How to Take Stock
Illustration for TIME Money by Bonnie Day Studio
Asia's markets are climbing again. Before you jump in, learn to recognize the warning signs
By TIM MORRISON
It's over. you can come out now. nearly two-and-a-half years after the financial crisis first hit the region, it now seems safe to jump back into the stock markets. And many investors are doing just that--with both feet. Resurgent faith in Asia's economies, coupled with knock-on effects from the U.S. market's recent tear, have pushed Asian share prices back up, well out of last summer's doldrums.
Is it time to bet the farm on stocks again? Not so fast. Just as most Asian countries are still some way from completing the restructuring of their economies, many companies haven't yet cleaned up their acts. Indeed, says Norman Chan, associate director of investment research at Allen Perkins Portfolio Management in Hong Kong, "the recent rally in the markets has probably taken some pressure off of them."
Experts say investors should not read too much into the rising share indexes of their home countries; instead, they should look closely at any stock before buying it. That, in turn, means studying the company concerned. "The basic principle is that you're not buying the stock, you're buying the company," says John Mangun, director of portfolio management at I.B. Gimenez Securities in the Philippines. "If you're looking at long-term investing, you've got to look at the underlying corporate value."
It's a principle called Value Investing: in the long term, well-managed companies with solid fundamentals provide steady growth--long after the "hot" stocks of today have flashed in the pan.
So how do you tell if a company is worth investing in? As your mother said, do your homework. Companies provide a wealth of information about themselves for shareholders and customers. Much of the data you need can be found in a company's annual and quarterly reports. Information is also available through brokers and at some websites, such as Investor Relations Asia (www.irasia.com), which carry financial information on scores of Asian companies. When evaluating a firm, Mangun says you should pay special attention to six numbers:
Book Value: This tells you the worth of a company's assets--inventory, cash, factories, property, investments. Book value gives a prospective investor an idea of the size of a company; in general, larger firms tend to be sturdier over the long term than smaller ones.
Return on Equity: This is a company's net income (essentially, profits), divided by the value of its stock. RoE, expressed as a percentage, measures how well a company's managers have made investors' money work. Low RoE is a sign that, while a company might be getting a lot of investment from its shareholders, it isn't from its customers. That's a warning sign that a company's business might not be as strong as it could be.
Debt-to-Equity Ratio: This is a measure of a company's long-term indebtedness. A company with a high D/E ratio is mortgaged to the hilt. This isn't necessarily a bad thing; often, a company has to borrow to finance expansion or to take its business to the next level. But borrowing lots of money--especially in U.S. dollars--is what got so many Asian companies into trouble during the financial crisis. When Asian currencies tanked and companies' revenues evaporated, many firms were stuck sitting on a pile of loans they couldn't pay off.
Profit Margin: This measures a company's profits as a percentage of sales. Companies with fatter profit margins are on a better financial footing; they can make more money than competitors selling the same amount of goods.
Cash Ratio: This is the amount of cash (or holdings easily converted into cash) a company has, divided by its liabilities (debts and other obligations it must fulfill). A company with a high ratio has more cash and less long-term debt--and thus tends to be more financially secure--than those with lower ratios. Such a firm can more easily pay off loans or obligations, or use the cash to cover unexpected costs, like a plunge in its home currency or a factory damaged in a natural disaster.
Price-to-Earnings Ratio: The P/E ratio, as it's commonly known, is a company's stock price divided by its earnings per share (total earnings divided by the number of shares issued). So if a stock is currently trading at $20 and earnings per share is $2, then its P/E ratio is 10. P/E ratios are a rough guide to how a company is valued by the market. If a firm's P/E is much higher than others in its industry, then the stock may be overvalued and headed for a tumble. Since markets tend to judge companies on the basis of future potential, though, P/E rations for Internet firms tend to be wildly higher than those in slower-growing industries, like banking and autos. Some investment professionals, in fact, rely more on indicators like cash flow (after-tax profits plus depreciation--a measure of a firm's liquidity) or Economic Value Added (profits minus the capital required to produce them--a gauge of how much management has increased the company's value for shareholders). Such investors use P/E ratios only to make comparisons with other companies.
To evaluate what these numbers mean, take a look at how a stock compares with those of local competitors across the categories. Then, compare the company against its own past performance. What you're looking for is stable growth. "If a company has suddenly gone from a debt-equity ratio of 2 to 5, that should alarm any investor," says Chan.
Numbers, of course, don't tell the whole story. In fact, when you're dealing with Internet or high-tech companies, the numbers might be downright misleading. "Looking at price-earnings ratios, what you may find in many cases is that there are no earnings, but there's a promise of earnings once a company develops distribution and market share," notes Kim Teo, whose firm, CMG First State Investments, has just launched an Asia-only technology fund. With a start-up, it's important to focus on the vision, quality and transparency of management, and on how well the company lives up to its own hype. "It's very important that you keep track of where a company is with respect to its business model and if it's meeting its targets," says Teo.
This holds true for brick-and-mortar companies as well, especially those that are rebuilding in the wake of the crisis. "You have to spot willingness to restructure by looking into whether they have done what they have pledged in the past," Chan says.
Other warning signs? Ben Robertson, an analyst with ABN AMRO in Taiwan, recommends looking out for "black holes" in a balance sheet--situations in which it's unclear where a company is earning--or spending--its money. Firms with a lot of "non-operating income," or revenue from things other than core businesses, deserve close scrutiny. If you're a relatively new investor, stick with the familiar: local companies that sell products and services you know and trust.
Finally, recognize that the pre-crisis era may never return--that it may no longer be possible to make easy money in the markets. "It's not the same game we played five years ago," says Chan. Be careful out there.
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