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Would Warren Buffett Be Interested In This Growth Company Trading At A 52-Week Low Price With A Dividend Yield of 5%?

The company in question, Micro-Mechanics (Holdings) Ltd (SGX: 5DD), is involved in making parts and tools for the semiconductor industry. Micro-Mecahnics’ share price closed last Friday at S$1.70, which is a 52-week low. Moreover, at that price, Micro-Mechanics had a high dividend yield of 5.3%, excluding any special dividend.

At such a low price, would legendary investor Warren Buffett see value in Micro-Mechanics?

We can’t ask him directly – and even if we could, we highly doubt we would get any answer. However, we can still get some insights by turning to a six-point acquisition criteria for businesses formulated by Buffett himself.

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 US$500 billion behemoth, so his acquisition targets need to be of a certain size to move the needle for Berkshire.

For its financial year ended 30 June 2018 (FY2018), Micro-Mechanics had revenue of S$65.1 million, which is much lower than what Buffett is looking for. However, retail investors looking into Singapore-listed companies should not be too strict about this rule as this might inadvertently sieve out many high-quality small-cap 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 Micro-Mechanics over its past five fiscal years:Source: Micro-Mechanics FY2018 annual report

The company’s net profit had grown by a commendable 22% annually, from S$7.7 million in FY2014 to S$17.1 million in FY2018. The steady increase could mean that Micro-Mechanics has a durable competitive advantage.

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.

The chart below illustrates Micro-Mechanics’ ROE from 2014 to 2018:
Source: Micro-Mechanics FY2018 Annual General Meeting presentation

Micro-Mechanics’ ROE has climbed over the past five years, from an already high level of 18.8% in FY2014. What’s more impressive is that the company managed the feat with no debt during that time frame.

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 retail 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.

Micro-Mechanics’ founder and chief executive is Christopher Reid Borch. He has more than 35 years of experience in the engineering, manufacturing, and management functions of the semiconductor industry. In July this year, he was handed the Best Chief Executive Officer Award at the Singapore Corporate Awards.

5. A simple business

In my view, Micro-Mechanics’ is a simple business to understand. The company designs, manufactures, and markets parts and tools used in the semiconductor industry.

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 Micro-Mechanics, at its share price of S$1.70 last Friday, it had a trailing price-to-earnings ratio of 14 and a dividend yield of 5.3%, without any special dividend. If the company’s special dividend of S$0.01 per share declared in the fourth quarter of FY2018 were included, the dividend yield would be 5.9% — that’s a yield that looks tasty for an income investor.

A Foolish conclusion

Micro-Mechanics seems to tick the right boxes with its growing net profit and ROE. A capable leader also helms the company. With a growing semiconductor market, Micro-Mechanics could be an interesting company for further research.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore has recommended shares of Micro-Mechanics. Motley Fool Singapore contributor Sudhan P owns shares in Micro-Mechanics.