Stock Picking Strategy Series: Dreman’s Contrarianism Part 1: Investment Philosophy and Strategy

This column is written by @j_chou.
-@J_chou has an interest in global macro trends, financial markets and equity research and enjoys applying a combination of the three in his investments. His eventual investing goal is to manage a risk parity portfolio and achieve true financial freedom.

David Dreman is the chairman of Dreman Value Management Inc. and his Dreman’s High Return Fund is one of the all-time highest returning mutual funds in the USA since its introduction in 1988. He is widely knowns for his iconic contrarian investment strategy and has authored a few books that revolves around this theme, including the investing classic and bestseller “Contrarian Investment Strategy: The Psychology of Stock Market Success(1980)”.

When Dreman first entered Wall Street in the 1960s he was caught up with the prevailing optimism in the market where “fashionable” stocks were up twentyfold. Within a couple of years many of those stocks had plummeted. Stung by his experience, Dreman began researching the drivers of investing bubbles. He was perplexed as to why investors hadn’t realised that they’d been swept up in an enormous folly.

Dreman’s Approach

Dreman’s strategy, backed up by years of research and illustrated heavily in his books, is outlined by his approach to both the behavioral and interpretational obstacles of investing. Behavioral obstacles include a tendency toward crowd psychology, while interpretational obstacles include the difficulty of actually estimating future company value. While the price of a stock will ultimately move toward its actual intrinsic value (regression to the mean), mistakes in estimating that value (interpretational obstacles) and market emotions and preferences (behavioral obstacles) will result in periods of undervaluation and overvaluation.

As Dreman observed:

“The failure rate among financial professionals, at times approaching 90%, indicates not only that errors are made, but that under uncertain conditions, there must be systematic and predictable forces working against the unwary investor.”

Dreman especially holds contempt for experts and analysts, whom he has extensively researched on and noticed that their estimates were on average 44% off even when provided with a 5% margin of error. He concluded that in general analysts are no better at stock picking than a flip of a coin! The latter half of his observation stems from the fact that investors pay too much for companies that appear to have the best growth prospects but react too negatively to companies with weak prospects. Hence, astute contrarians can profit by taking a position against the crowd with anticipation that results will be better than expected and an improving trend in return-on-capital will emerge.

Graph from The Economist: Sell-Side Share Analysis is Wrong

With this investing philosophy in mind Dreman surmised his simple yet mechanical strategy of picking stocks:

“I buy stocks when they are battered. I am strict with my discipline. I always buy stocks with low price-to-earnings ratios, low price-to-book value ratios and higher-than-average yield. Academic studies have shown that a strategy of buying out-of-favor stocks with low P/E, price-to-book and price-to-cash flow ratios outperforms the market pretty consistently over long periods of time."

To summarise Dreman’s 5 criterias for picking stocks:

1. Low Price-to-Earnings Ratio
2. Signs of Earnings Growth
3. Medium to Large Company Size
4. Financial Strength
5. Above-Average Dividend Yield

Low Price-To-Earnings Ratio

Source from

Stocks with high PER are often attributed to investor’s overconfidence in the stock. Hence Dreman researched on how earnings surprises, both positive and negative affect the prices of expensive and cheap stocks for a period of 24 years between 1973 and 1996. 95 quarters in all were studied and between 750-1000 companies in each of the 95 quarters of the study.
They ranked stocks into five sets of quintiles ranked by PER, PCR and PBR. The top quintile (quintile = 20% of sample) were the most favoured stocks, the bottom quintile the least favorited. Prices were measured against consensus forecasts every quarter between 1973 and 1996.

Results were as follows:

The bottom (cheap) quintile of stocks responded positively to earnings surprises. Per quarter they averaged 1.5% above market and over the full year beat the market by 4.2% per annum. This means that the combined effect of all surprises, positive and negative, worked in favour for the cheap stocks. Middle quintile stocks performed just below neutral, underperforming by 0.2% per quarter and 0.5% per annum. Top quintile stocks underperformed, returning 1% per quarter less, or 3.5% per year. Stocks with a low price to earnings ratio surprised the market by returning 4.2% per year above the general indexes whilst expensive stocks disappointed by 3.5% per year.

It can be concluded in a longer time frame low PER stocks will outperform stocks with high PER.

Signs of Earnings Growth

Companies that are ripe for contrarian plays often have a good reason for being in that particular position, mostly due to enormous losses and poor business operations. As such, further losses will likely see muted negative impact on share prices. However, if the company makes even a modest profit which may signal a turnaround, the growth in earnings will probably be astronomical.

Hence, for this criteria Dreman has learned to keep an eye out for companies that still have a long way to fall. He will only invest if he can determine if a company has decidedly hit the bottom and is starting to turnaround.

He has a simple approach to determining if a company has bottomed out, which is to look at consensus estimates. Though he has a disdain for analysts and does not follow precise estimates, he does look at Wall Street forecasts to a certain extent, to see if forecasts show huge continued losses. He has observed that when analysts are overwhelmingly convinced that earnings have further to fall then it is best to take heed and avoid the stock.

Medium to Large Company Size

Dreman generally dislikes investing in small cap and penny stocks as he observed that for such stocks survival rates are lower and transaction costs are higher Furthermore, due to the illiquidity of such stocks the spread is big, which may completely offset the much higher theoretical profits of such companies.

Also, Dreman is of the opinion that accounting is a “devilishly tricky subject” as from experience both novice and sophisticated investors have often misinterpreted crucial elements of accounting statements. Hence, medium to large firms that will generally provide a more honest view of accounting are preferred as larger firms with long records are watched more closely by a wider range of investors and regulators.

Another reason to favour medium to large cap companies is that through studies Dreman has found fewer large firms has gone completely out of business. Furthermore, large companies have greater managerial and financial resources to weather a company or industry slowdown or problem. Also, stocks of rebounding large companies tend to be in the public eye and get noticed more quickly when things go better for the company which should result in a higher valuation for a given level of earnings.

Financial Strength

Dreman was a big fan of Benjamin Graham’s work. For added margin of safety, Dreman also believes it is important to consider the financial strength of a company when pursuing a contrarian investment strategy. A strong financial position enables a company to work through periods of operating difficulty commonly experienced by out-of-favor stocks. Financial strength is also a measure of stability and ensures that dividend payout is sustainable.

Both short-term obligations of the company along with long-term liabilities should be considered when testing for financial strength. Ensuring that the company has sufficient reserves and conservative debt levels will mitigate the risk of default in turbulent times.

Sustainable Above-Average Dividend Yield

Lastly, Dreman seeks companies with a high dividend yield that the company can sustain and possibly raise. The yield helps to provide protection against a significant price drop, and also contributes to the total return of the investment. Hence, ensure dividend cover and dividend payout ratios are reasonable, as a cut in dividend will have a negative impact on share price.

Exit Strategy

Dreman also discussed a little about his exit strategy in his books. It mostly boils down to one rule, which is to sell a stock when PER approaches that of the overall market, regardless of how favourable prospects may appear. Hence, sell when the stock has reached the same price as the general market as a new contrarian stock will have better prospects. Also, look to sell it if the stock appears to have a deteriorating outlook, as fundamentals have changed. Dreman warns against applying contrarianism for the sake of contrarianism. The idea of contrarianism is to buy undervalued stocks, not bad stocks.

Dreman also has suggestions on how long to hold onto a stock that has not realized its potential. To him it is all pretty much a matter of choice, but give a period of 2.5 or 3 years for the stock to work out.

To be continued…

In the next post I will look at a few SGX stocks where the contrarian strategy could theoretically be applied. Given the poor performance of some mid to large cap stocks recently there should be some interesting picks! Hint: $M1(B2F.SI) anyone?

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Write a comment...I learn a lesson, jump ship don't know jump back to the pilot seat. journey learning from kidstart


A few things to note here, 1. they are using stats from a baskets of low pe or low pb stocks, not a single stock. Don't assume you also can buy one or two low pe or low pb stocks n expect to outperform. 2. The stats show it can outperform does not mean we can outperform. We are likely to sell for all kinds of reasons, stats are emotionless n have no commitments. 3. Time frame is important, stats can be chosen from a certain period to either support or argue against the writer's view. #HindsightIs20/20

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Contrarianism Part 2: Lessons from Templeton. Vote for your stock!

If you like this column, please start voting which stocks you would like them to write on in their next article! This is your chance to interact with them and they will write on the most voted stock of your choice!

How to vote: Comment any of the 4 listed stocks of your choice mentioned in the article (M1, Comfort Delgro, SPH, SIA Engineering). The most number of likes/comments by Monday morning will be chosen. It’s that simple!

Voting starts now and ends on Monday (31st July) when market opens (9am)!

Disclaimer: this article simply provided analysis on stocks from the fundamental perspective, it does not represent any buy/sell recommendation from Investingnote. *All the dollar unit ($) in this article refer to SGD.

This column is written by @j_chou.
–Jay has an interest in global macro trends, financial markets and equity research and enjoys applying a combination of the three in his investments. His eventual investing goal is to manage a risk parity portfolio and achieve true financial freedom.

With S&P 500 and NASDAQ closing at record highs today and VIX Index at a 23-year low, the timing seems ripe to revisit the contrarian approach!

Besides Dremen, another famous investor whom we can learn the contrarian approach from is Sir John Templeton. Known for his acumen in global stock-picking, Templeton’s principles of purchasing at “maximum pessimism” pushed him towards stocks that had been entirely neglected. His story of profiting off the Great Depression is legendary: in 1939, he purchased $100 worth of every stock which was trading below $1 per share on the New York and American stock exchanges. This totaled about 104 different companies, a whopping 34 of which were bankrupt, and Templeton’s initial investment was $10,400. After four years, he managed to sell those shares for nearly four times the money he had initially invested. His genius proved to be timeless, as yet again in 1999 during the dot com bubble he famously predicted that 90% of the new Internet companies would be bankrupt within five years, and he very publicly shorted the U.S. tech sector.

Let’s look back on some of Templeton’s famous words of wisdom and see if we can gain any new insights into the current market!

“The four most dangerous words in investing are: ‘this time it’s different.'”

Against the calls of caution by some prominent hedge fund managers, there are many who have instead been up in droves to quash any bearish sentiments. Many bull investors view this run as different from the dot com bubble; they believe that this time round stock market appreciation is driven by fundamentals and earnings growth.

In fact, even prominent bears are increasingly turning bullish.

Robert Shiller, famed for creating the Shiller P/E and predicting the dot-com bubble and housing bubble, has frequently warned that the market looks “very expensive” but has recently claimed that several sectors in the market are relatively cheap, including the best performing tech stocks and “stocks could go up 50% from here”.

Three years ago, famous bear investor Jeremy Grantham of GMO was firmly in the camp that the extended post-crisis market rally was due for a correction. However, recently Grantham has decided that U.S. large caps deserve to trade at higher multiples than the past as they have far more earning power.

Even Warren Buffett, once famously averse to technology stocks, is now one of Apple’s (AAPL) biggest shareholders. He pointed out at Berkshire Hathaway’s recent annual meeting that big tech firms are different from traditional companies as they do not require much capital to grow.

Maybe this time it really is different?

“Bull markets are born in pessimism, grow on skepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.”

Templeton warns against being too confident of one’s own investing abilities, as “An investor who has all the answers doesn’t even understand the questions.”

The brilliant former Business Times columnist Teh Hooi Ling noted: “Humans are by nature optimistic. When two views are presented, the optimistic and pessimistic ones-we tend to think that the optimistic view will pan out. That is until we are proven so dead wrong that we lose hope entirely and regard any light at the end of the tunnel as an oncoming train. That’s the time we would dismiss any optimistic prognosis.”

It is indeed common sense that one should buy low and sell high. Yet due to human behavior it is hard to go against the herd mentality. As such, it is best to rely on technical indicators to provide a clear outlook of the market.

One such indicator as suggested by Teh Hooi Ling in her article “Spotting A Bubble From Some Distance Away” was to use the equity risk premium(ERP). By analyzing when to hold stocks or cash by setting a buy signal when ERP rises above 4%, and selling when ERP is below 2%, for a period of 15 years, she managed to generate compounded annual return of 10.5%, above STI return of 6.2% for the same period.

Hence, when ERP gets too low it may indicate a bubble forming, and it may be better to hold cash until ERP increases.

“Focus on value because most investors focus on outlooks and trends.”

As InvestingNote members often gripe, being contrarian is easier said than done. How are we to be greedy when others are fearful, when we are at the same time afraid of catching a falling knife? The answer, as surmised by Sir John Templeton, is to focus on intrinsic valuation. It is no coincidence notable contrarian investors are also strong believers of value investing: Graham, Buffet, Klarman, Dreman, Neff, Templeton etc. Instead of panic-searching for news or analyst opinions, assessing a stock based on fundamental analysis and healthy ratios into the long term is probably the safest and surest way to successful contrarian investing. After all, if due diligence was done your investments will be protected by margin of safety.

Contrarian opportunities in SGX?

Recently, there have been some SGX stocks that have seen a plunge in prices and generated negative sentiments in the InvestingNote community. Are these companies a contrarian opportunity or are the fall in prices justified?

Vote in the comments below and let me know which stock you would like me to analyse!


Post by @RetiredOldMan:

Post by @KallangRiverWoof:

Post by @Sporeshare:

$SIA Engineering(S59.SI)

Post by @CASHFLOW:

Post by @PhilipCapital:


Post by @akwl88:

Post by @BrennenPak:

Post by @Jimes:


Post by @indigo:

Post by @mlow:

Post by @Turtle_Investor:

Please cast your vote on your favourite stock (pick 1 out of 4) in the comments below before the market opens on Monday at 9am!

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3 Recent Developments You Should Know About $StarHub(CC3) and the Telco Industry
$SingTel(Z74) $M1(B2F)

This article is jointly written by @fayewang, @calvinwee and @gordon_ong.
This is just a summary, please refer to the attachment for the full article.

Executive Summary

In Singapore, with a sky-high mobile penetration rate of 150% and stagnant subscription numbers since 2014, there is literally no room to attract new consumers. With an already saturated market, the Singapore telco industry is fast becoming a zero-sum game. New alternatives such as online services and new entrants will only further fragment the market and capture niche segments at the expense of incumbents’ market share. This applies all of StarHub’s 3 business segments: mobile, broadband and cable TV. We may have to prepare ourselves to enter a new norm of more sluggish top-line growth for incumbents, and valuations that take that into account.

One research article that covers the telco sector has been done by the Research and Education department from NTU Investment Interactive Club @ntuinvestmentclub. Refer to the research here:

As such, we will be delving deeper into recent developments involving the sector: namely, TPG’s entrance as the 4th telco, Netflix’s entrance and the collaboration between Starhub and M1 in a bid to counteract their difficulties.

1. TPG’s entrance as the 4th telco

TPG’s entrance into the mobile market does not pose a large threat to Starhub as Starhub can differentiate themselves through providing bundled plans. Starhub’s “Hubbing” product bundle offers all 4 services: cable, broadband, mobile and home tel, at discounted rates. However, if TPG captures only 7% of the market and takes market share proportionally, Starhub’s mobile market share will fall from 26.7% to only 24.8%.

Although TPG’s main line of business within Australia is broadband, it is unlikely that it will enter the broadband arena in Singapore in the near future as its allocated CAPEX resources are currently tied up in establishing nationwide coverage for mobile data in Singapore and Australia

As a new entrant, TPG may not gain traction due to its nonexistent branding and most handphone subscribers prefer to stick to an existing plan since they are rewarded with accompanying loyalty benefits. Moreover, TPG may struggle to develop a network with sufficient quality to challenge the incumbents as its estimated CAPEX of 200-300m is seen by the industry as modest at best. Market research firm Ovum believe that the CAPEX set aside is insufficient to install base stations, data centres and the backend fibre-optic cables.

2. Netflix and the impact on Starhub’s Pay TV business segment

In Singapore, rather than directly disrupting the Pay TV industry, streaming video providers such as Netflix are likely to complement each other and by offering both services as a bundle. The collaboration is necessary as Netflix ride on the Internet infrastructure owned and operated by telcos and Internet service providers (ISPs).

The Pay TV business segment contributed 17% to Starhub’s total revenue for FY 2016, down from 17.6% in FY 2015. With the decline, the Enterprise Fixed segment’s revenue eclipsed Pay TV’s contribution for the first time in 2016.The number of Pay TV customers fell 7.2% yoy to 498,000, Starhub recorded a corresponding drop in revenue of 3.3% yoy to $378 million. In summary, All in all, StarHub’s Pay TV business ended FY2016 with a loss of 47,000 subscribers – or 8.6% of the segment’s subscriber base since 2015.

It seems that as Netflix will eventually ease into the role as a complement to Starhub’s offerings rather than as a direct competitor. Firstly, existing Pay TV customers will still pay for regional and localised content in the local languages. Next, some consumers subscribe to Pay TV is to watch sports content such as EPL and NBA which is not available on OTT services. Lastly, Starhub joined in the OTT fray with their own mobile TV apps which do not charge subscribers for mobile data consumed while watching on the go. Also, StarHub, allows its customers to sign up for Netflix through StarHub's Fibre TV set-top box.

The decline in subscribers does not represent a complete shift towards Netflix as some consumers are merely shifting to a different platform for video consumption. That said, although Netflix might not have fully displaced conventional cable TV, but its hold on the local TV-watching landscape grows stronger every month, thanks to its original or exclusive content.

In conclusion, whether Netflix will continue to convert existing Starhub users to its services depends on one word: content. If Starhub can deliver content that is equally entertaining in addition to its current offerings of Asian TV shows, we will see the numbers of conversion stabilize. Ultimately, Netflix and Starhub have a symbiotic relationship,, collaboration rather than competition will lead to the greater good for both the companies and the consumers.

3. What investors should know about Starhub’s collaboration with M1

In January 2017, Starhub announced a Memorandum of Understanding (MOU) with M1. It stated that the two companies are in negotiations regarding mobile network infrastructure sharing for Radio Access Networks (RANs), backhaul transmission and access assets. Despite this apparent collaboration between Starhub and M1, they are still competitors in the telecommunications industry.The MOU was not the first synergy of Starhub and M1, their collaboration through network infrastructure sharing has been in process for several years, and this includes cooperation on combined antenna systems, in-building fibre and tunnel cables.

According to Starhub’s 1Q17 result that released on 3 May, Starhub’s Capex cash payment has decreased 19% when compared to data of first quarter in 2016, and the percentage of Capex to revenue observed 1.4% drop from 7.1% to 5.7%. Thus, based on this, network infrastructure for RAN indeed help Starhub cut its capital expenditure. However, investors should know that Capex will not be wholly charged as current year’s expense; instead, it will be expensed yearly through depreciation based on the useful life. In a nutshell, Capex reduction affect only small portion of total expenditure, thus will not guarantee less expenses.

Though Starhub’s other operating expenses had drop of 6.7% in 1Q17, the total operating expenses increased 2.6% due to the higher cost of sales. Since Starhub almost earned same revenue as 1Q16, the higher operating expenses became one of the reasons of declining quarterly profit.

From the perspective of cash position, Starhub’s net cash from operating activities was S$18.5 million higher because of the lower working capital needs and income tax paid. Net cash used in investing activities decreased S$9.8 million to S$31.8 million in 1Q2017, which is mainly because of due to lower CAPEX payments and repayment of loan from associate.

We can draw a conclusion that the collaboration between Starhub and M1, has benefited Starhub from the reduction of Capex and partial expenses. Also, share of network allowed Starhub accumulate greater amount of cash because it didn’t need to invest as much as in previous years on infrastructure construction. However, the competition is still fierce and the market is already saturated. This collaboration seems more likely to be for the purpose of maintain rather than boost Starhub’s business, and it failed to save Starhub from the downtrend.
Please refer to the attachment for the full report.

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$M1(B2F), is it the One?
This article is written by @fayewang from InvestingNote.

Brief Background:
M1 Limited (M1) is one of the biggest telecommunication services providers in Singapore, it also engages in international call services and broadband services, retail sales of telecommunication equipment and accessories, customer services and investment holding. The company and its subsidiaries operate in Singapore in one business segment, but there are three components that contribute to the operating revenue:
1) Mobile communication services
2) International call services
3) Fixed services

Related Events and News:
M1 released their 2016 Full Yearly Results at 24 Jan, 2017. See attached report.

18th Mar, ‘3 largest M1 shareholders reviewing their stakes’, check it out here:

17th Mar, ‘M1 and listed shareholders call for trading halt’, refer to the news here:

17th Mar, ‘M1's chief financial officer resigns’, see the full news at:

Performance Summary:
In 2016, M1 had a declining revenue and profit compared to the performance in the last year. M1 maintain a stable balance sheet and improvement has been seen in the amount of cash. However, when compared to its peer companies, M1 held the least favourable cash position and paid the lowest dividend. Given the situation that Singtel earn absolute advantage in both market share and profit margin, and under the pressure of the fourth entrant in telco industry, M1 chose to build a partnership with Starhub in mobile network business. However, after news that three biggest shareholder of M1 plan to sell their share portion and the Chief financial officer (CFO) resigned came out in March 17, share price of M1 surged 8% and ended up with a trading halt because of the possible ‘mysterious buyer’.

Financial Highlights:
1. Operating performance:
a) Yearly comparison: M1 maintained stable amount of revenue during the recent five years, but when compared to the performance in 2015, the group observed 8.3% decline in revenue, 16.1% decline in net income and lower profit margin.

b) Quarterly result: M1’s 4Q revenue experienced 27% drop, which is due to higher customer acquisition cost, and this result also reflects customer’s disappointment in traditional telecommunication services.

c) Operating components: M1 had a shrinkage of $27.7m in their mobile telecommunications services, which is their main business that occupied 57.7% of the total revenue, but they earned more from the fixed services. From the chart, it is not difficult to find that the proportion of fixed services has overtaken the international call services and become the second largest source of revenue.

2. Financial and cash flow position:
Compared to the performance in 2015, M1 had larger amount of assets, with a 5.6% increase to $1,146.6 million in 2016, driven by rising amount of Property, plant and equipment (PP&E). The group had less inventories, less receivables and less borrowings, thus gained better position by improving its liquidity and solvency. M1 had both higher amount of operating cash flow and free cash flow at the end of the 2016 financial year. The amount of net cash generated from operating increase 40%, but increase in free cash flow is only 10%, which is due to $64m investing outflow on purchase of spectrum rights.

3. Stock information
In the financial year of 2016, M1 payout 95.057% of their net earnings to their shareholders as dividend. Dividend per share (DPS) is 12.9 cents and Earning per share (EPS) for M1 stock is 16.10 cents. The P/E ratio of 13.665, which is higher than the telecommunication industrial ration of 8.734. The change of dividend policy in recent year will be compared with its peer companies in the following part. M1 has a slight lower P/E ratio than that of Singtel and Starhub, which means stock price of M1 is still comparatively undervalued.

4. Peer companies comparison
As the smallest operator among three telecommunication companies in Singapore, M1 should compare their performance with the rest two to understand their position in the industry.

a) Profit Margin

Obviously, Singtel maintained its absolute advantage with highest profit margin among the three local telecommunication companies in the recent five years. M1, with the trend of beating Starhub in 2014, however, had a similar profit margin with Starhub in 2016.

b) Dividend policy

From the two charts above, it’s not hard to tell that, generally Starhub is the company in telecommunication industry that has the highest payout ratio and highest dividend per share, and the payout ratio in 2016 is more than 100%. Though Singtel has the lower payout ratio than M1, it paid greater dividend per share than M1 (except in 2014). To draw a conclusion, M1 has the most fluctuated dividend policy and it basically paid the lowest dividend per share among the 3 telco companies except in 2014.

c) Free cash flow

Singtel has been the company with the largest amount of cash flow in the telco industry during the recent 5 years, which is reasonable regarding the company scale and operating profitability. Comparatively, M1 has the least favourable cash position as its cash flow is always a small positive number and the amount is the lowest among the three companies.

M1’s Mobile Network Business:
Given that 57.7% of the total revenue is from the mobile communication services, M1 kept putting their efforts into acquiring local market share by improving their network business.

‘M1 gives 3G users with big data plans free upgrade to 4G’, refer to this article here:
‘5G well on its way towards reality in Singapore’, check the detail of the news here:

Discussion in our community:
The hottest discussed issue about M1 is the strategic review and whether there will be the potential buyer of its stock.
Some discussion can be found in the post of @MasterLeong : and the post of @andrewko:

Research report links:
Credit Suisse:

Key takeaways:
M1 has witnessed less satisfying performance in the financial year of 2016. When compared to competitors, M1, as the smallest telecommunication service provider in Singapore, has to admitted its weakness and competitive disadvantages. The CFO resigned may indicates some strategic change within the firm, and the priority of M1 is to expand its local user base on telecommunication services. The appearance of new buyer may bring M1 additional room for edge up, but on the contrary, absence of deal may lead a sharp drop for its stock price. In the long run, M1 must focus on updating technology and improving its exist services. For now, M1 is still the weakest one among the three telcos.

Related Estimations:

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Getting started on picking and analysing stocks: Part 2

This is written by @fayewang, stock market analyst at investingnote.

How to analyse a stock: Step by step guide on how to do fundamental analysis

I would like to share my method of analysis in this part. I believe that there are different investment strategies, and my method of analysis in this article is just one of all the possible approaches. My method of analysis puts more focus on the operating performance because I believe that the stock price in the long-term will depend on whether a company has a sustainable business, and I would also like to emphasise the phrase ‘long-term’ here because I am a fundamental investor and I think my method will be more applicable for medium/long term investment.

1. Start with the financial statements
Financial statements are crucial because they show the performance summary of companies. Normally, they are audited and released on an annual basis. From, financial statements, investors can get the detailed explanations of a firm’s operating performance, financial positions, strategies and prospects. They are valuable and useful because all the numbers reflect a firm’s operation and management directly. Furthermore, such information is un-paralled because it comes direct from the companies themselves. In order to conduct analysis in an efficient way, I will break them into several parts, and filter the data according to my analysis criteria.

a) Income Statement
Also known as ‘consolidated profit and loss account’, income statements provide analysts and investors with a straightforward gauge for performance. This statement can answer three questions that investors care about the most: 1) how much revenue did the firm generate 2) how much expenditures did the firm spend and 3) how much profit can the firm distribute.

As there are varieties of ratios or indicators you can choose to estimate the firm’s performance, I will introduce the indicators that I usually use in my analysis.

Revenue and revenue growth
As revenue gives a first impression of a company, it gives investors a rough idea how it is doing. Before checking other numbers like expenditure, revenue provides information about how much money a company can generate from its business. If you observe a firm with declining revenue, that may mean that the firm is facing problem with running its business or is experiencing unfavourable economic situations.

Another important thing to note is the growth rate of revenue. It indicates a company’s potential for further expansion, and it is also a good indicator that can show the developing stage of a firm in a business cycle. To be more specific, a company with revenue growth rate higher than 10% can be viewed as a growing company at the expanding stage, while those with ranges between 5%-10% can be seen as enjoying reasonable steady growth and might also be experiencing the peak of their business. For companies with revenue growth lower than 5%, it can indicate that it is already a mature company and may be falling into the recessionary stage. Particularly, negative revenue growth may indicate serious problems of a business or even the start of an economic recession if many firms witness decline at the same time.

Net profit and profit margin
Net profit is the number after subtracting all the expenses from revenue, and thus reflects the cost management and efficiency of a company’s operation. As it also shows the result after the deduction of taxation and interests, it can be considered as the net value that a firm has created from its business. In some cases, a company’s net profit can be low even when the amount of revenue is high, which shows the inefficiency of cost management.

Profit margin represents how much of sales actually paid off and is earned by the company. It is suitable for comparison amongst a company’s peers because it can eliminate the size and scale differences between companies. Looking at the absolute amount of net profit only is not sufficient in analysis, it would be more relevant to compare it with industry peers. For example, the net profit of Singapore airline in FY2015 is $406.7 million, while Cathay Pacific held $6 million net profit in 2015. Based on the absolute amount, Cathay Pacific definitely has a smaller scale and lower profit. However, in the financial year of 2015, Cathay Pacific observed higher profit margin of 5.9% as compared to 2.6% of SIA group, which means Cathay Pacific has a higher rate of converting sales to company earnings.

Some firms also put basic and diluted earning per share in their income statement, and these ratios will be discussed in the “stock information” section later on. As investors, we also have to bear in mind that time matters here, hence the comparison on a year-on-year (yoy) basis or on a quarter-to-quarter (qoq) basis can give you different analysis results.

b) Balance Sheet
The balance sheet shows you how well the firm utilizes its assets and how much liabilities does the firm owe to its debtholders. Therefore, the whole sheet can show the firm’s overall financial position. There are three parts in the balance sheet: Assets, Liabilities and Shareholder’s Equity. The basic formula is known as Assets = Liabilities + Equity. The underlying principle is simple: all the funds that company can use for acquiring assets is either raised from borrowings or from issuance of equity.

Namely, there are 2 key principles for analysing a balance sheet:

i) Check specific items based on the nature of the company’s business

(Source: Shareinvestor financials)
The first picture is the balance sheet components of Sheng Siong,
The second picture is the balance sheet components of M1.

The items stressed in the balance sheet can be different according to the types of firms. Using supermarket retailer like Sheng Siong as an example, a majority of their non-current assets will be property, plant and equipment (PP&Es) such as retail outlets, while their current assets will include inventories, trade & other receivables, and cash & cash equivalents. Sheng Siong does not have much intangible assets and non-current liabilities because they sell physical commodities and are focused on high liquidity. Hence, if there is a higher amount of inventories and lower amount of cash and receivables at the same time, it implies that they might have problems with selling their goods. However, things are different with companies in different industries. Take M1, the telecommunication service provider for example. M1 holds a larger amount of non-current assets (which is their fixed assets and licences) than their current assets. Compared to Sheng Siong, M1 also owns a greater proportion of non-current liabilities in their balance sheet because they may have signed long-term contracts.

ii) Investigate items with extraordinary numbers
Analysts should pay attention to “extraordinary numbers” such as too much debt, or some unusual change in numbers. For example, a sharp increase/decrease of receivables from previous financial year. Debt can be a great source of capital and can benefit companies by creating a certain tax shield. However, they can also bring stakeholders headaches when the company bears the burden of heavy debt. For example, Ezra has seen their net debt-to-equity ratios over 100% before they went bankrupt. This example illustrates that several ratios can be used to test the solvency and liquidity of a company, such as debt-to-equity ratio and interest-Coverage Ratios, you can check more at

c) Cash Flow Statement
Cash flow statements show the details of a firm’s cash inflows and outflows. In simpler terms, shows exactly how a firm earns and spends every dollar in their operation. For cash flow analysis, I will usually focus on 2 items specifically: 1) net cash generated from operating activities and 2) free cash flow.

Net cash generated from operating activities directly show you whether a firm earns more from selling goods or providing services than their purchasing expenditure. This indicator is similar to net profit, but focuses on the flow of cash in their main business activity. Free cash flow (FCF) here refers to the ‘cash and cash equivalents at end of the financial year ’ in the cash flow statement, and represents the amount of cash a firm can spend freely on certain purpose. However, free cash flow can also be tricky because the number is cumulative based on the amount at the beginning of the financial year. Hence, when a firm has a higher free cash flow at the end of financial year, it might not mean that it actually generated a higher net cash as compared to the previous year.

Normally, the higher the number, the better the performance. From my perspective, as long as the firm is able to generate stable and positive net cash, it is a good sign. If there is huge change in the FCF, the reason should be shown in the notes section of the report.

d) Earnings Manipulation

Although there is a possibility for firms to manipulate their financial statements (as seen in the cases of multiple accounting scandals and frauds), all the accounting standards and audit firms are designed to prevent earnings manipulation (also called as ‘earnings management’). Besides, the technique of ‘cook the book’ is already familiar with analysts, and thus can be easily be identified by them.

Here are some common ways of earning manipulation:

2. Stay updated with related news

Financial statements are an internal source of information, but news about a firm is information source reported externally. As companies only releases results once in a while, news is an important source to keep shareholders updated. For Singapore market, following links should be helpful to get timely news:

As the market responds to news quickly, thus it is important to be updated. News might not be information for thorough analysis, but it will give readers clues about a company’s management. Readers can then discern whether it is a bad or good news and then act accordingly. Some news that have significant influence to a stock’s price include : 1) IPO and delisting 2) Mergers and acquisitions 3) government policy change 4) Financial result release 5) Business expansion or close.

3. Peer Companies Comparison
Investors should know by now that any comparison is meaningful only when there is an appropriate benchmark. For example, a revenue of $15,228.5 million may mean a lot, but a 5% increase from $14467.075 million in the previous year could be mean a little. The point is, solely observing a company’s data is not so conclusive as comparing it with its peers in the same industry. For example, looking at the performance of M1 in the recent 5 years, it will show the group having a slight decline in revenue and profit, but still holding a stable balance sheet and an improved cash position. It might not seem that the company is facing serious performance issues. However, when peer comparison is done, it will show that M1 is the weakest company in the telco industry compared to its peers like Singtel and Starhub.

For peer comparison, I will focus on certain criteria: the profit margin from the income statement, payout ratio and dividend per share from the key stock information, and the free cash flow from cash flow statement. I would usually skip indicators of balance sheet because different firm have various focus on items based on their business nature. The industry’s average are also important, as it provides a benchmark for the firms within a particular industry. For example, it is better to compare the P/E ratio with peer companies and also with the industry’s average, in order to better understand a firm’s position in one industry.

4. Key Stock Information
As mentioned before, I will not focus too much on the price of a stock but here are the key ratios that are valuable to show the stock price performance.
a) Earnings per share. For EPS, the higher the better. In the long-term, avoid stocks with negative earnings per share.
b) P/E ratio and Price per share/ EPS. Usually, the lower the better. A lower P/E ratio indicates that the stock is undervalued. However, P/E ratios provide different indications for different stocks. For growth stocks, a higher P/E ratio might be more anticipated.
c) Payout ratio. Firms with higher payout ratio is more willing to distribute their earnings to shareholders, but payout ratio over 100% is not always good as they are paying more than they can afford.
d) Net asset value (NAV). NAV indicates the debt-free assets companies have, that can be used for their business activities. The higher the better.

Personally, I suggest investors to choose stocks which meet the following conditions: 1) a positive EPS 2) a payout ratio more than 70% 3) a P/E ratio lower than industrial and peer number (normally lower than 15 is preferable) 4) a firm with an ROE over 15%.

Key takeaways
In conclusion, this article explains my method of fundamental stock analysis. In the previous part 1, I explained the importance of time horizon and how to choose different types of stock and build portfolio based on time horizon. In this part 2, as a fundamental investor, I focus on long-term (about or over 1 year) investment and the analysis is based on financial reports. The aim is to check a firm’s performance in recent years, and to see if it has the potential to maintain growth in the future. Thereafter, using several indicators to determine whether the stock is undervalued or overvalued. Making comparisons with peer companies will reveal its position and competition within the industry. Lastly, getting updates on a stock from related news also provide more information about the overall management and performance.

Examples of Analysis
Some examples here can demonstrate how I actually apply my analysing method.
“Can $SIA(C6L) Fly Again?”, check the article at:
$M1(B2F), is it the One? ”, check the article at:
“Can $ComfortDelGro(C52) regain its customers of taxi service?”, check the article at:

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