THIRD IMPORTANT STEP – SELECTING THE STOCKS TO INVEST IN

By NEOH SOON KEAN, B.Sc. MBA Ph.D. and SIM YE WEI, B.Mgmt. CFA

Sim Ye Wei is a long-serving staff member of Dynaquest Sdn Bhd, the investment advisory firm set up by Dr Neoh Soon Kean. She joined Dynaquest in 2008 and has worked her way up to becoming a Senior Analyst as well as a Director of the company. She holds a First Class Honours degree in Management majoring in Finance. She is also a Chartered Financial Analyst and has held a Capital Market Services Representative Licence issued by the Securities Commission of Malaysia since 2016.

PREAMBLE

If you are serious about investment, be warned that the hard work starts from now. To become a seasoned investor takes a lot of time and effort.

We are fully aware of the reality that it is extremely daunting if you are starting from ground zero. There are, after all, 1,000 companies (and increasing every year) listed on the Kuala Lumpur Stock Exchange (KLSE or Bursa for short). From this huge number, you have to choose 15-30 stocks to invest in if you follow our earlier recommendation. How and where are you even going to make a start?

For the average investor, stock selection consists of: whittling down the 1,000 or so stocks to a number which is much more manageable for carrying out further investigation – say 40-50 stocks, that is, a short list. After that you have to carry out a more in-depth analysis of those in the short list to reduce them eventually to the 15-30 stocks you may want to put your money in.

This is obviously a complex process and we shall try our best to make your task ahead as easy as possible. This article is written in two halves. In the first half today (called The Principles), I shall first explain to you how you can progressively whittle down the number of stocks on which you need to investigate. We can do this by setting up a list of the important characteristics you want the stocks you invest in to have. Those companies which do not fit these characteristics can then be rejected.

In the second half (July 22) that we shall call The Practical Steps, I shall introduce you to what I believe is the best and easiest to use website from which you can obtain data to help you to make your in-depth analysis. Once again, I must say that modern investors are a very lucky lot. There are several very powerful (and totally free) websites which are extremely useful in helping you to carry out your analysis to uncover the most suitable stocks for you. The one I shall introduce is that of the Bursa itself (https://www.bursamalaysia.com/).

Before we start on the article proper, I have a piece of perhaps unconventional advice for all of you. One of the best things you can do for yourself before you start investing seriously is to find a good remisier. Unfortunately, in our modern world, I fear these professionals are a dying breed.

I give this unconventional advice because I strongly believe that even though they are a dying breed, good remisiers can greatly help the neophyte investors. Unfortunately, with widespread adoption of online trading with its attendant low fee, there are not many of them left. Check with friends who are seasoned investors whether they can recommend anyone. Why is having a good remisier important for a neophyte?

First, if you are a newcomer to the investment world, there are a lot of intricate details and concepts which you would not be familiar with. Take for example the terminology: “ex date”. I doubt if many newcomers to investment know the full ramification of this term.  A good remisier will be able to help you navigate through all these unfamiliar terrains.

Second, if you can find a good remisier who follows and supports the philosophy of our articles, he/she will be able to provide a second opinion on your choice of stocks. A good remisier will also advise you against rumours and hearsay as well as “stocks du jour”.

So, what are important characteristics of the company/stock which you should pay attention to? I would like to stress that stock investment can be very risky. For small investors just starting out in this venture, we have to try to minimise their exposure to risk.  I choose the High DY approach precisely because it is less risky compared with other popular methods such as going for growth stocks or momentum stocks.

The other important characteristics which we look out for relate mainly to the financial and management quality of the stocks. They are similarly chosen because these reduce the riskiness of the stocks we invest in.

HOW TO SIEVE OUT THE MOST SUITABLE STOCKS FOR YOUR INVESTMENT?

As you will learn from the second half of this article, the Bursa website provides you with the tool to sieve out (or screen out) those stocks which are suitable for you to invest in. The most critical steps for screening out these stocks are described below.

(1)    HIGH DIVIDEND YIELD. This whole series of articles is built upon the buying of high dividend stocks. Hence screening out the high dividend yield stocks is the most important first step. How do we define high DY? A simple method is to compare the DY of the stocks you intend to buy with the current FD rate (say, 1 year FD).

Not counting the special offers, at present the 1-year FD rate is under 4%. Thus, 4% or 5% DY would constitute a very good return on investment if you intend to treat your stock investment as long-term FD. Using the Bursa website, we find that there are 149 stocks with DY of 4% or greater; and 91 stocks which have DY of 5% or greater. It is obviously still a very large number. We then have to apply the second screening step.

(2)    LARGE MARKET CAPITAL. By “market capital”, investors mean the total market value of a listed company. The Total Market Value is obtained by multiplying The Number of Shares Outstanding by The Market Price of the Share. For example, if a company has 5 billion shares outstanding and the share has a market price of RM1.00, the market capital of the company would be RM5.0 billion.

Why do we use market capital as a screening step? Although it is not a hard and fast rule, on the whole, companies with large capital are more stable and less risky. Some of you may well ask: “What about those large market capital companies which are neither stable nor risky?” It is true that there are some large companies which are risky and unstable but if we apply the high DY sieve, most of them would not qualify. We shall also apply another screening tool. The next question to ask is “How to define ‘big’?”.

We first apply the obvious definition of RM1.0b as the cut-off. We then use the Bursa website’s screening tool to sieve out all those companies which have a market capital of over RM1.0b with DY of either greater or equal to 4% and 5%.

The website tells us that there are 61 companies of this type with 4% or greater DY and 44 with 5% or greater DY. These are now much more manageable numbers to do further investigation. If you think these are too many for you, you can apply a higher market capital as a screen (but this requires you to become more familiar with the website).

At this stage, let us restrict ourselves to using DY of 5% and market capital of RM1.0b. You would be presented with a list of 44 stocks. As stated, you would only want 15-30 stocks: you therefore need to whittle the number down further by screening for other preferred characteristics.

(3)    LONG HISTORY. A company which has survived through many decades is usually one which has overcome many obstacles and has adapted to changing market conditions. Such a company is more like to continue to perform adequately in the future.

How do we find out if a company has a long history? You would need to do some additional research unless you are already familiar with the companies. If a company is very large, it is likely to have its own website where you are likely to find a description of the company and its history. If it does not have such a website, you can download the Annual Report from Bursa website. Most annual reports carry a description of the history and nature of the company. Look for one which is well established in this country and has a strong market position.

(4)    CONSISTENT PERFORMANCE. As with history, a company which can produce a consistent set of results (in terms of earnings and dividend) is likely to be a less risky company to invest in. In fact, we have just gone through a really tough test of the quality of the management of a company – the Covid Pandemic.

If a company survived the last four or five years with reasonably stable earnings and dividend, it is most likely a well-managed company. How do you find out whether the company has a consistent record? Again, you have to do some research. If you study the latest annual report of a company (downloaded from the Bursa website as before), you will find that nearly all these reports carry the summary financial and operation data for the last five years.

The Bursa website also provides some of the critical financial data for all the PLCs for the last five years. By doing a cross comparison with other companies, you would have a good idea whether the target company has good consistent performance.

MAKING THE SELECTION

So, by investigating all these characteristics of the stocks, we can make a final selection based on how positive they are in terms of these criteria. To start with you have a list of shares with market capital of over RM1.0b. From these you would want to select those with the highest DY (the higher the better).

There is one important caveat in choosing stocks with very high DY. Some companies occasionally pay an exceptionally large dividend for one reason or another. You obviously cannot use that single dividend payment as the basis of your selection.

For those companies with very high DY (say, over 7%), you would want to check its dividend payments for the last five years or so. If it was only a one-time event, you would want to ignore that particular payment and use the average dividend as the basis for computing the DY.

After making your first cut, you would want to investigate them in terms of criteria (3) and (4) and select those with the longest illustrious history and most consistent dividends and earnings. Do not over-worry about choosing the wrong stocks. We all make mistakes and if you have a wide selection of stocks, a small number of bad choices will not affect the overall portfolio performance very much.

OTHER CHARACTERISTICS TO LOOK FOR

The investigation of the quality of a company is not limited to the above four criteria. If you have the inclination and the time, you can carry out more study and analysis of your own. Do look also into: FINANCIAL STRENGTH, PAST GROWTH TREND and GROWTH PROSPECTS as well as the CASH FLOW STREAMS of the companies you are keen to invest in. If there is enough interest we can also consider writing more on this fascinating subject.