LATELY, interest has grown in overseas stock investment. Given the foreign markets’ relatively high volatility of returns compared with the local market, a lot of retail investors find it more exciting to invest in overseas stocks.
However, a common problem most investors face is how to filter, from among all the listed companies in the respective markets, the right stocks that are suitable for long-term investment.
Market capitalisation
One of the most important selection criteria is buying stocks with big market capitalisation. The market cap of a listed company can be computed by multiplying the number of its outstanding shares with the current share price.
In general, we should buy stocks with big market cap because they are normally well-established blue-chip stocks with higher turnover and widely-accepted products and services.
Even though some academic research shows that buying into small market cap stocks can provide higher returns compared with big market cap companies, unless we are quite familiar with the stocks available in those overseas markets, it is safer to put our money into bigger market cap stocks.
It is not difficult to find out which companies have the largest market cap in any stock exchange.
Such information is available in most major newspapers in that particular country or the stock exchanges themselves.
For example, if we intend to buy some Singapore stocks, we should pay attention to companies that are ranked in the top 30 in terms of market cap. One can get the rankings by market cap for the Singapore Exchange in StarBiz monthly.
Price/earnings ratio
Once we have filtered out the blue-chip stocks, the next selection criteria is the price/earnings ratio (PER), which should be lower than the overall market PER. This is computed by dividing the current stock price by the earnings per share (EPS) of the company. It represents the number of years that we need to get back our money, assuming the company maintains identical earnings throughout the period.
Even though some published PER may use historical audited EPS compared with forecast EPS, given that our key objective is to do stock screening, the PER testing will provide us with a quick check on the top 30 companies – whether they are profitable and selling at reasonable PER compared with the overall market PER.
If we cannot get access to the overall market PER, we may want to consider Benjamin Graham’s suggestion of buying stocks with PER of lower than 15 times.
Dividend yield
A good company should pay dividends. We strongly believe that this is one of the most important ways for the investors to get any returns from the companies that they invest in.
Our rule of thumb is that a good company should have a dividend yield that at least equals or is higher than the risk-free return, which is usually based on the fixed deposit rates.
The dividend yield is computed by dividing the dividend per share by the current share price. In general, most blue-chip stocks do have a fixed dividend payout policy and reward investors with a consistent and growing dividend returns.
Based on our observation, most smaller companies may not be able to pay good dividends as they may need the capital for future expansion programmes.
Price-to-book ratio
Most investors would like to invest at a market price lower than the owners’ costs in the company. The book value of a company represents the owners’ costs invested in it.
In a normal business environment, unless the company has some problems that the general public may not be aware of, it is quite difficult to find stocks selling at a price lower than the book value of the company.
As a result, we may need to purchase at a market price higher than the book value. According to Graham, the maximum price one should pay for any stock is the price which gives a price-to-book ratio no greater than 1.5 times. This means that we should not pay more than 1.5 times the owners’ costs invested in the company.
Lastly, the above four selection criteria are merely a preliminary quick stock screening process. Even though investors may be able to find stocks that fit the criteria, we suggest investors check further the fundamentals of the company, such as the balance sheet strength, its gearing, future business prospects and the quality of the management before deciding to invest.
● Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting.
Thestar
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