My Foolish colleague, Chong Ser Jing, recently ranked all the stocks in the Singapore market according to the Magic Formula, an investing strategy popularised by Joel Greenblatt in his book, The Little Book That Beats The Market. Ser Jing wanted to find the 30 best stocks in Singapore for 2018, based on the Magic Formula, and United Global Ltd (SGX: 43P) happened to be one of them. United Global is an independent lubricant manufacturer mainly serving the automotive, industrial and marine industries. It manufactures a wide range of lubricant products under its in-house brands such as United Oil, U Star Lube, Bell1…
My Foolish colleague, Chong Ser Jing, recently ranked all the stocks in the Singapore market according to the Magic Formula, an investing strategy popularised by Joel Greenblatt in his book, The Little Book That Beats The Market. Ser Jing wanted to find the 30 best stocks in Singapore for 2018, based on the Magic Formula, and United Global Ltd (SGX: 43P) happened to be one of them.
United Global is an independent lubricant manufacturer mainly serving the automotive, industrial and marine industries. It manufactures a wide range of lubricant products under its in-house brands such as United Oil, U Star Lube, Bell1 and Hydropure.
The company also produces lubricants for third-party brands. Other than manufacturing lubricants, it is involved in the trading of base oils, additives and lubricants.
Even though United Global ranked highly on Greenblatt’s Magic Formula, would one of the greatest investors in the world, Warren Buffett, be interested in the company? We can’t ask him in person, but we can turn to a six-point acquisition criteria formulated by the Oracle of Omaha to give us some clues to answer the question. However, more importantly, Buffett’s checklist, together with a deep dive into United Global’s financials that I did recently, can help investors develop a better understanding of the company.
With that, let’s turn to Buffett’s acquisition criteria.
1. Pre-tax earnings of at least US$75 million
In 2017, United Global had pre-tax earnings of US$10.6 million, which is much lower than the first criterion. Retail investors looking into Singapore-listed companies, though, should not be too strict about this rule as this might inadvertently sieve out many small-cap quality companies.
Buffett has this criterion in place because the conglomerate he controls, Berkshire Hathaway, is a near-US$500 billion behemoth, so his acquisition targets need to be of a certain size to move the needle for Berkshire.
2. Demonstrated consistent earning power
The second criterion helps Buffett determine if a company has a stable and/or growing business. Companies that have a history of steady and growing earnings tend to have competitive advantages that help their businesses grow over time.
The table below shows the net profit for United Global over the past four years:Source: S&P Global Market Intelligence
United Global’s earnings have increased consistently from 2014 to 2017, except for a decline in 2016. However, its net profit in 2017 was higher than that of 2015. In all, the lubricant manufacturer’s net income had grown at a commendable annual rate of 39.4% for the time frame above.
3. Good returns on equity (ROE) while employing little or no debt
This criterion’s purpose is similar to the second: It helps Buffett identify companies with competitive advantages. Generally, a company that has a history of generating good ROE while employing little or no debt has a high chance of possessing durable competitive advantages.
Here’s a table illustrating United Global’s return on equity, and total-debt-to-equity ratio, from 2014 to 2017:Source: S&P Global Market Intelligence
The company ended 2017 with an ROE of 35.9% and manageable debt. Its cash balance, as at 31 December 2017, was US$10.6 million, with US$11.4 million in total debt.
4. Management in place
Buffett included this criterion because he did not want to have to provide a management team when he acquires a company. For stock market investors like you and me, this criterion has no real meaning, since public-listed companies almost always have leaders in place. However, this point is a reminder for us to take a look at the people running a company when researching a stock.
According to United Global’s 2016 annual report, Wiranto and Jacky Tan, who are the chairman and the chief executive officer of the firm, respectively, are also the founders of United Global.
Tan has more than 18 years of experience in the lubricant industry. The annual report added that under his management and leadership, United Global had built its business and reputation over the years to become a prominent lubricant manufacturer in the lubricant industry.
5. A simple business
In my view, I think United Global is a simple business to understand as it is involved mainly in the manufacturing of lubricant products.
However, it is worth noting that Buffett had this rule in place to cater to his circle of competence. He is only interested in acquiring businesses that he understands. Going with this train of thought, what I think is a simple business may be complicated for you, and vice versa.
6. An offering price
This is another criterion in Buffett’s checklist that is not applicable for stock market investors, since stocks have quoted prices that are easily seen, unlike the private businesses that Buffett evaluates for acquisitions. This criterion, though, serves as a useful reminder that the price we pay for a stock is critical.
If we overpay for a stock (meaning we invest in a stock at an expensive valuation), the chances of our investment succeeding will be low. A famous quote from Buffett, “Price is what you pay, value is what you get,” rings true here.
Coming to United Global, the company ended Monday at a stock price of S$0.435, giving it a trailing price-to-earnings ratio of 11 and a dividend yield of 2.7%.
A Foolish conclusion
The deep dive I did earlier on United Global, and the application of Buffett’s checklist should help investors make a better-informed investing decision on the company. I like United Global’s simple-to-understand business, strong net profit growth, and high ROE.
Stay tuned for more on the rest of the companies from the 2018 best stocks list. For a repository of all the articles in this new series that uses Warren Buffett’s acquisition criteria to analyse the 30 best stocks, head here.
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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 Sudhan P doesn’t own shares in any companies mentioned.