1 Risk to Look Out for While Bargain Hunting During a Market Slump

It’s been a rough month for the Singapore stock market to say the least.

After peaking at 3,550 points in April this year, the Straits Times Index (SGX: ^STI) gradually started to fall. The descent intensified over the past two months, culminating in it closing at 2,801 yesterday. This represents a 21% fall from its peak.

While the slide may be gut wrenching, it may also be an opportunity to pick up some bargains. But, it’s important to be aware of any risks which may be present before we invest. Here’s one to note.

Watch the balance sheet

“I have pledged — to you, the rating agencies and myself -– to always run Berkshire with ample cash. We never want to count on the kindness of strangers in order to meet tomorrow’s obligations.”

– Chairman and CEO of Berkshire Hathaway, Warren Buffett

When it comes to hunting for bargains, we may want to start with the basics. For that, we may want take a leaf out of Warren Buffett’s playbook and start with the balance sheet.

Relevant questions for any company’s balance sheet might be:

  1. Does the company have a net cash or net debt position? (To avoid confusion, net cash is better than net debt, all things being equal)
  2. Does it have too much debt relative to its industry norms?
  3. Does it have a healthy interest-coverage ratio?

Different companies can have different balance sheet risks even if they’re involved in similar businesses. This can be illustrated with the duo of Capitaland Commercial Trust (SGX: C61U) and Mapletree Greater China Commercial Trust (SGX: RW0U). Both are real estate investment trusts that focus on commercial/retail properties.

In its latest quarterly earnings (for the quarter ended 30 June 2015),  Capitaland Commercial Trust reported an interest coverage ratio of 7.6 times. Mapletree Greater China Commercial Trust on the other hand, had an interest coverage ratio of just 4.2 times for the same period – this makes it riskier from a balance sheet standpoint.

While it does not automatically mean that Mapletree Greater China Commercial Trust is a bad investment choice, it’s a risk worth taking note of while deciding among the opportunities available.

A Fool’s take

Buying shares when they’re cheap can pay off down the road, but we should still be aware of the risks. The balance sheet of a company or trust may be a good place to start in assessing risk.

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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 owns shares in Berkshire Hathaway.