Here’s 1 Blue Chip That Might Be a Cheap Bargain

John Neff might not be a household name like Warren Buffett is, but Neff’s still every bit a bona fide investing legend like Buffett.

In his 31-year tenure as manager of the U.S.-based Windsor Fund from 1964 to 1995, Neff had earned a very impressive annualised return of 13.7%.

For some perspective, every $1,000 that had been entrusted to Neff at the start of his career in 1964 would have become $53,000 by 1995. In contrast, the same $1,000 investment into the S&P 500 would have grown to “only” $23,000 over the same time period.

A cheap investing gem

Given his track record, Neff’s thoughts on investing would be well worth heeding. That is also the reason why Jardine Cycle & Carriage Limited (SGX: C07) might be a real bargain at the moment.

The company, which is a blue chip that’s part of Singapore’s market barometer the Straits Times Index (SGX: ^STI), is Indonesia’s largest automotive group by virtue of its majority ownership of Indonesia-based-and-listed Astra International. Beyond the automotive industry, Astra also has wide-ranging business interests in financial services, heavy equipment, mining, palm oil production, and more.

In Neff’s aptly-titled investing book, John Neff on Investing, he had laid out several defining elements of his investing strategy. Within these elements are a number which are very helpful even for us investors in Singapore when it comes to seeking out potential investing opportunities.

And as you’d be able to see later, Jardine Cycle & Carriage has ticked most of the right boxes.

Finding the gems

Here are the relevant elements of Neff’s investing strategy:

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

Neff liked to invest in cheap stocks and for him, a key definition of cheapness would be a valuation that’s lower than that of the broader market.

With the SPDR STI ETF (SGX: ES3) having a trailing PE ratio of 13.9 (the SPDR STI ETF is an exchange-traded fund tracking the fundamentals of the Straits Times Index), shares which have a PE ratio that’s lower than 13.9 could be potential bargains in Neff’s view.

  1. Strong fundamental growth in excess of 7%

Being cheap isn’t enough. For Neff, a share’s businesses must also be able to exhibit sustainable earnings growth of between 7% and 20% a year.

A company that can grow its earnings is in effect, increasing its intrinsic value with the passage of time and that’s a desirable thing for investors. That said, Neff had set a ceiling of 20% because he felt that businesses that were growing too fast can find it hard to grow sustainably.

  1. 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.” In other words, having a share with a solid dividend yield would mean that we’re being paid to wait while the market takes its time to reflect the share’s real underlying economic value.

The SPDR STI ETF’s current yield of 2.66% can be a good benchmark to compare against the dividend yields of other shares.

  1. A business with strong fundamental support

To recap, Neff wants a share that has a low valuation, a strong dividend yield, and an ability to grow its earnings at a healthy clip. But that’s not all – he also wants a business with strong fundamentals.

On that front, one measure that he likes to look at would be the company’s return on equity. Here’s how Neff describes it:

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

Neff did not mention any specific number for what’s a good ROE, but the experience of Buffett suggests that a useful benchmark here would be a ROE of 15% or more on a strong balance sheet that has little debt.

Three-and-a-half aces

With that, here’s how Jardine Cycle & Carriage has fared against the four criteria (numbered in the same order as above):

  1. At its current price of S$39.75, the conglomerate has a trailing PE ratio of just 13.2.
  2. Between 2009 and 2014, Jardine Cycle & Carriage’s earnings per share had grown from US$1.44 to US$2.31; that translates to a compound annual growth rate of 9.9%.
  3. Jardine & Carriage has a historical dividend yield of 2.83% thanks to its annual dividend of S$1.126 in 2014.
  4. The ROE metric is where Jardine Cycle & Carriage may have hit a snag. The conglomerate has a healthy ROE of 16% over the last 12 months, but it has achieved that with a balance sheet that has US$1.95 billion in cash and short-term investments and US$5.3 billion in borrowings (as of 31 March 2015). The high amount of borrowings might not be desirable, but to the credit of Jardine Cycle & Carriage, the firm does have a very manageable net-debt to equity ratio of just 32%.

We can see that Jardine Cycle & Carriage has indeed checked off most of the right boxes. But, it’s important to note that Neff’s criteria are meant to help us narrow the field and shouldn’t be used as the final word for picking investments.

More work certainly needs to be done beyond this before any investing decision can be reached, given that other important questions about the firm’s business – such as the integrity and ability of its management team and its cash-flow situation – have yet to be answered.

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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.