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This Tiny Stock Has Gained 26% In the Last 12 Months: Here’s Why There May Be More Room to Run

Over the last 12 months, precision manufacturer Micro-Mechanics (Holdings) Ltd (SGX: 5DD) has seen its stock price surge by 26% to S$1.015. For perspective, Singapore’s market barometer, the Straits Times Index (SGX: ^STI), has gained just 11.25% in the same period.

Given this run-up, investors may be wondering if there’s any gas left in the tank for the small company (Micro-Mechanics’ current market capitalisation is just S$141 million). Turns out, there are signs that the company is still worthy of a deeper look by investors who are on the hunt for long-term bargains.

An investing legend

The signs come from the legendary investor John Neff, who ran the US-based Windsor Fund from 1964 to 1995. In those 31 years, the US stock market had gained 10.6% per year whereas Neff generated a compound annual return of 13.7% for the Windsor Fund.

At those rates of return, a $1,000 investment into the US stock market and Neff’s fund in 1964 would have become around $23,000 and $53,000, respectively, by 1995.

Given Neff’s accomplishments, there’s plenty that investors can learn from him. In his book John Neff on Investing, Neff shared a few of the defining elements on how he invested at the Windsor Fund.

Signs of winners

In the list of elements that Neff wrote about are four that I think investors here in Singapore can use to help them dramatically narrow the universe of listed stocks into a more manageable pool for further research. They are:

1. A low price-to-earnings ratio

Neff was a bargain-hunter who liked his stocks to be cheaper than the market. In Singapore’s context, the market can be represented by the SPDR STI ETF (SGX: ES3) given that the exchange-traded fund closely mimics the fundamentals of the Straits Times Index.

Right now, the SPDR STI ETF has a price-to-earnings (PE) ratio of 12.9. This can be used as the valuation-ceiling for the stocks we’re looking at.

2. Strong fundamental business growth in excess of 7%

Besides wanting a low valuation, Neff also wanted his stocks to possess growing businesses. This makes sense – a business that can’t grow can’t build long-term value for its shareholders.

3. Having yield protection

A high dividend yield was an attractive proposition for Neff as it meant that he could be paid to own a stock while he waited for the market to recognise its value.

We can use the SPDR STI ETF’s current dividend yield of 3.0% as the “floor” for the yield that a stock should have.

4. A business with strong fundamental support

Neff also prized a strong business. In his view, the return on equity is a great yardstick for measuring the strength of a business.

Although Neff did not specify what a healthy return on equity is, a general rule of thumb is that a figure of 12% (on a strong balance sheet that has minimal debt) is reasonable.

The case of Micro-Mechanics

Keeping the four signs from Neff in mind, here’s how Micro-Mechanics’ business looks like according to data from S&P Global Market Intelligence:

  • At the precision manufacturer’s current stock price, it has a PE ratio of 11.5 and a dividend yield of 5.9% (thanks to its annual dividend of S$0.06 per share for its fiscal year ended 30 June 2016).
  • The company’s net income has displayed a compound annual growth rate of 19.6% over the last five years.
  • It has a trailing return on equity of 24.8% with a balance sheet that currently has S$21 million and zero debt.

It’s clear that Micro-Mechanics has ticked all the right boxes given its low PE ratio, high dividend yield, impressive earnings growth, strong returns on equity, and debt-free balance sheet.

But, it’s worth noting that Neff’s checklist is only meant to help with narrowing the field, like I had mentioned earlier. A deeper study of Micro-Mechanics’ business fundamentals (such as the market opportunity it has) is needed before any firm investment decision can be made.

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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 does not own shares in any companies mentioned.