The Definitive Guide: How to Start SG Stocks Investing [Part-6]
WOW I can’t believe how fast time has flown. My last series was three week ago!
Many might have thought that I’m dead. Don’t worry I’m not. Much of my time had spent on creating mini-Ebooks which I sent out via Email on previous week(check your inbox :)) and setting up my home page which initially I thought I had a pretty good layout until a friend of mine told me it looked terrible and messy.
So I reworked it and cut down to 4 sections( excluding header & footer), it looks pretty neat now.
Oh yea, I know some readers may find it annoying as now you are required to one additional click to get to my blog’s section. What you can do is to type : GiraffeValue.com/blog to land straight to my blog’s page.
Alright let’s get back to stocks investing. I will continue to finish up Debt to Equity ratio, then go into explaining the ratios how it can be seen in term of multiple and yield.
Lastly, I will touch on the investing strategy particularly on portfolio approach, DCA and I have included articles on various investing approaches that might want to read to explore which approach suits you best,
This will probably be the last series prior I revamp almost everything on the guide. I will be adding a resource page. Hence probably there will be about 7 chapters on this guide.
Debt To Equity (D/E)
Up to now, of all the ratios I have covered : P/E, P/B, EV/EBITDA, Dividend Yield, and Payout ratio. Debt to Equity is the one that tells us about the financial risk of the company.
Particularly its debt’s risk, this risk exist because of the possibility that the company may not have sufficient cash to meet its debt obligation such as paying the amount that they own(principal) and/or interest expenses.
Failure to do so may result in company having to force sell its assets to meet its debt obligation and may even result in the company into liquidation.
I will split into two parts on explaining D/E: 1. Capital structure and 2. What is D/E about.
Capital Structure of the company
In case you are wondering why has debt got to do with equity and why are we looking at this ratio, and how does it tell us about the financial risk?
Before I’m able to answer you that you will have to know what is the capital structure.
First, as you are aware capital is the money that contributed by the shareholder or/and debt holder i.e banks. Hence there are two forms of capital: Equity and Debt. Capital structure is simply referring to the proportion of debt and equity on its capital.
Equity – Remember in the earlier series? Equity is the money that contributed by the shareholder. Hence they are also called equity holder.
This is the safest form of capital in the company as the money does not have to be repaid as the contributor of capital will receive shares in return. From the company’s perspective this is safe as they do not have to replay the capital and there’s also no legal obligation to pay dividend to the shareholder.
Debt – Is the money that usually come from bank as a loan or loan in general. Debt has a legal obligation on the company to repay its capital at a later period and usually with interests in between.
From the company’s perspective or even for shareholders this is a risk. Why? Because there is a possibility that the company does not have the cash flow to meet such debt obligation at times of poor business performance.
In general sense, the higher the debt level is the riskier it is to the shareholder and the company.
Debt To Equity (D/E)
Back to the above, D/E is simply a debt ratio used to measure company financial leverage i.e the amount of borrowing relative to its equity. It tells us how much debt the stock has in using to finance its assets relative to the amount of value that proportion to its shareholders’ equity.
Long-term loan : $10M
Short-term loan : $5M
Equity : $100M
Debt($15m) to equity($100) ratio = 0.15 or 15%
What Does This Ratio Tell Us?
It tells us how much debt the company has on every $1 of equity/net assets. Or it can be expressed in percentage such as 30% D/E would mean debt presenting 30% of the company equity.
What Does High D/E Means?
Generally high D/E ratio would mean higher risk of unable to fulfil the debt obligation of capital and interest.
Higher debt with variable interest rate(non-fixed) will incur more interest expenses that will hit the earnings at time where the banks increase the interest rate.
Company with high financial gearing such as high D/E will find it hard to borrow money from bank, even if banks are willing they will charge the company for higher interest to compensate their risk of non-repayment.
So what is considered as high?
Again, same as the above ratios. There are no rule as to what constitute to high or low as it largely depend on the industry the company is in. For example for financial institution such as banks it is common to see D/E ratio of 10+.
Whereas for a non-financial company D/E ratio of just 1 is considered very high. Usually, for wide range of business it will be less than 1 or even lower than 0.5. Personally for myself, I prefer stocks that have no debt or debt level below 0.4.
High debt does not necessarily mean it is bad, we need to know the reason behind it such as what the debt is for? Some company may use it to finance project and generate net positive return in the future which in turn will increase shareholder value.
Multiple vs Yield
NOTE: I have missed Price to Book which is under Multiple section
Have you wondered why some of the ratios covered above and previous series some are in multiple and others are in yield? Wondering what’s the difference and how can you interpret it?
Let’s recall back a little, on the earnings’ ratios that we have touched on are: P/E and EV/EBITDA. These two ratios are expressed as multiple because it tells us how many time the market price is traded over/under its current earnings.
P/E = 3x – It means the price is traded 3x of its current earnings that is usually based on the latest ANNUAL report unless it stated otherwise.
EV/EBITDA = 20x – It means the price(enterprise value i.e factoring debt & cash) is traded 20x of its current earnings(excluding interest, tax, depreciation & amortization).
In other words, P/E 3x mean you are paying $3 for every $1 of current earnings. And for EV/EBITDA you are paying $20 for every $1 of its earnings.
Now, let’s talk about Price to Book. The same concept:
P/B = 1.2x – It means the price is trading 1.2x of the company net assets (total assets – liabilities = Equity) for every $1 of its book value. That’s to say you are paying $0.20 MORE to own the stocks at its current market price.
Go and look at the picture once more. You will notice that for P/E and EV/EBITDA the formula of both are exactly the same but now with the denominator becomes nominator.
So what is yield? Yield is the reward you get that is expressed as a percentage based on the investment cost.
E/P (Earnings Yield) = 0.30 – That means the company is yielding 30% of earnings based on the investment cost i.e stock price. To put it simply, every $1 you pay to own the stock will yield $0.30 of the company earnings.
I’ll skip on the earnings yield on EBITDA/EV as the concept is the same.
Right now you probably see a rough picture of how to interpret yield ratios, we will get into dividend yield and payout ratio. Probably by now you are able to tell what dividend yield ratio is called yield.
Dividend Yield explained:
The exact same concept: Div per share / Earnings per share = 0.05 or 5% means that for every $1 you invested, you will get back $0.05 of dividend per share. Of course, that is assumed that the stocks remain its dividend level for the upcoming year.
With the above, you are probably able to tell how it works. That is right, exactly the same. But instead of share price as the denominator which represent the cost rather it is the earnings that the percentage is based on that tells us how much dividend is yielded: Payout ratio = 0.3 or 30% means every $1 of the stock’s earnings it pays out $0.30 as dividend.
By now you should probably have a clearer picture why some of the ratios are in multiple and others are in yield form, and how you are able to use it for stock analysis.
Basic stock analysis
Now, let’s get into action. Over here I will walk you through one example on using the above ratios for simple stock analysis so that you can have a “feel” on its application.
First, on the mkt. cap. Metro is a property stock as most of its assets consist of property. Mkt. cap. of $729M for a property stock is considered low as most of it is far exceed 1 billion for example: CapitaLand $13B, City Developments Limited $6.6B and etc.
From here you can tell this is a mid-cap stock.
The P/B is 0.53: Which the market price is almost trading at half of its net assets value that means this is stock is trading at a discount!
P/E ratio of 5.71 tells us that should all things being equal, we will be able to recover our investment cost over close to 6 years period. Generally for Singapore stocks P/E are around 10. Current STI ETF P/E is about 11.76. Low P/E ratio also suggests the stock is cheap in term of its earnings’ valuation.
So over here, it is clear that on both net assets and earnings ratios perspective this stock is cheap.
Now let’s get into the dividend yield of 2.27%(excluding special div): which is quite low as the dividend yield for STI ETF is 2.5-3.5%. And usually for the mid-cap stocks the dividend are around 4%-6%.
Having said that the total dividend yield for Metro stock is actually 6.4% which includes special dividend.
For the consistency of dividend we can click on the dividend section which shows us the history of dividend payment – Which is also clear that Metro pays dividend every year.
Dividend payout ratio of 0.347 : Which is a decent number. I’m using Shareinvestor as the number on SGX is inaccurate and the company site does not provide the figure either. Alternatively, you may get the ratio from your online brokerage which most provide except Standard Chartered Bank.
Lastly, let’s look at the financial risk of the company on the total Debt to Equity ratio of 0.02 or 2%. Over here we can tell that the debt level in the company is very low, its capital structure largely comprise of equity, and debt only represent a nominal 2% of its equity. Hence the risk on its debt is insignificant.
The conclusion: In both P/E and P/B which tell us that this stock is trading below its valuation i.e cheap. On the dividend yield perspective it looks decent as well with the average total yield of 6%+. Hence for an investor who seeks for cash flow this is a stock that satisfies that.
Lastly, the finance risk which low Debt to Equity suggests it is insignificant.
So now, all the above ratios suggest this is a cheap stock. But do note that cheap stock does not mean the stock price will go up in future, as it can always be cheaper and cheaper depending on the market expectation.
Beside that we are simply touching on the basic ratios – there may be a reason why the stock is cheap.
But let’s assume this stock is really cheap, and it makes all senses for you to invest. So now, the next few questions to answer are: Should you invest? And how much to invest?
In order for us to answer these questions we have to know what is our investing strategy. Different strategy will suggest a different answer.
For a passive index investor he may not even bother to learn about investing ratio but simply knowing that using a disciplined periodic investing on STI ETF would yield him good market returns over the long run and that is good.
However, for an investor who is using a portfolio approach may feel that this stock satisfies its criteria. Hence it makes sense for him to buy and since he is using a portfolio approach the holding of this stock will be small.
For example this could be the 1 out of 20 stocks he is about to buy. Hence this stock only represent 5% of its total portfolio.
This is why in investing it is often hard to determine whether a stock is a buy or sell. Why? Because we do not know the person investing strategy or approach. The worst is the investor has no approach to stock investing and simply follows what others are buying.
So next, I will be touching on the portfolio approach and dollar cost averaging. Lastly for the specific investing strategy I have curated the articles from the local blog that you may like to read.
No matter how good an investor is it is impossible to be right all the time. Forecast and analysis often get wrong no matter how good the investor is. You may attempt to spend countless of hours to attempt to dig the inside out of the stock that interest but the stock still turns out to be a bad pick.
So what can you do? Benjamin Graham has advocated strongly on the concept of a group approach meaning looking at stocks with the perspective of a portfolio rather than individual stock basis.
That is to say, we should not put all our eggs in one basket, and should diversify it reasonably. The recommended number of stocks in a portfolio is 20, and any amount that is lesser than 10 stocks is considered risky.
Why? Just think about it with 10 stocks that would mean that each stock contains a weightage of 10% and if 2-3 stocks turn out badly, you will be losing 20-30% of your capital. However, for a 20 stock portfolio that impact will be divided by half.
So one might ask, then why 20? And not 30 or more? Actually according Modern Portfolio Theory: It suggests 20 stocks portfolio would come close to achieving optimal diversification. Any number more than that the incremental benefit will greatly be reduced.
For more read: http://www.investopedia.com/articles/01/051601.asp
Dollar Cost Averaging
By now you should have probably know that DCA is referring to setting a fixed amount of dollar to be invested in a stock/ETF regardless of the market up or down as compared to lump-sum investing.
This approach reduces the risk of investing huge capital at a high price by allowing investors to slowly accumulating stocks at a fixed dollar and period. Hence in the event where the market is trending down the investor will be able to accumulate more stocks as the stock get cheaper.
For beginner investor it is often encouraged to use DCA rather than lump-sum because of the lack of experience in the stock market, and DCA prevent the mistake from being too costly by investing smaller bits of capital at a time.
Another aspect is to cultivate investor’s temperament by following a disciplined approach and ignore the market’s noise.
For more read: Dollar-Cost Averaging Pays
Alright here is the best section you have long awaited for!
I have broken it down into three section : Passive, dividend and value investing.
Passive investing (Index)
Ignore the noise, little effort and accept market returns i.e 7% CAGR. No one would disagree that passive index investing on STI ETF is by far the best investing approach for most working class given our limited time and expertise on stock-picking. Oh and I have almost forgotten 1 more point!
That is by investing in a market index fund like STI ETF, you are almost 100% guaranteed to be better off than people who do stock pick. Why? Because most investor even the institutions fail to outperform on a consistent basis.
The best two articles I have found on passive index investing:
Dollar and Sense 5-part passive investing series
The Turtle Investor Beginner’s Guide To Index Investing
Two ways to realize a gain on your investment: 1. Sell the stock 2. Get paid by DIVIDEND! This is probably the most sough after investing approach among investors because of the periodic cash flow the investors receive though dividend.
There are also numerous of studies that show dividend stocks as a portfolio are more resilient during market downturn and generally perform better than stocks which do not pay dividend.
The few of the best articles I have found on dividend investing:
The Complete Guide To REITs Singapore Investing by yours truly:)
5 steps to make the power of compounding work in dividend income investing by InvestmentMoat
Tell me if you can find anyone who has been investing in the stock market but have never heard of the term value investing. I will bet my entire “wealth” for it! You can’t find anyone. Why? Because it is the most battle-tested approach to investing that shows to beat the market on a long and consistent basis.
Value investing is nothing fancy. It is the exact same concept as the value buy you see on any warehouse sales. If you are investing in a stock where its fundamental value is higher than the price shows in the market – that is value investing.
It is hard to find blogs that offer practical steps to value investing, the majority are in-depth stock analysis and often not easily understood by beginner.
The below are some of the articles I can find:
CNAV Strategy by BigFatPurse
V Scorecard by T.U.B Investing
Check out A Foolish Guide to Investing In Singapore by Motley Fool it covers three section on investing: Growth investing, special situation and dividend investing.
I know there are plenty of articles out there but I only want to keep it local-focused. Thank you for following it so far. I know I have been very slow in producing article. So much slower than I ought.
Alright – that is all. This is the end.
Thank for reading!