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These 2 Singapore Stocks May Get a Nod from Warren Buffett

Credit: Fool Editorial Photos

Warren Buffett is someone whom serious investors may want to learn something from.

Since taking control of U.S. textile maker Berkshire Hathaway in 1965, Buffett has transformed the company completely over the years through smart investments in stocks and astute acquisitions of private companies.

Buffett’s still at the helm of Berkshire today and from 1965 to 2014, he has helped Berkshire grow its book value per share at a remarkable 19.4% per year on a compounded basis.

In Buffett’s annual Berkshire shareholder letters through the years, he has often laid out a number of key criteria a company has to meet to be considered for an acquisition by Berkshire. Given that stocks are essentially pieces of a business, the hallmarks of a good acquisition target for Berkshire may also be applicable in an investor’s search for solid long-term investing opportunities.

The key criterion: Making sense of the Return on equity

One of Buffet’s criterion is this: “Businesses earning good returns on equity while employing little or no debt.”

The return on equity (or ROE), is simply a company’s net income as a percentage of its shareholder’s equity. The reason for the existence of the aforementioned criterion is that those characteristics may be clues that a company has strong competitive advantages that can protect its profit streams from competitors.

A long-term track record of delivering solid ROEs may also be a sign that a company has a highly competent management team. The following is Buffett’s explanation as given in the 1977 Berkshire annual shareholder’s letter:

“Most companies define ‘record’ earnings as a new high in earnings per share. Since businesses customarily add from year to year to their equity base, we find nothing particularly noteworthy in a management performance combining, say, a 10% increase in equity capital and a 5% increase in earnings per share.

After all, even a totally dormant savings account will produce steadily rising interest earnings each year because of compounding […] [W]e believe a more appropriate measure of managerial economic performance to be return on equity capital.”

Buffett’s caution against excessive debt is also important to note here. The use of high levels of borrowings can juice up a company’s ROE, but it saddles the firm with financial risks. “I like to look at the balance sheet and I don’t like debt because it can really get a company in trouble,” the late Walter Schloss, another super investor and a long-time friend of Buffett’s, once said.

Two great stocks

Keeping all the above in mind, here are two Singapore-listed stocks which may catch Buffett’s eye: Luxury watch retailer Hour Glass Ltd (SGX: AGS) and cleanroom & healthcare nitrile gloves maker Riverstone Holdings Limited (SGX: AP4).

ROEs for Hour Glass and Riverstone in last 10 completed fiscal years

Source: S&P Capital IQ

From the chart just above, you can see that both Hour Glass and Riverstone Holdings have delivered strong average ROEs of 14.6% and 20.7%, respectively, over their last 10 completed fiscal years.

Net-cash position (total cash & equivalents minus total debt) for Hour Glass and Riverstone

Source: S&P Capital IQ; author’s calculations

The second chart illustrates how the two companies’ balance sheets have evolved over the same timeframe as the first. As you can see, Hour Glass and Riverstone Holdings have had strong balance sheets with a net-cash position (meaning to say there’s more cash than debt) for the most part. In other words, both firms have generated good ROEs over the years with little or no debt.

A Fool’s take

What you’ve seen here shouldn’t be taken to be a buy or sell call on Hour Glass and Riverstone Holdings. But, they’ve had beautiful track records and for that reason alone, they may be worth a deeper look by investors.

A company’s ROE is a trait we may want to keep an eye on in our quest to find winning investments. That said, it’s also crucial to note that the ROE is not the sole determinant of how well a company’s stock will fare as an investment.

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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 owns shares in Berkshire Hathaway.