 12%.

The chart also makes it clear that ComfortDelGro has been operating with a clean and strong balance sheet over the past decade given that its cash position has always exceeded that of its total borrowings. With these, criteria 4 and 6 would also deserve “yes” responses.

ComfortDelGro's return on equity (ROE), total cash, and total borrowings

Source: S&P Capital IQ

Dorsey’s pen-ultimate criterion on his checklist is also an area where ComfortDelGro shines; a glance at the firm’s historical financials would reveal that it has hardly logged any significant one-time “other” charges in its income statements over the 10-year block under study.

ComfortDelGro's share count

Source: S&P Capital IQ

Moving on to the last criterion on Dorsey’s checklist, we can see from the chart above that ComfortDelGro has experienced a consistent increase in share count over the years. But it should be noted that the pace of increase has been miniscule (only 0.4% per year on average) and so, the transport company would also have a “yes” checked here.

A Fool’s take

Rounding up the scores, we have ComfortDelGro checking off all the right boxes – that’s great. But it’s important to remember here that the checklist is meant to help narrow the field and isn’t supposed to be used to pick investments.

A deeper look at ComfortDelGro is still required. One particular risk would be the blue chip firm’s valuation. At the transport outfit’s current price of S$2.94, it’s valued at 22 times its trailing earnings despite having seen its latest quarterly earnings per share grow by only 4.7% year-on-year. Such dynamics might suggest that the risk-reward playoff may not be in the investor’s favour.

But that said, ComfortDelGro’s track record thus far would still make it worthwhile for investors to take a deeper look.

For more investing analyses and important updates about the stock market, sign up to The Motley Fool Singapore's free weekly investing newsletter, Take Stock Singapore. Written by David Kuo, it can help you grow your wealth in the years ahead.

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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.