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 Sunright Limited (SGX: S71) happened to be one of them. Founded in 1978, Sunright is the world’s biggest independent “test and burn-in” service company and a leading manufacturer of parallel test equipment. The firm also houses an electronics manufacturing services division to provide design, engineering and…
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 Sunright Limited (SGX: S71) happened to be one of them.
Founded in 1978, Sunright is the world’s biggest independent “test and burn-in” service company and a leading manufacturer of parallel test equipment. The firm also houses an electronics manufacturing services division to provide design, engineering and manufacturing services for the aerospace, automotive, consumer electronics, industrial and medical sectors.
Even though Sunright was 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 Sunright’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
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.
In 2017, Sunright had pre-tax earnings of S$15.9 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.
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 Sunright over the past five years:Source: S&P Global Market Intelligence
Sunright had a loss-making year in 2013. However, from 2014 to 2017, its bottom-line had grown at an impressive rate of 351% per annum.
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 Sunright’s return on equity, and total-debt-to-equity ratio, from 2013 to 2017:Source: S&P Global Market Intelligence
Sunright ended 2017 with an ROE of 13.3% and manageable debt. Its cash balance, as at 31 July 2017, was S$45.4 million, with S$25.9 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.
The executive chairman and chief executive of Sunright is Samuel Lim Syn Soo, who has more than 45 years of experience in the semiconductor and electronics industry. He has also obtained three US patent families due to his inventions with regards to “burn-in and test”. As at 27 September 2017, Lim held 54.9% of the company and is Sunright’s biggest shareholder.
5. A simple business
In my view, Sunright is not the simplest of companies to understand. 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 complicated business may be simple 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 Sunright, the company last traded at a stock price of S$0.82 yesterday, giving it a trailing price-to-earnings ratio of 10 and a dividend yield of 0.4%.
A Foolish conclusion
The deep dive I did earlier on Sunright, and the application of Buffett’s checklist should help investors make a better-informed investing decision on the company. 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, you can 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.