6 Points That Say This Company Might Be a Great Growth Stock

Diamond manufacturing equipment and technology supplier Sarine Technologies Ltd (SGX: U77) has been a great market-beater with its shares rising nearly 870% to S$2.83 since its listing in April 2005.

In comparison, Singapore’s market barometer, the Straits Times Index (SGX: ^STI), has gained just 57% over the same time period.

Sarine Technologies’ share price growth hasn’t come about in a vacuum. From 2005 to 2013, the company’s sales and profit have grown at compounded annual rates of 12.2% and 12.4% respectively. Although not stunningly high, these are certainly still impressive growth rates.

But that is then and this is now. Can Sarine Technologies still keep up its status as a growth stock going forward?

It won’t be an easy question to answer, but for some help, we can turn to growth-investor-extraordinaire Philip Fisher for some help.

Fisher, who’s the lesser-known mentor of billionaire investor Warren Buffett, had laid out 15 characteristics that he looked out for in a share in his best-selling investment book Common Stocks and Uncommon Profits.

To fill in the blanks for the 15 characteristics, Fisher would dig deep into the details of a company and try and speak to company insiders, industry experts, customers, suppliers, and competitors.

I don’t have the connections needed to find out all 15 characteristics, but here are six of them about Sarine Technologies which can be found from the company’s publicly-available information.

Characteristic No.1: Does the company have products or services with sufficient market potential to make possible a sizeable increase in sales for at least several years?

Sarine Technologies’ main bread-and-butter currently involves the sale of technology and equipment to diamond manufacturers (the ones who turn rough stones into polished gems) that help them improve the efficiency of their operations and the quality of their output.

However, the introduction of new products – Sarine Light (a system for grading certain aesthetic qualities of polished diamonds which are prized by jewellery consumers) and Sarine Loupe (an imaging system that allows diamond traders to accurately assess a diamond through virtual images, hence reducing friction in the trading of polished diamonds) – sees the company aiming to enter the retail trading segment of the diamond industry value chain.

This segment was estimated by Sarine Technologies to have had a market value of US$74.5 billion in 2013. Given the firm’s revenue of “just” US$86.1 million over the 12 months ended September 2014, there does seem to be room for further growth for the company over the next several years.

Characteristic No.2: Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited?

Sarine Technologies has been a serial innovator judging from the pipeline of new products it has introduced over the years (see the chart  below; click for a larger image). This is a clue that management’s not sitting still and is constantly thinking about new ways to drive further growth.

Sarine's product pipeline

Source: Sarine Technologies’ Q3 2014 earnings presentation

Characteristic No.5: Does the company have a worthwhile profit margin?

Period Sarine Technoloies’ net income margin
2011 30.0%
2012 32.6%
2013 31.3%
12 months ended 30 September 2014 32.3%

Source: S&P Capital IQ

As you can see in the table above, those are some serious net income margins.

Characteristic No.6: What is the company doing to maintain or improve profit margins?

Sarine Technologies endured a difficult 2008 and 2009 as its business was severely crimped by the Great Financial Crisis; as an example, its profit of US$8 million in 2007 fell to US$1.6 million in 2008 despite seeing revenue dip only slightly from US$37.1 million to US$33.1 million.

But from those ashes came the company’s desire to change its business model. Prior to that, Sarine Technologies’ revenue came mostly from the one-time sale of its equipment and technologies to diamond manufacturers.

In 2009, starting with the launch of the Galaxy family of systems, the company started to introduce equipment and technologies which can be charged on a per-use basis. This gave the firm recurring revenue and a stronger profit-margin-profile.

Sarine Technologies’ new products mentioned earlier – Sarine Light and Sarine Loupe – are also “expected to add to the Group’s recurring revenue base,” according to its latest earnings presentation.

Characteristic No.11: Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?

Sarine Technologies may have its fair share of competitors, but that has not stopped the company from dominating its space.

According to the company’s presentations, it commands a market share of approximately 70% in the diamond planning & grading products space. In other words, Sarine Technologies is actually larger than all its competitors combined.

Characteristic No.13: In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders’ benefit from this anticipated growth?

Fisher was wary of firms that needed to issue new shares to raise capital for growth. For investors, what’s important is the growth in a company’s per-share figures. If new shares are constantly issued, there might not be any meaningful per-share growth for investors to enjoy.

With Sarine Technologies, the company ended the third quarter of 2014 with zero borrowings and US$40.7 million in cash and short-term investments. In addition, the firm has generated an average annual operating cash flow of US$20 million between 2011 and 2013.

What this means is the company has plenty of cash resources on hand to fund its growth and likely wouldn’t need to resort to dilutive means to raise additional capital.

A Fool’s take

So there you have it, six points from Fisher which point to how Sarine Technologies may be a great growth stock.

But, none of the above is meant to say that Sarine Technologies will definitely be a good investment. There are still important risks to consider.

For instance, the demand for the company’s equipment and technologies is in certain ways, affected by the price differentials between rough diamonds and polished diamonds. There’s always the chance that Sarine Technologies’ results will suffer if future price movements of polished diamonds in relation to rough diamonds makes diamond manufacturers’ (Sarine Technologies’ main customers for now) business less economically viable.

Then, there’s also the company’s valuation to consider. At Sarine Technologies’ current price, it’s trading at 26 times its trailing earnings – that’s not exactly a low valuation. For some perspective, the SPDR STI ETF (SGX: ES3), an exchange-traded fund which tracks the Straits Times Index, has a price-to-earnings ratio of just 14 at the moment.

All told, investors have to weigh the risks and rewards with Sarine Technologies to come up with an intelligent investing decision on their own.

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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 Sarine Technologies Ltd.