What is Value Investing?
Value Investing is the process of finding underpriced stocks, buying them, and holding them for the long-term until the market sees the value in the company and what it does.
I previously talked about Value Investing: 5 Things To Look Out For In A Company, which I suggest that you read before coming back to this article.
This time, I want to analyse a specific company, to see whether it checks the five metrics mentioned.
The 5 Metrics To Look At
- Valuation Metrics
- Intrinsic Value
- Debt-to-Equity Ratio
- Price-to-Free Cash Flow
- Company Fundamentals
You may go like, “Wait… I’m lost…”
Well, let me explain further below.
Disclaimer: The intent of this article is to evaluate and discuss our opinions. We’re not advocating any particular investment instrument. As always, you should do your own due diligence.
As Simple As Buying Low, Selling High?
Buying low and selling high is the gist of value investing. But it isn’t always that simple to find underpriced stocks.
Small companies may not be good. And good companies may not be cheap.
But with the market facing so many crises, it brings about an opportunity as prices are low. This a good time to look for value (underpriced) stocks.
Such stocks are usually smaller companies as they have a greater potential to see a large increase in their share prices.
Let’s walk through together this analysis.
1. Valuation Metrics
There are 3 valuation metrics that we can look at:
- Price-to-Earnings Ratio (P/E Ratio)
- Price-to-Book Ratio (P/B Ratio)
- Price-to-Earnings Growth
Looking at the formulas for these financial ratios, cheap share prices would naturally drive down the price ratios.
I’m going to filter out stocks that have a small market capitalisation with low P/E and P/B ratios.
Scrolling down the list, I found this familiar name…
SK Jewellery (SGX: 42G)
With around 60 stores around Singapore and Malaysia, I’m sure you have seen SK Jewellery shops around. But if you are unaware…
SK Jewellery Group Limited (Soo Kee Group Ltd.), is a Singapore-based company, which operates through the retail and trading of the jewellery business. It offers a range of jewellery products through its Soo Kee Jewellery, SK Jewellery and Love & Co. brands.
— Source: SGX.com
This is what you are paying compared to what the company is worth in their books. The benchmark can be taken to be 1 (what you are paying equals to the actual value of the company now) i.e you are paying a fair price.
The Price-to-Book Ratio is 0.856. A P/B ratio of less than one means that it is technically underpriced, based on the company’s net assets or equity.
This shows you the current prices as compared to their earnings per share.
What does a P/E ratio of 9.906 actually tell you?
Well, it will make sense to compare this with a comparable company, TLV Holdings. TLV Holdings is also a listed company and operates under the brands Taka Jewellery and Lovis Diamonds.
TLV Holdings has a P/E ratio of 11.502, higher than SK Jewellery. This means that you are paying less for SK Jewellery for each dollar that the company generates, which makes SK Jewellery comparatively cheaper.
Not forgetting the dividend yield of 5.263%… That is pretty sweet too!
You may want to read: How to Read Financial Ratios: P/B and P/E Ratio & Liquidity Ratios
2. Intrinsic Value
Net-net value = Current Assets – Total Liabilities
This is a technique that Benjamin Graham used to value a company. A positive net-net value and is good.
Financials are based 31 December 2018.
Net-net value = 83,283 – 60,513 = 22,770 (thousand)
A positive number, which is good! This means their short term assets can sufficiently cover its total liabilities.
3. Debt-to-Equity Ratio
This shows you the financial leverage, or the percentage of the mode of financing of the company.
Total debt = 19,740 + 21,508 = 41,248 (thousand)
Total equity = 60,635 (thousand)
Debt-to-Equity Ratio = 41,248 / 60,635 = 0.680
A high D/E ratio bring about the concerns that the company may not pay off its debts in time.
A D/E ratio of 0.680, which is less than one, is alright.
4. Free Cash Flow
A company’s free cash flows represent the cash flow available for all the stakeholders.
Free Cash Flow = EBIT x (1-Tax Rate) + Non-cash Expense – (Change in Current Assets-Current Liabilities) – CAPEX
FCF = (7,006+1,342)x(1-0.17) + 4,537 – ([101,647-51,731] – [83,283-39,467]) – (31,988-33,136+4,537) = 1,976.84 (thousand).
A high free cash flow is healthy for the company, as it means that they have the cash to take actions like:
- Expanding their company
- Paying off debts
- Paying dividends to shareholders
5. Company Fundamentals
Having been around for so many years, SK Jewellery is a longstanding brand. The management has largely been around for many years as well, and probably has a good understanding of the business and the market.
Furthermore, I like the nature of the company. The fact that their inventories are jewellery, which is not perishable, which means this is a good thing. I mean, certain pieces can go out of trend, but unlike foodstuff, jewellery would not turn “obsolete” as quickly.
SK Jewellery checks all five aspects. We know that if you manage to find a company that checks ALL five metrics, then you have potentially found a value stock. Of course, you still need to do your own due diligence as these are just five aspects.
There are definitely more criteria you can look at, such as:
- Revenue and profit growth
- Profit margin
- Industry – Profits are declining, and one of the reasons is due to an increase in competition
Closing Thoughts… What’s Next?
You may ask, “I’ve bought a value stock! What should I do next?”
A value stock may take a few years for the market to appreciate its value.
So sit back, relax and wait patiently.
Yes, really. I mean I’m not asking you to do NOTHING – you still have to be kept updated on news on that company. Especially when an increasing number of companies are placed under the SGX watch-list. But what I’m saying is, value investing usually takes a longer period of time.
For more explanation into each of the five metrics mentioned, you may wish to check out Value Investing: 5 Things To Look Out For In A Company.