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4 Simple and Important Questions You Have To Ask About a Share

Credit: Ethan Lofton

There are so many things to learn about a company that investors may sometimes suffer from a case of paralysis-by-analysis.

But, as the great investor Marty Whitman once said, “Rarely do more than three or four variables really count. Everything else is noise.”

Here are four important and simple questions you can ask about a company which can help you learn a great deal about the firm and its investing merits, if any.

  1.  Is this a profitable business that can earn good returns on capital without using too much debt?
  2. Is the management team equally and sufficiently talented and honest?
  3. What are the reinvestment dynamics of the business and how does it manage its capital?
  4. What is the business’s valuation and what do we have to pay to acquire ownership in the business?

Given its status as the largest component within Singapore’s market barometer the Straits Times Index (SGX: ^STI), let’s use the ubiquitous telecommunications operator Singapore Telecommunications Limited (SGX: Z74) as an example on how we might answer the four questions above.

Is this a profitable business that can earn good returns on capital without using too much debt?

The earliest financial data I have on Singtel goes back to the financial year ended 31 March 1997 (FY1997). And from then till now, Singtel has never suffered any annual losses. In other words, it has been a solid profit-making enterprise for nearly 20 years at least.

Meanwhile, the telco has generated an average return on equity of more than 15% over the same period and it has managed to do so without the use of excessive amount of borrowings (this is seen by how Singtel’s debt to equity ratio has been kept lower than 50% for the most part).

Is the management team equally and sufficiently talented and honest?

This question is not easily answered. Without deep knowledge about Singtel’s management bench, we can only rely on public information to make a judgement.

But, it’s worth noting that Singtel has not had any cases of major mismanagement issues going back to at least 1997. That by itself can be a reassuring piece of information for investors.

What are the reinvestment dynamics of the business and how does it manage its capital?

In this area, Singtel seems to have done a great job.

The company has not raised much equity (if it all) since at least FY1997. Yet, it has been able to provide consistent dividends (SingTel has not missed an annual dividend payout since at least FY1997) and has managed to expand outside Singapore and become a giant multi-national telecommunications outfit.

As a sign of how much Singtel has grown, its revenue has nearly quadrupled from S$4.4 billion in FY1997 to S$16.8 billion in FY2014.

Furthermore, as I mentioned earlier, Singtel’s returns on equity have remained strong over the years. These are all signs that Singtel has good opportunities for reinvesting capital and that the management team is doing a fine job as capital allocators.

Currently, Singtel is not just growing its overseas operations, it is also investing into other areas such as tech firms in order to remain relevant.

What is the business’s valuation and what do we have to pay to acquire ownership in the business??

Singtel’s shares, at their current price of S$4.38, offer a dividend yield of 3.8% based on the telco’s dividend of S$0.168 per share for FY2014.

At S$4.38, Singtel’s shares are also carrying a trailing price-to-earnings ratio of 19. Although a PE of 19 is not within the lower end of Singtel’s historical valuation ranges, that figure does not seem excessive too.

Foolish Summary

What I’ve shared above about Singtel is not meant to be a recommendation to do anything with the company’s shares. Instead, it’s meant to highlight how four simple questions can allow us to understand important aspects about a company’s business.

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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 Stanley Lim does not own any company mentioned above.