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Why Golden Agri-Resources Ltd May Not Be a Great Blue Chip Stock to Own

Palm oil producer Golden Agri-Resources Ltd (SGX: E5H) has been one of the worst performing blue chips – referring to the 30 constituents of Singapore’s market barometer, the Straits Times Index (SGX: ^STI) – over the past five years.

To that point, Golden Agri-Resources’ shares have fallen by a drastic 55% in that timeframe, while the Straits Times Index has experienced a much gentler 9% decline.

Could there be brighter days to come for Golden Agri-Resources’ investors, after having suffered for years? That would largely depend on the firm’s long-term business performance and unfortunately, there are signs which point to the company actually possessing a low quality business.

An investor to listen to

When it comes to assessing the quality of a business, billionaire investor Warren Buffett is someone we ought to lend our ears to.

In his role as chairman of Berkshire Hathaway Inc since 1965, Buffett has helped grow the conglomerate’s book value per share – a good proxy for the economic worth of the company – by nearly 20% per year through 2014. And, he did that mainly through smart acquisitions of companies and investments in stocks.

Buffett, in his 2014 letter to Berkshire’s shareholders, had penned six criteria that a business needs to meet in order to be a potential acquisition target for him. They are:

“(1) Large purchases (at least [US]$75 million of pre-tax earnings unless the business will fit into one of our existing units.),

(2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations),

(3) Businesses earning good returns on equity while employing little or no debt,

(4) Management in place (we can’t supply it),

(5) Simple businesses (if there’s lots of technology, we won’t understand it),

(6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).”

Stocks represent partial ownership of a business and so, Buffett’s acquisition criteria for private businesses can also be helpful for us when thinking about stock market investing. In our case though, criteria (1), (4), (5) and (6) are not really applicable.

As private investors, we’re not hamstrung by a company’s size. Meanwhile, publicly-listed companies will also have management teams in place running the show and have a stock price that’s refreshed all the time. As for the fifth criterion, that’s just a reflection of Buffett’s own circle of competence.

Keeping the above in mind, let’s see how Golden Agri-Resources fares against the remaining two filters in Buffett’s test.

Quality… or not?

Chart 1 just below shows how Golden Agri-Resources’ revenue and profit have changed over the past 10 years from 2004 to 2014.

Chart 1 - Golden Agri-Resources' revenue and profit
Source: S&P Capital IQ

While the palm oil producer’s top-line has displayed remarkable and consistent growth over the timeframe under study, (the firm’s revenue has jumped nearly 10-fold in 10 years!) the profit picture is a different matter altogether – Golden-Agri Resources’ bottom-line has been positive all these while, but they’ve had erratic fluctuations.

Chart 2 - Golden Agri-Resources' returns on equity (ROE)
Source: S&P Capital IQ

The second graph, Chart 2, illustrates Golden Agri-Resources’ returns on equity over the same period as Chart 1. As you can probably tell, the company’s returns on equity have plummeted in recent years, coming in at a miserly 1.3% in 2014.

A Fool’s take

Over the past decade, Golden Agri-Resources has generated poor returns on equity at times and seen its profit numbers swing violently from high to low. Such characteristics would likely make it look like an unattractive business in the eyes of Buffett.

It’s important to note that the numbers we see above are backward-looking and so, it’s entirely possible that management may be able to turn things around in the future. But, in the here and now, I think it’d be hard to call Golden Agri-Resources a quality business and that’s a risk that prospective and current investors of the company may want to be aware of.

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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.