Invest Idol's picks: Two small-caps with big potential

Nicholas Lim, winner of ShareInvestor's inaugural contest, explains how he chose counters for his $50,000 portfolio

Mr Lim graduated from NUS in 2005, finished his bond with the Republic of Singapore Navy and worked in the financial sector in wealth management and risk management before becoming a full-time investor in March.
Mr Lim graduated from NUS in 2005, finished his bond with the Republic of Singapore Navy and worked in the financial sector in wealth management and risk management before becoming a full-time investor in March. PHOTO: SEAH KWANG PENG

Full-time investor Nicholas Lim has just won a major investing contest - with a $10,000 cash prize - not bad for someone who went full steam into stocks only in March.

Mr Lim, 34, won Invest Idol, a new feature of Invest Fair 2015, which ShareInvestor has been running since 2007 for retail investors and traders.

ShareInvestor, a financial media and technology company and subsidiary of Singapore Press Holdings, holds the annual event to enhance investors' education and raise the level of financial literacy.

Invest Idol started this year and targets students and retail investors between 18 and 35 years old aiming to exploit their knowledge in stock investing to devise the most profitable portfolio.

Participants had to submit a theoretical portfolio comprising at least two stocks and up to eight, not exceeding $50,000 in total value.

Only Singapore-listed stocks could be selected, while warrants, exchange-traded funds and indices were excluded. Submissions closed in mid-July.

The target returns of the portfolio would be a minimum projected gain of 8 per cent per year, based on the initial capital of $50,000, excluding trading commissions and fees. Short-selling was not permitted.

The judging criteria were based on the portfolio's profitability, the candidate's investment knowledge and methodology and his or her analysis of the portfolio with supporting documents. These could include industry research reports, charts, excerpts from annual reports and news reports.

Presentation and time management were also assessed, as were the long-term (six to 12 months) potential gains based on projected returns with supporting reasoning. This was to test a participant's knowledge and understanding of his or her portfolio and how the counters were expected to perform.

The judges were Mr Christopher Lee, ShareInvestor's chief executive, Mr Gabriel Yap, executive chairman of GCP Global, and Ms Lynn Gasper, senior vice-president and head of retail investors at Singapore Exchange.

  • What the judges say

  • Mr Christopher Lee:
    Nicholas stood out as he has a clear investment approach that is well researched. For the purpose of the contest, we structured the rules to focus on growth stocks as our contestants are between 18 and 35 years old.

    In that phase of their life, they should be looking at wealth creation and hence, we wanted them to focus on growth rather than defensive dividend-centric stocks.

    In his analysis of the two companies, which are fundamentally sound small-caps, he demonstrated the potential of capital appreciation over a 12-month horizon, which is also the time frame given to the contestants.

    I like the margin-of-safety approach that he took when he was looking at the various fundamental indicators. He had a clear view of what the companies wanted to do moving forward and identified the key catalysts that will drive growth. Insider trades (company share buybacks and directors' trades) are important indicators which retail investors should take note of and these were highlighted in his presentation.

    He was also quick to highlight the risks associated with each company and that gave a balanced assessment to his stock recommendations. He did a great job in condensing his thoughts and presenting them within the time limit (only 12 minutes) given. That to me is discipline, which is an important attribute in fundamental investing.

    Mr Gabriel Yap: Nicholas has picked this high-risk-high- gain/loss approach and he was aware of the risks. It can swing big both ways. It does takes a lot of courage to do that. He scored more on the presentation.

    Lum Chang is cheap for a reason as its earnings growth is limited. Falcon Energy is a high- geared stock in a risky sector, so it is a high-risk bet. Nicholas' methodology of a concentrated strategy is non-market consensual. Most analysts would not risk their heads on the chopping block for two stocks. It is either you win big or you lose big.

    Ms Lynn Gasper: Nicholas had clear investment goals, strategy and approach, and was consistent in applying that approach in selecting his stocks for his portfolio.

    Even in the short run (first 30 days), his portfolio returns held up above what the markets were doing, and in line with his targeted returns for the longer term.

    Although I was initially sceptical, surprised that someone who had $50,000 to invest would allocate to shares in only two companies, I was convinced by the fairly detailed and thorough company analysis that Nicholas presented. It covered fundamental analysis, industry/sector assessment, economic exposures and valuations.

    And most importantly, for someone who is actively targeting a high-growth strategy, Nicholas had done a lot of legwork to support his top-line/revenue growth assumptions that are the basis for his valuations and target price. His assumptions were quantitatively tied to specific opportunities cited and verified, and supported by other macro-economic factors as well.

    Although no one has a crystal ball for what the future holds, Nicholas made a conscious and conscientious effort to identify all known variables and rationally considered them to make the best investment decision for his goals.

    Ultimately his focused, high-growth strategy worked because he was consistent and disciplined in his approach, and had rational bases for his growth assumptions and valuations.

    While it doesn't mean that he can leave his over-achieving portfolio on cruise control for the next year (he will need to monitor it with as much effort as he put into researching them), he is at least on his way to achieving his return targets.

Winning portfolio

Mr Lim's stocks were construction firm Lum Chang (100,000 shares at 38.5 cents each, or $38,500) and Falcon Energy Group (50,000 shares at 22.5 cents each, or $11,250) for a total investment sum of $49,750. He allocated 77 per cent of his portfolio to Lum Chang and a smaller proportion to Falcon because the oil and gas sector is deemed riskier now.

Mr Lim told The Sunday Times he picked small-caps that were relatively cheap so a small price change would translate to higher percentage gains, and companies with sound fundamentals as reflected in the low price-earnings (PE) ratios, sustainable dividend policies and discounts to net asset value (NAV).

Generally, small-cap stocks tend to be firms whose total outstanding shares are valued at less than $1 billion. In Singapore, the market capitalisation of such stocks averages about $300 million.

Lum Chang's market cap is about $149.9 million. At the buy-in share price of 38.5 cents, Mr Lim was getting the counter at a 28.1 per cent discount to the NAV of 53.6 cents, the earnings per share was 6.73 cents with a PE ratio of 5.72, dividend yield of 5.2 per cent, and the cash at hand was 31.83 cents.

Mr Lim noted that Lum Chang has either been increasing or maintaining its yearly dividends over the past decade. And for the last three years, its dividend was two cents a year.

Mr Lim projected a target price of 50 cents for Lum Chang. This translated to a potential 30 per cent upside which would exceed the 8 per cent per annum return target set by the competition.

He felt there were potential catalysts that would boost its earnings, including a good balance of public-sector infrastructure projects and private-sector developments on the order book, providing certainty to its earnings over the next two to three years.

It is also set to enjoy steady recurrent income from investment real estate, such as its latest acquisition of a London property in May.

Another factor Mr Lim considered was that substantial shareholders Raymond Lum and David Lum had been buying shares from the market since February, which reflects their confidence in the firm.

But Mr Lim highlighted a few potential risks of investing in Lum Chang - the prolonged weakness in the property market here, the possibility of stricter foreign worker quotas and rising labour costs.

As for Falcon Energy, Mr Lim was a shareholder of CH Offshore, in which Falcon has an 86 per cent stake. At the buy-in share price of 22.5 cents, he was getting the counter at a 47.6 per cent discount to the NAV of 43 cents.

The earnings per share was 3.81 cents (excluding CH Offshore), the PE ratio was 5.832 and the dividend yield was 6.6 per cent. He projected a target price of 30 cents, which would translate to a potential 33 per cent upside.

"One key consideration was that Falcon's market cap was $182 million versus CH Offshore's market cap of $348 million. So I am paying $182 million for something that includes a $348 million subsidiary," he said.

Mr Lim's research showed that the potential catalysts included the majority ownership stake in CH Offshore, which has zero borrowings and had been cash-flow positive for the past decade.

The strengthening United States dollar, the firm's steady dividend policy of 1.5 cents a year for the past two years and its share buybacks early this year were also seen as positives. The risks include the high gearing and the prolonged weaknesses in the oil and gas sector.

The target price of 50 cents for Lum Chang and 30 cents for Falcon are still at discounts to the companies' approximate NAVs. And given the potential earnings catalysts, there is a good chance that the NAVs might increase in the coming year, added Mr Lim.

He used data from ShareInvestor and annual reports from the Singapore Exchange (SGX) website for his analysis.

Investment strategies

Mr Lim started dabbling in stocks when he was a second-year civil engineering student at the National University of Singapore (NUS), with some encouragement from his accountant father, who also invests in stocks.

"My father suggested that it will be a useful skill that can last me a lifetime and can be applied anywhere in the world with a stock market," recalled Mr Lim.

His investment philosophy was greatly impacted by a couple of workshops he attended in the early 2000s by SGX and the Securities Investors Association of Singapore with trainers Gabriel Yap and Robert Tay about value investing. They cost him less than $200 each.

He also discovered investor-friendly tools at that help him to filter out stocks, map out the PE, dividends, NAV and so on.

He is a firm believer in the value-investing philosophies practised by star stock-pickers Warren Buffett and Peter Lynch.

This means that if he had buys in a fundamentally good company at a good price, he would be willing to hold the stock over several years. In fact, he recalls that most of his bigger profits were made only after holding on to a company's stock for two to three years.

"I like to get paid while waiting for the value to be unlocked, so I will select companies that give reasonable dividends," he said.

Mr Lim has about 10 stocks in his portfolio - a balance of small-cap counters and blue chips that are diversified on the sector level as well. They include OCBC, Keppel Corp, Lum Chang, QAF and Far East Orchard.

"These companies have a long track record of paying steady, increasing dividends and I bought them at entry prices that give me reasonable dividend yields. If prices are right, I will sell or buy more according to circumstances," he said.

In May, he pared down his exposure to the oil and gas industry because he was uncomfortable with the delayed resolution of the Brazil saga in which Keppel Corp and Sembcorp are embroiled and the downward trend in oil prices. As a result, he realised some profits before the market headed south.

Although the market value of his portfolio has dropped by about 10 per cent over the past two months ago, he can sleep soundly as most of the companies have a good history of giving dividends even through past crises, and he had bought in at entry prices with a decent margin of safety.

"I see this high-volatility period as a good opportunity to increase exposure in selective quality companies should their prices overshoot to the downside," he said.

Looking ahead, he plans to achieve a target of $120,000 per annum income from dividends for his retirement when he reaches 45. This means a $2.4 million portfolio, assuming a 5 per cent annual dividend yield.

Mr Lim graduated from NUS in 2005, finished his bond with the Republic of Singapore Navy and worked in the financial sector in wealth management and risk management before becoming a full-time investor in March.

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A version of this article appeared in the print edition of The Sunday Times on September 20, 2015, with the headline Invest Idol's picks: Two small-caps with big potential. Subscribe