Taking Stock: How to choose which companies to invest in

A banker in a famous 19th century French novel made a killing buying bonds and shares based on his wife’s dreams. “I know the lucidity of your dreams,” he said. “So I secretly bought up all the Haitian bonds I could find and I made four hundred thousand francs on them.”

Dreams, gut feel or intuition are hardly part of the sound reasoning which guides those who choose which shares to buy. (The banker learned that the hard way when he went bankrupt toward the novel’s end.) That said, this article offers some suggestions for choosing which companies to invest in when purchasing stocks, particularly in the Singapore Exchange.

The suggestions that follow are not one-size-fits-all — the kinds of companies you choose will depend largely on what kind of investor you are. This not only encompasses your age and purchasing power, but also your personality — are you the type of investor who likes to take risks or play it safe on the bourse?

The Big Three

David Kuo’s Foolish Guide to Investing in Singapore gives an overview which describes three types of companies and the types of people who tend to invest in them:

1. Fast-growing companies. People who choose to buy shares of this type of company are mostly young (usually in their 30’s) with a firm belief in the possibility that these companies will be able to give higher returns. Those who invest in these companies are called Growth Investors.

2. Well-established companies. More mature investors (usually retirees in their 60’s) tend to choose these kinds of companies because they are able to give their shareholders larger dividends. Having been firmly established, these companies don’t need to keep a large part of their profits in order to grow. People who invest in these companies are called Income Investors.

3. Companies in temporary trouble. For some reason, some investors believe that someday, these companies would be able to reverse their current misfortunes and come back stronger than ever. These investors are called Turnaround Investors.

The Guide goes on to list certain characteristics to keep an eye out for when choosing companies belonging to each type.

Growth investors may want to look for the following in a potential investment. The company should:

• Have a potential, protracted increase in profits
• Be a market leader in terms of growth rate
• Have significant returns (e.g. 24% per annum)
• Have enough room or market opportunities for growth

Growth investors should bear in mind, however, that there are always risks: A fast-growing company may be unable to deliver the returns that they first seemed to be able to.

Income investors usually have these pointers on their company-selection checklist. A well-established company should have a track record for:

• Increasing dividends
• Increasing liquidity
• Producing cash flow over and above paid dividends
• Having a robust balance sheet
• Finding potential growth areas in its industry

Other income investors simply prefer to look at

• How well a company is doing financially
• Whether a company is over or undervalued
• Whether a company is subject to more than usual financial risks

Speaking of risks, these investors would do well to remember that though well-established companies may seem to be a surer investment, they come with their own risks as well. A company of this type might suddenly decide to lower their dividends or simply decide to not give them out one day.

Be that as it may, it may be safe to say that well-established companies remain among the more popular investment choices. There are several other pointers that may be referred to as guides for income investors.

For their part, turnaround investors might want to choose bigger companies with a minimum market value of, say, SGD1billion. They might also want to steer clear of companies waving these warning flags:

• No or a not long enough track record
• Not liquid or has no operating profits
• Has incurred huge debts
• Has high operating expenses
• Has high non-recurring income

Find your own style

It is well to note that these three types of investors are not the only types out there. It is also noteworthy to remember that it can take some time for someone to find their own personal investment style.

If you have yet to figure out what kind of investor you are (and hence, the type of companies you’d prefer to invest in), there are other methods that may help give you an idea of which shares to buy.

The Singapore Exchange (SGX) itself, for instance, has the financial reports of the companies that are listed there. Investors are free to check these reports out or peruse the plethora of other company data on their site to help them make their decisions.

The SGX also has a free tool called Stockfacts that is relatively easy to use. This tool may be able to help income investors in particular to pick out good companies among the hundreds of listed companies.

For more in-depth methods of selecting shares, there’s the American Association of Individual Investors (AAII). The AAII offers several strategies for investing in stocks, all of which are systematic and have been proven over time.

Freestyle

At least one investor out there does not recommend picking out stocks, citing the near impossibility of being able to receive good returns on a regular basis, as well as the market’s stock pricing efficiency. This investor does recommend, however, keeping a diverse portfolio comprising low cost index funds.

Other stock market advisors recommend buying shares belonging to certain sectors. For 2016, their suggested sectors include

• Banking
• Transportation
• Technology
• Plantations
• Utilities

Real-time style

When it comes to choosing company shares, sophisticated investors may well be the best advisors. Those looking for a guide in the vast complexity known as the SGX, can take their investment cues from these investors in real-time. Using the Spiking app, investors — be they growth, income or turnaround — will be able to keep tabs on which sophisticated investors are buying which shares, and perhaps make their decisions accordingly.

As you continue to weigh your options and select your shares, it’s a good idea to also keep a record of the investment decisions you’ve made. Note down not only which shares you ended up buying but also your reasons for each purchase. These notes may also serve as a guide in helping you choose which companies to invest in the next time around.