In search of next stocks to buy

On Jul 7, 2007's Weekend edition of Business Times, Ms Teh Hooi Ling gave us the following clues to find our next winners.

"Go for stocks with high return on equity but low price-to-book ratio"

What are those ratios?

• Return on equity (ROE) - We have several versions of the formula to ROE. Basically "return" could profit before tax or profit after tax and "equity" would be the summation of paid up capital plus all the reserves. Ms Teh is telling us to look for companies with high ROE.

Take for example - If most businesses in Singapore are able to generate a return of 10% on its resources, that 10% becomes the normal rate of return. Then look for companies making above the normal rate.

• Price to book (PTB) ratio - What price? Share price of that company. What "Book"? It refers to the net assets value as reflected in the accounts. PTB ratio will give an indication of how much we are paying in excess of the book value per share of the target company. Thus Ms Teh rightfully told us to look for companies with LOW PTBs.

Take for example - If the book value is $1 and the share price is trading at $2.40, PTB is 2.4x.

So where to find those ratios?
Sadly, such information is not easily found and nicely presented somewhere for us to see. Ms Teh had downloaded the ROEs and PTBs of all the companies listed on the Singapore Exchange from 1990 until 2007 from Thomson Financial Datastream. She had done a lot of secondary analysis to do the article.

As retail investor, we can do calculations on the few target companies. But market or industry figures would be the value added of institutional investors.

But if you actually do your homework, you will be well rewarded as per historical data. Ms Teh found out that the top 10 per cent of companies with the highest ROE/PTB would have turned your $100 into $34,048 in 17 years ie. average growth of 41% per annum.