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How to Find Cheap Investing Gems

When it comes to picking great investments, John Neff would be someone well worth listening to.

As manager of the Windsor fund in the U.S. from 1964 to 1995, Neff managed to help his fund post a phenomenal compounded annual return of 13.7% over his 31-year tenure. A $1,000 investment given to Neff in 1964 would have become $53,000 by 1995; in comparison, the same thousand bucks invested in the U.S. stock market would only have grown to nearly $23,000.

Neff had laid out several defining elements of the investing strategy he used at Windsor in his book John Neff on Investing. Amongst those are a few which are actually useful for even investors in Singapore when it comes to finding potential investing opportunities:

1. A low price-to-earnings (PE) ratio

Neff liked his stocks cheap and he defined cheapness as a share that’s’ trading at a PE ratio lower than that carried by the broader market.

Singapore’s market barometer the Straits Times Index (SGX: ^STI) is valued at around 14 times its trailing earnings at the moment; so, shares which carry a PE ratio lower than 14 could make for potential bargains.

2. Strong fundamental business growth in excess of 7%

Having a cheap valuation is not enough. Neff also liked businesses that were able to grow their earnings sustainably at a rate of between 7% and 20% per year.

A company that’s able to grow helps to improve the odds that its shares would become more valuable over time; as for the 20%-ceiling, Neff felt that shares with businesses that were growing too quickly will find it increasingly hard to maintain such growth-momentum.

3. Having yield protection

By yield protection, Neff meant that “a superior [dividend] yield at least lets you snack on the hors d’oeuvres while waiting for the main meal.”

With the SPDR STI ETF (SGX: ES3) – an exchange-traded fund which tracks the fundamentals of the Straits Times Index – carrying a yield of 2.7% at the moment, that can be used as the benchmark with which to compare the dividend yields of different shares.

4. A business with strong fundamental support

Besides wanting a share to have low valuations, a high dividend yield, and growing earnings, Neff also wanted a business with strong fundamental support. One of the measures he likes to look at when it comes this is a firm’s return on equity. Neff describes:

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

Although Neff did not specifically mention what’s considered a “good” figure for the ROE metric, the experience of another great investor in Warren Buffett suggests that a useful benchmark here would a be ROE of 15% or more on strong balance sheets that have little or no debt.

Pulling everything together

So, if we pull all the four points together, a share like Micro-Mechanics (Holdings) Ltd (SGX: 5DD) might just make the cut to be a great, cheap share. You can see this in the table below.

Micro-mechanics' fundamentals

Source: S&P Capital IQ

But, it’s important to note that Neff’s criteria are meant to help narrow the field and shouldn’t be the final word on picking investments. As such, we’d still have to scrutinise a share like Micro-Mechanics carefully and determine if its strong historical business performance can carry on in the future.

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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 company mentioned.