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 http://quickbooks.intuit.com/r/financial-m...

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: http://www.investopedia.com/articles/analy...

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:
http://www.theedgemarkets.com.sg/
http://www.straitstimes.com/business/compa...
http://www.businesstimes.com.sg/
https://www.fool.sg/

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: https://www.investingnote.com/posts/54429
$M1(B2F), is it the One? ”, check the article at: https://www.investingnote.com/posts/53014
“Can $ComfortDelGro(C52) regain its customers of taxi service?”, check the article at: https://www.investingnote.com/posts/48646

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41 likes
7 comments
traderx

Thank you. Good and came at the right time. In summary, am I right to say you use FA to shieve out good companies and use TA for entry?
(1) Do you buy even in a downtrend since you will never be 100% sure when is the bottom;
(2) How do you exit if the fundamental remain unchanged but the share price has downtrend or lose say 20% to 50%. And bear in mind Financial Report are not updated to investors monthly; are you going to wait for quarterly report before taking action and risk it losing more by the day? Or are you going to talk yourself out of exiting in downtrending since fundamental remain unchanged. If not; what is your TA rules to exiting since fundamentally remain the same?

traderx

Reply to @fayewang : Thanks @fayewang. for most people it is easy to enter but hard to exit as we have a tendency want to talk ourselves out of it. It is not advisable to enter when it is obviously on the downtrend especially on bigger time frame knowing the momentum of market sentiment will push you down further no matter how good is the fundamental unless one has a lot of capital to wait it out. I believe market moves by sentiments and emotion rather than purely intrinsic values; it is safer to trade in the direction of trend although TA are all lagging indicators but it is more or less capture the market sentiments. But a good knowledge in FA is a big plus as we surely want to hold for longer term a good company. FA is hardwork. Perhaps you can write how to quickly scan a financial report.

  View More Replies
thatsasecret

Extremely well written!

Delinz

Thanks for the informative article!

wellhandy

wah you write a lot.


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The 6 Stocks Which Grew More Than 5% In Price In A Month

With the trade talk between China and US being resumed after the G20, both Singapore and HK markets rallied big time. It's time to spot some potential stocks!

Let's look at 3 Hong Kong stocks that have caught the public's eye:

According to Reuters, on 27th June Shares in Hong Kong rose on Thursday, extending the previous day's cautious gains, as investors' hopes of a trade truce between the United States and China rose ahead of a highly anticipated meeting between the countries' leaders. At the close of trade, the Hang Seng index was up 399.44 points or 1.42% at 28,621.42, adding to the previous day's 0.1% gain.

The top gainer on the Hang Seng was Sunny Optical (2382 HK)-mainland China’s largest manufacturer of smartphone camera modules and lenses which gained 4.03%. Sunny Optical is also up by at least 20% within a month. If you have a 5x leverage, it would be more than 100% gain!

Besides Sunny Optical Technology Group Co Ltd, AAC Technologies (2018 HK)-acoustic components supplier to Apple Inc also rose 7.1 per cent to HK$47.50 as reported by South China Morning Post. It has also risen more than 10% within a month. If you have a 5x leverage, it amounts to more than 50% gain!

The third HK stock would be Sands China (1928 HK) – subsidiary of Las Vegas Sands Corp, currently operates The Venetian Macao, Sands Macao, The Plaza Macao, Sands Cotai Central and The Parisian Macao. Macau’s casino operators have pledged billions of dollars to develop non-gaming attractions in a bid to secure new licenses, but analysts predict only the more efficient like Sands China and Galaxy will be able to curb losses and emerge winners. Analysts are also bullish on Macau’s long-term fundamentals given it is China’s only legal casino hub, its greater connectivity to the mainland and massive growing middle class as reported by Reuters. Sands China rose more than 10% within a month. If you have a 5x leverage, it would give you more than 50% gain!

Now back to the local stocks, we have three blue-chip Singapore names which the market has been longing for: SGX, City Development, Singapore Airlines.

From FY2014 to FY2018, Singapore Exchange’s earnings climbed 13.4% from S$320 million to S$363 million, an increase of around 3.36% per annum. The growth is supported by its revenue rising from S$686 million to S$845 million during the same time frame. As of the end of June 2018, Singapore Exchange’s balance sheet carried S$831.6 million in cash with zero debt. It had an ROE of 34%, which is considerably high. Singapore Exchange’s current share price is at S$7.94, translating to a price-to-earnings (PE) ratio of 23.47 and a dividend yield of 4.72%. It rose more than 5% within a month and if you have a 5x leverage, that would be 33% gain!

In the earlier part of June, The Business Times named CITY Developments Limited (CDL) as one of the hot stocks to look out for. CDL gained more than 5 per cent in the early session on its renewed offer for all remaining shares in London-listed subsidiary Millennium & Copthorne hotels (M&C). Traders told The Business Times that CDL's share price may have also been given a lift due to growing optimism that the US Federal Reserve is looking at the possibility of rate cuts. It rose more than 15% within a month and if you have 5x leverage, it would be close to 75% gain!

Lastly we have Singapore Airlines(SIA) which rose more than 5% within a month. If you have a 5x leverage, the gain would be more than 25%!

How can you leverage up 5x without using margin or CFDs?

Simply by using a derivative called Daily Leverage Certificates (DLC). It is a derivative issued by Societe Generale, and listed on the Singapore Exchange (SGX). Learn more here: https://dlc.socgen.com/en/product/search

Here's the new batch of DLCs just released on 3rd July 2019:
$SUNNY OPTICAL(2382.HK) , $AAC TECH(2018.HK) , $SANDS CHINA LTD(1928.HK) , $SIA(C6L.SI) , $CityDev(C09.SI) , $SGX(S68.SI) .

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That One Stock Everyone Was Crazy Over In 2017


We’re off to a good start to 2018. But have you ever wondered which was the stock that got everyone crazy over in 2017?

As you already know, we’re a growing community of nearly 50,000 investors strong.

Each and every day, our social network accounts for a daily average of a few hundred posts and a few thousand comments posted by our users. This is a significant surge in the average posts and comments back in 2016. Although the Singapore stock market only operates on weekdays, our social network runs 24 hours a day and 365 days a year.

Looking back at the data from 2017, we were interested to find out from our community activities, if there were any interesting insights.

Let us present some data in our platform:

From the infographic, we can see that ComfortDelgro is amongst the top 3 most tagged and discussed stocks in all the posts made in 2017.

Comfort has been a hot topic for many investors in 2017. It became caught in the ruffle between popular ride-hailing apps Uber and Grab. Grab held a public campaign specifically targeted at Comfort cab drivers to switch to over. Comfort also acquired Uber's car rental subsidiary, Lion City Holdings. In early 2018, Comfort became integrated within Uber’s app as UberFlash. In October 2017, one of our veteran community members and a pioneer of financial blogging, Kyith posted his analysis on Comfort as well: https://www.investingnote.com/posts/334210.

From his analysis, we can see that Comfort is a indeed big organization with its fair share of problems.

With the aggressive expansion of Uber and Grab threatening its taxi business segment, Comfort became the talk of the town.

From our data, we’ve found some interesting facts:

- Comfort is the most discussed stock in our community with the most tags.

- Comfort is the second most estimated stock.

- Comfort has also been everyone’s second most favourite stock to be included into their watchlists and portfolio.


Coincidentally, ComfortDelgro’s 75-days beta is 1.171, as compared to its 500-days beta at 0.733.

The beta of a stock or portfolio is a historical measure describing the relations of the volatility of its returns an investor is exposed to as compared to the entire market as a whole. A beta of 1 means the security has volatility that mirrors the degree and direction of the market as a whole.

For Comfort’s case, it’s short-term volatility had a significant increase compared to its long-term volatility.

The only other transport company listed in Singapore, SBS Transit, has a 75 days beta of 0.246 and a 500 day beta of 0.311. In terms of industry-peer comparison, Comfort’s short-term volatility is almost 5 times that of SBS Transit.


In terms of stock performance, Comfort underperformed against the STI, when its return was around -19% as compared to the benchmark’s return of +18% for 2017 (excluding dividends).

ComfortDelgro is known to be a household brand for Singaporeans as it is well known to provide public bus and taxi services. It is also a constituent of the STI, and considered a blue-chip stock.

We can safely say that even though Comfort really underperformed, its volatility increased and it was the most-discussed stock that everyone was crazy over it in 2017.

Are you buying or holding $ComfortDelGro(C52.SI) in 2018?

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$ComfortDelGro(C52.SI): Grow or No Grow?

This column is written by @j_chou from InvestingNote.com.
@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.

A component of the STI, Comfort Delgro was once championed as a stable dividend paying stock with a strong economic moat. Recent disruptions in the taxi industry have since changed that view, causing the stock to tumble to its 52-week low despite a relatively muted 1Q17 earnings report. Investors were likely concerned with the falling revenue and operating profits, mostly attributed to the decline from the taxi segment. The share price has since recovered slightly from its 52-week low to $2.310, but there is still an opportunity to capitalize on the negative sentiments towards the company. In this article I will look to determine whether Comfort Delgro is ripe for a contrarian play by assessing its long-term prospects from a bullish, neutral and bearish perspective for the next 5-10 years.

Comfort Delgro: Much more than just a taxi company

The distinct blue and yellow taxis that peppers the streets of Singapore may cause investors to mistake Comfort Delgro as primarily a taxi company.

But a quick look at the company’s financial report will reveal that the taxi segment only contributes 33% of total group revenue; Public transport segment, which comprises of buses and rail, is the largest contributing segment with over 60% of revenue.

By every measurement Comfort’s management has shown that the company is well-run and deserving of its past glory: Since the merger of Comfort and Delgro in 2002 the company has leveraged on its advantages in the Singapore transport industry and successfully expanded overseas. A scan through their annual report will show that Comfort is a leading player in the transport industry: it has a diversified portfolio of transportation services in 35 cities and 7 countries, including Singapore, China, Australia, UK, Ireland, Vietnam and Malaysia, with the overseas segment contributing 36% of total revenue.

Given that the public transport and taxi segments contribute over 90% of total revenue, I will break them down by employing mostly a top-down approach and determine a bullish, neutral and bearish scenario for each.

But before analysing the company itself I will like to discuss about a certain issue that I observed has been widely neglected in the Taxi vs. Uber & Grab saga which will definitively disrupt the transportation industry and form a revolving theme for determining Comfort’s future position in the industry.

The Rise of Autonomous Driving

For decades autonomous driving has always been a hot topic of research in the transportation industry. If fully implemented, autonomous driving will have a massive disruption on urban mobility (one of the many reasons why Tesla’s share price is so expensive!). In recent years, the entry of automotive and AI market players and the combination of three interlocking trends has accelerated the development of autonomous driving technology.



Computer vision: Advances in big data and machine learning have allowed computer vision to finally be good enough to distinguish objects on the road, build 3-D maps of the surrounding area, and be supported by processor speeds powerful enough to be able to operate them natively in a car.

Ride-sharing: The self-driving technology stack is currently still too expensive for the average consumer, but the advent of ride-sharing companies like Uber and Grab has allowed the possibility of distributing the cost over many passengers.

Electrification: Every fully autonomous car company today is planning on an EV platform. This is only secondarily about the environment. Primarily, it is because the cost of maintenance of an EV car is dramatically lower. If a single company owns the car and it has an incredibly high utilization rate, then that lower maintenance cost is easily worth the higher upfront cost.

And the technology is actually not too far away from being implemented. Self-driving cars have already been introduced by Uber in the United States, and companies from Tesla to Baidu have already proven the effectiveness of autonomous driving.

See: Testing Tesla’s Autopilot System At 70mph:https://www.youtube.com/watch?v=tP7VdxVY6UQ
With technology aspect overcome sooner rather than later, the concerns with autonomous driving will lie only with governmental regulations and consumer acceptance.
With Singapore being a densely packed urban city with land scarcity issues, it should come as no surprise that the government is very receptive to implementing an autonomous driving system. According to a report from Singapore’s Land Transport Authority (LTA), the potential benefits of driverless vehicles include improved fuel efficiency, enhanced mobility for the elderly and the disabled, and the reduction of land needed for roads and parking lots.
Tan Kong Hwee, director of transport engineering at Singapore’s Economic Development Board (EDB), noted: “We have a growing population and more than one million vehicles on the road. Being a small and densely populated country, Singapore has a real need for more effective transportation solutions, while optimising our limited resources in space and manpower.” Hence, in the long term, it is clear that the government is aiming to adopt autonomous driving on a large scale to complement the public transport system.

An article on the many benefits autonomous driving will bring to Singapore:
See: Self-Driving Vehicles: Future of Mobility in Singapore: https://www.smartnation.sg/initiatives/Mob...



Therefore, taking into consideration the inevitable adoption of autonomous driving on Singapore roads within the next decade, how will Comfort’s transportation segments fare?

Public Transport
The public transport segment is broken down into two sub-segments, mainly bus and rail. The segment is primarily operated under its subsidiary SBS Transit, which owns a significant fleet of public buses and runs the North East Line (NEL), Punggol and Sengkang LRT as well as the new Downtown line (DTL).

Buses
Comfort operates bus services in Singapore(through subsidiary SBS), UK (through subsidiary Metroline), Ireland and Australia. The overseas bus business actually contributes a significant amount to the public transport segment; It is not specified in 2016 Annual Report but from past data it is highly likely the contribution from overseas bus segment amounts to 2/3 of total bus revenue.
In Singapore, 75% of subsidiary SBS’s total revenue of $1098M in FY16 comes from the public bus segment. The catalyst for this segment going forward will be the change in revenue model given the LTA’s decision to transit to the Bus Contracting Model, which states that the government now bears all fare revenue risk and the capital expenditure for the purchasing and ownership of public buses. Operators such as SBS will be instead paid a fixed amount to operate the buses. This has so far been a positive change for the bus segment, evident by the 0.75% growth in 1Q17. Management has also stated in 1Q17 that the BCM will allow Comfort to enjoy greater revenue intake. Looking forward, this provides a clearer outlook for projected bus income from 2017 until 2025(maximum duration of current BCM contracts) and the substantial reduction in capital expenditure(as the company will not have to purchase buses anymore) will free up cash flow for Comfort.
Not much information is divulged with regards to Australia and UK Bus business but management guidance states revenue from the Australia Bus Business is expected to be higher while revenue from the UK bus business is expected to decrease from the foreign currency translation effect of the weaker £.

Bullish:
Switch to BCM has a net positive effect on profit margins and winning upcoming Bukit Merah Bus Package and maintaining existing 8 bus packages until 2025. Conclusion of Brexit will bring certainty and strengthen the pound, resulting in increased revenue from UK bus business. Australia segment to also maintain its revenue growth. Utilising cash holdings to make more acquisitions and increase overseas revenue.

Neutral:
Renewals for existing bus packages will be more difficult as Increase in competition for tenders will squeeze margins and cancel positive effect of BCM. Revenue contribution from Australia and UK to maintain and grow at rate of inflation. Utilising cash holdings to make more acquisitions and increase overseas revenue.

Bearish:
SBS to lose some of its existing bus packages to competitors as LTA seeks the participation of more competitors to improve operational efficiency. Acquisitions overseas to also become less effective due to disruption from autonomous driving.

Overwhelmingly Bearish:
Government has hinted on occasion in the past that the public transport system may have been over privatised. The switch to the new contract model signals LTA’s intent to wrestle more public control. By taking back ownership of public buses, the introduction of autonomous driving may cause the role of operators to be reduced significantly reduced as drivers and other operating services such as bus depots are no longer required; hence future operator contracts will be awarded at a fraction of current cost thus severely impacting operators’ revenue.

See: LTA inks agreement with ST Kinetics to develop and trial autonomous buses: https://www.lta.gov.sg/apps/news/page.aspx...

Rail
The rail segment has enjoyed positive growth y-o-y. Operating under its subsidiary SBS, rail segment contributed around $250M to total revenue. For FY16, demand for SBS Transit’s rail services grew with over 329 million passenger trips made, which is a 27% increase over the previous year. The spike came from the Downtown Line (DTL), which added on 12 more stations in December 2015. Ridership hit 80.7 million during the year, which almost tripled that of 2015. Average daily ridership on the North East Line (NEL) grew by 5.2% to 564,701, while that of the Sengkang and Punggol Light Rail Transit systems (SPLRT) saw a double-digit growth of 15.3% to 114,094. With the opening of Downtown Line Phase 3 in 2H17, the tender for Thomas-East Coast Line and projected CAGR of 10% for LRT and 5% for MRT ridership, there are multiple catalysts for growth in the rail segment. However, the reduction of 4.2% in fares and the likelihood of further decrease may counteract the positive effects.

Bullish:
SBS wins tender for operating Thomson-East Coast Line, which is a strong possibility as competition is only between them and SMRT. Given the route’s location it is projected to have ridership volume comparable to that of NEL and hence increase daily ridership on SBS rails by 30-40%.

Neutral:
SBS does not win tender for TEL, but increase in ridership volume will still allow rail segment to enjoy stronger revenue growth.

Bearish:
I can’t really think of a bearish scenario in the case of rail.

Taxi
The introduction of ride-sharing companies Uber and Grab has had a swift impact on the taxi segment as the bad reputation, uncompetitive taxi rentals and lower demand for taxis are compelling taxi drivers to abandon the once dominant market leaders, with the unhired rate of taxis hitting 9.1% this quarter, which is double the average unhire rate of 5% in the same period last year. As per LTA, Comfort’s taxi fleet also recorded a decline in numbers of 5.7% YTD to 15,683. Given historical data for the past one year, the decline will look to accelerate given increasing supply of private cars on the road. Furthermore, average daily ridership of taxis was at an eight-year low of 853,000, which is a 12% drop in the same period last year.

Comparison: Jan 2017 vs July 2017

Comfort should be worried about taxi’s future prospects. Uber and Grab are not disrupting the taxi industry simply through introducing a fancy app and artificial pricing. And institutional investors such as SoftBank and BlackRock are definitely not mindlessly dumping money into a loss-making taxi business. The excitement with ride sharing companies is in its potential to radicalize the transportation landscape. Uber and Grab are competing not just on pricing but also technology: It is no secret that the most inefficient component of the taxi business is in its drivers, hence eliminating the need for one will significantly reduce cost, improve trip efficiency and keep pricing competitive. As such, if implemented successfully, which could be as early as within the next decade, it will not bode well for Comfort. The major problem is that Comfort’s current business model is asset heavy; through purchasing a fleet of taxis and relying on rental fees collected from the drivers. In comparison, Uber and Grab’s model is currently asset light as they anticipate to spend massively on driverless cars in the future. Hence, they currently do not own majority of the existing cars and instead generate revenue by taking a 20% cut of ride fares. As you can see, this is a huge problem. On top of Comfort requiring a very large amount of capital expenditure to replace their existing fleet with driverless ones, their lack of R&D in technology will imply that even if they switch business models and implement driverless taxis it is unlikely to be as efficient as the ones introduced by Uber and Grab. Hence one way or the other once driverless is introduced Comfort will soon lack a competitive advantage in the taxi industry. Of course, on a positive note if the technology fails to take off then Uber and Grab’s current model which is unsustainable will lead to their demise and Comfort should again see the light of day. But I would think the former scenario is much more likely and will err on the side of caution.



Investors that are also hoping for some sort of intervention from the authorities to protect local taxi drivers (case in point: Taiwan, Italy, Denmark) may be disappointed to know that in Singapore’s case it is apparent as shown in my previous paragraphs that the government is very open to disruptive technology and highly enthusiastic about the prospects of a driverless system. In fact, the world’s first self-driving taxi was actually implemented right here in Singapore!

See: World’s First Self-Driving Taxis Debut in Singapore
https://www.bloomberg.com/news/articles/20...

Consumer resistance is also in my opinion a non-issue. Uber and Grab can simply offer a cheaper fare for the driverless option and Singaporeans are tech-savvy enough to respond to new technology. Government may even offer incentives to encourage consumers to engage driverless in a bid to implement an autonomous system.

Also to take note, the increasing network of public transport systems may cause cannibalization as increasing accessibility of MRT and buses will imply less commuters willing to travel by taxi. Automotive engineering segment, which contributes around 5% of total revenue will also take a hit as revenue contribution from that segment is highly dependent on servicing of Comfort’s taxis.

Bullish:
Autonomous driving technology takes a lot longer than expected to develop. LTA implements stricter regulations for private car hires. Uber and Grab are unable to further compete on prices and Comfort is able to improve upon their business model and maintain market dominance.

Neutral:
Self-driving cars successfully implemented on the roads. Comfort acquires self-driving car technology such as nuTonomy. gradually transitions to a mixture of drives and driverless business model. Significant decrease in market share but able to engage in healthy competition.

Bearish:
Self-driving cars successfully implemented on the roads. Comfort is unable to adapt and could only maintain minority market share with existing fleet of drivers.

Conclusion
The transportation industry is facing an impending disruption in the next decade, and I fear Comfort is underprepared to face it. Management has hinted from FY16 annual report that they do not think autonomous technology will be disruptive play here; “We will keep a keen eye on the development of electric, hybrid and autonomous technologies and the ensuing changes in legislation, which I suspect will take a while as mindsets and attitudes towards such new innovations slowly change.”
I think that they may have underestimated the technological forces at play here, and that is concerning. Remember the case of Nokia and Blackberry?

Nevertheless, management are not resting on their laurels and have indicated their intent to further expand overseas:

“Our efforts to continue our overseas investments may need to be intensified. A new strategy may need to evolve in light of new changes and challenges.”

Comfort’s main issue currently is that Singapore is small and revenue growth here is limited. Management has already shown they can do a stellar job translating their local expertise into expanding to other geographical regions. With a healthy amount of cash and low gearing levels, It is my guess that moving forward they intend to focus more on inorganic acquisitions and increase revenue contribution of the overseas segment. As such, I believe Comfort will follow in the footsteps of SingPost, hence expect a cut in dividends as the company reverts back to a transitional period and utilize more debt and cash for expansion purposes.

Valuation
I will attempt a simple DCF valuation based on my personal opinion of how the three main segments of buses, rail and taxi will play out.
Bus segment: Neutral
As stated on the LTA website, SBS operates 8 bus route packages from 01 Sep 2016 for a total sum of $5,322M. Given the total number of bus operating years is 58, we can assume each bus operating year will generate around 95M of revenue p.a. If SBS is able to renew its contract for upcoming Bukit Merah Bus Package, revenue should project to 760M p.a. till 2025. For overseas segment, in UK and Australia Comfort enjoys significant market share and is likely to seek growth hence I anticipate 2017 revenue from both UK and Australia bus business to maintain at 1200M and a conservative growth rate of 3%p.a. until 2025. This is of course assuming that autonomous buses has not become a thing within the next decade. Cost efficiencies from transition to BCM should allow operating margin to improve slightly from 7.7% to around 8%.



Rail segment: Bullish
As per LTA projections, with the opening of DTL phase 3 daily ridership should increase by another 100,000 on the existing 1 million SBS riders, hence rail segment revenue of around 300M should see further growth of 10%. Subsequently, it should rise by around 5% year on year given increasing daily ridership for MRT and LRT. Using the DTL contract as a benchmark, which was awarded at $1.6billion for 19 years, translating to a value of around $850million for 9 years, adjusted for different contracting model, for the TEL tender. Given that the government will now bear all revenue risk for the TEL, this should translate to additional fixed revenue stream of around 95million per year for SBS however this can only be realized in parts from 2019 onwards as the line will be opening in 5 stages: Stage 1 in 2019, Stage 2 in 2020, Stage 3 in 2021, Stage 4 in 2023 and Stage 5 in 2024.

Taxi segment: Bearish
I will go out on a limb and predict self-driving system to be fully implemented by 2023. Local taxi fleet contributes around 75% of taxi segment revenue. In between, Comfort should see a decline in taxi fleet of around 5% year on year. Based on 2016 data average revenue generated by each taxi should arrive at around $66,000 p.a. given 5% unhired rate. With a constant 10% unhired rate, each taxi should contribute around $62,500p.a. moving forward. The negative effect should actually be counteracted by more drivers returning back to Comfort as Uber and Grab utilise more driverless cars, though I am unable to determine by how much hence I will not factor that in. However, after 2023 with the implementation of driverless system I expect Comfort’s business to rapidly decline by an extreme 20% year on year. This will leave Comfort with a minority share in the taxi market, to cater to niche consumers who do not wish to use driverless. This is also assuming that Comfort sticks with its current business model and does not implement driverless themselves.

For reasons unknown Comfort stopped reporting breakdown of overseas segment since FY15. Hence, due to lack of information on how their overseas segments will play out, I will simply base this DCF on initial assumption that Comfort’s revenue will maintain at 65% Singapore, 35% overseas. I predict that management will attempt to grow the overseas segment, hence overseas segment will increase by 2 percentage points year on year, playing out to 40% Singapore, 60% overseas in 2026 assuming constant currency. Correspondingly Capital Expenditure should increase to around 500M per year for increase in overseas acquisitions. This is counteracted by less capital expenditure in Singapore due to BCM and decrease in purchase of new taxis.

With that in mind, my breakdown of Singapore segments:



My view is that bus segment with a fixed contract model and limited number of new routes will only enjoy stable growth of 1% p.a. Rail segment to have explosive growth if TEL tender can be secured. Taxi segment to rapidly decline in face of disruptive technology. I have cross checked the table figures until 2018E with that provided by other analysts, and the numbers were similar hence I have confidence that my estimates(at least until 2018) are fairly accurate.

I employed a 10-year two stage FCFF model as I view Comfort to soon undergo a transitional phase ala $SingPost hence stable dividend pay-out will unlikely be maintained. I mainly use this to do a sensitivity analysis on how the extent of decline in the taxi business will impact the overall share price. I calculate total revenue based on how the overseas expansion will play out and determined EBIT margin to be around 10%, which when cross checked with other analysts numbers were again quite similar. However, I project capital expenditure should increase to at least 500M per year given management hint of overseas expansion and technology development, which differs from other analysts who have CAPEX mostly projected at around 300M.

Using a 9% WACC and 2.0% terminal growth, assuming taxi business will decline 5% year on year from 2017 and then 20% year on year after implementation of driverless system in 2023, counteracted by the slight growth for bus segment and huge growth in rail segment, I arrive at a price of $1.57 (34% downside).

Even with a more muted decline of 3% y-o-y from 2017 then 10% decline from 2023 onwards price still arrives at around $1.63 (30% downside).

Hence, my long term view is that taking into account the growth story in Singapore has more or less been maximised, Comfort will have to prove over the next few years that it can further expand overseas, to the point where overseas segment will have to comprise more than 70% of overall revenue for the company to counteract the negative impact of a devastated taxi business in order to maintain and grow its current share price level.

Disclaimer:
All research reports are of the analysts’ personal opinions and do not in any way reflect InvestingNote’s official opinion. InvestingNote does not issue a buy or sell recommendation on any security, and any research paper published by The Signal Blog is purely for informative purposes. This research is based on current public information, but we do not represent it is accurate or complete, and it should not be relied on as such. The information, opinions, estimates and forecasts contained herein are as of the date hereof and are subject to change without prior notification. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual InvestingNote users. InvestingNote users should consider whether the information in this research is reliable, and suitable for their particular circumstances and, if appropriate, seek professional advice. The price and value of investments referred to in this research and the investment income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Fluctuations in exchange rates could have adverse effects on the value or price of, or income derived from, certain investments.

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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.

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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!

$M1(B2F.SI)

Post by @RetiredOldMan: https://www.investingnote.com/posts/143401

Post by @KallangRiverWoof: https://www.investingnote.com/posts/146351

Post by @Sporeshare: https://www.investingnote.com/posts/146442

$SIA Engineering(S59.SI)

Post by @CASHFLOW: https://www.investingnote.com/posts/145930

Post by @PhilipCapital: https://www.investingnote.com/posts/146289

$ComfortDelGro(C52.SI)

Post by @akwl88: https://www.investingnote.com/posts/145310

Post by @BrennenPak: https://www.investingnote.com/posts/144298

Post by @Jimes: https://www.investingnote.com/posts/145354

$SPH(T39.SI)

Post by @indigo: https://www.investingnote.com/posts/144840

Post by @mlow: https://www.investingnote.com/posts/141963

Post by @Turtle_Investor: https://www.investingnote.com/posts/141131

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

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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 Dreman.com

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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