Editor’s note: There was an error with a debt figure in this article and it has since been corrected (see strike-through portion). At the Fool, we believe that in order to find good shares to invest in, one has to start with figuring out how strong a company’s business is. And to do so, we can turn to the Rule Maker framework outlined by Motley Fool Chief Executive Officer Tom Gardner in his book Rule Breakers, Rule Makers. The Rule-Maker Framework Here’s how the framework looks like: Is the company selling low priced, everyday items? How does the business’s gross…
Editor’s note: There was an error with a debt figure in this article and it has since been corrected (see strike-through portion).
At the Fool, we believe that in order to find good shares to invest in, one has to start with figuring out how strong a company’s business is.
And to do so, we can turn to the Rule Maker framework outlined by Motley Fool Chief Executive Officer Tom Gardner in his book Rule Breakers, Rule Makers.
The Rule-Maker Framework
Here’s how the framework looks like:
- Is the company selling low priced, everyday items?
- How does the business’s gross margins look like?
- What about its net margins?
- Is the company’s sales growing?
- What about its cash to debt ratio?
- Is its Foolish Flow Ratio (a gauge of how fast the business can bring in cash) strong?
- Lastly, what’s your level of familiarity and interest with the business?
Figuring out SBS Transit Ltd
With that, let’s run transport provider SBS Transit Ltd (SGX: S61) through the framework today. We will use figures from its financial year ended 31 December 2014 for this exercise.
The following’s a quick rundown of how SBS Transit has fared against the Rule Maker framework (numbered in the same order as the seven criteria above):
- The business of SBS Transit can be divided into four different business segments – Bus, Rail, Rental, and Advertisements. The land transport company owns the largest fleet of buses in Singapore and serves more than 3,500 bus stops island-wide. Furthermore, it operates the Downtown Mass Rail Transit (MRT) Line and the Light Rail Transit (LRT) System for Sengkang and Punggol. Given all these, SBS Transit’s services can be considered to be recurring in nature – that’s a trait that Tom likes.
- In the case of SBS Transit, we can use its operating margin as a proxy for the gross margin. For 2014, SBS Transit reported a slim operating margin of just 2.3%.
- In the same year, SBS Transit had $14.3 million in net profit attributable to shareholders and that represents a tight net margin of just 1.5%.
- Moving on to the top-line, SBS Transit’s revenue has grown by 6.4% annually from 2009 to 2014. For 2014, its revenue stood at $951 million.
- As of 31 December 2014, SBS Transit had $5 million in cash and cash equivalents, and $483
billionmillion in borrowings. This gives a cash to debt ratio of just 0.01 which is nowhere near Tom’s desired figure of at least 1.5.
- As of 31 December 2014, SBS Transit had $5 million in cash and cash equivalents, $92 million in current assets, and $486 million in current liabilities. This gives a Foolish Flow ratio of 0.2, which comfortably meets Tom’s requirement of having the figure come in at 1 or below.
- It is hard to judge the level of interest for each individual, but the bus and rail services of SBS Transit should be familiar to most investors.
Putting a company through the Rule Maker framework can help you size up the type of opportunity at hand.
With SBS Transit, we might see a transportation company with a steadily increasing revenue base. As the largest bus operator in Singapore, its revenue base can be considered to be recurring and relatively predictable.
These revenue characteristics are critical for SBS Transit since most of its other metrics do not inspire confidence. The company has a net margin of only 1.5% and it has an eye-popping mountain of debt. While SBS Transit’s Foolish Flow ratio holds some promise (it meets Tom’s criteria), the company has not generated any free cash flow for the past five years.
As a final note, it is important to understand that no one company is perfect.
With the characteristics defined above, the onus remains with the Foolish investor to decide if SBS Transit’s current share price provides an appropriate margin of safety and whether it fits into his or her portfolio.
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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 contributor Chin Hui Leong doesn’t own shares in any companies mentioned.