This Tiny Market-Beating Stock (A 208% Gain In 5 Years) May Have More Room To Run

In the 12 months, three years, and five years ended 27 March 2017, this company has seen its stock price climb by 61%, 92%, and 208% respectively. Over the same timeframes, Singapore’s market barometer, the Straits Times Index (SGX: ^STI), has gained just 10%, lost 1%, and inched up by 4%.

Paper packaging products manufacturer Tat Seng Packaging Group Ltd (SGX: T12) is a tiny stock with a market capitalisation of just S$97 million. But, as I’ve showed, its stock market gains have been anything but tiny.

Could there be more gas left in the tank for Tat Seng Packaging’s stock to deliver long-term gains? There are signs that there may be.

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 in 1964 into the US stock market and Neff’s fund 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

Here are four of those elements and how they can be applied to the Singapore stock market:

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 of between 7% and 20%

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. Neff also placed a limit on the growth rates because he thought that explosive growth can be risky.

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 Tat Seng Packaging 

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

1. It has a PE ratio of 6.7 and a dividend yield of 6.5% (thanks to its annual dividend of S$0.04 per share for its fiscal year ended 31 December 2016).

2. The company’s net income has displayed a compound annual growth rate of 26.7% over the last five years.

3. It has a trailing return on equity of 14.8% with a balance sheet that currently has S$45.4 million in cash and equivalents, but just S$37.1 million in debt.

We can see that Tat Seng Packaging has ticked most of the right boxes given its low PE ratio, high dividend yield, strong returns on equity, and net-cash balance sheet. Although Tat Seng Packaging’s five-year earnings growth rate is very impressive (which is a good thing!), it does exceed Neff’s preferred range – that’s the only kink.

At this point, it’s worth noting that the four signs from Neff’s checklist should only be used to help with narrowing the field. A deeper study of Tat Seng Packaging’s business fundamentals (such as the market opportunity it has and the quality of its earnings) 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.