SINGAPORE (Feb 28): Covid-19 continues to take its toll globally and have adversely impacted the financial markets. Global stock markets are on a decline, with the local Straits Times Index (STI) down more than 4.1% since mid-January. In light of the pandemic fear, the market and investors have shifted to safe haven assets, namely gold, government securities, and cash. The price of gold is up 4.7% from last month, while the “risk-free” asset – Singapore 5- and 10-year government bonds, have seen their yields drop by 200 basis points on average due to high levels of demand. A multitude of scenarios have been projected by market analysts and watchers alike — some may say that stocks are cheap, others might say the worst is yet to come. Regardless, when it comes to investing, particularly in times like these, investment safety is of utmost importance. Preservation of capital — as aptly put by many investing gurus — takes precedence over perceived growth.
When it comes to investment safety for stocks, there are multiple metrics that can be looked at to determine whether an investment is safe enough. It mostly revolves around the balance sheet, which reflects what a company owns and owes at a certain point in time. Assuming the worst-case scenario, the safety analysis ought to determine the maximum downside of a stock. This article will explore the various indicators, ratios and metrics used to assess the investment safety of a company, focusing on SGX-listed stocks. It is also important to note that stocks with cheap valuations do not necessarily imply that they are safe. Cheap valuations merely suggest that the stock’s intrinsic or fair value is above its current share price.
The indicators to gauge and assess investment safety include liquidity, solvency, beta, NAV or net asset value, reserves and operating expenses. We have shortlisted the top companies using data from Bloomberg that have the best overall cumulative safety ratio.
Liquidity ratios reflect a company’s ability to meet its shortterm financial obligations. The most liquid asset a company can have is cash, so liquidity ratios also show how quickly a company can convert its assets into cash. Commonly used liquidity ratios include the cash ratio, quick ratio and current ratio. The benchmark is usually anything above 1 for these ratios, as it indicates that the company has enough liquid assets to cover its short-term financial obligations.
Similarly, solvency ratios reflect a company’s ability to meet its longer-term financial obligations. It is focused on the company’s ability to remain as a going concern, or in other words, operate its business normally and profitably. The gearing and interest coverage ratio is used to gauge a company’s solvency. The gearing ratio refers to the company’s debt relative to its equity, as a company can be funded by either debt or equity. Too high of a gearing, in this case, anything more than 50% generally is considered risky. A company that is net cash means that its cash is more than its total debt, which is a desirable investment trait when it comes to safety. The interest coverage ratio refers to the ability of a company to settle interest payments on its outstanding debt using earnings before interest and taxes (Ebit). Higher ratios are more desirable, and the general consensus view is that anything below four times is considered risky.
A stock’s beta reflects the volatility in its share price against the overall market or the stock exchange. A beta of more than 1 indicates that the stock is more volatile than the market, hence is riskier but has a higher potential upside. Conversely, if a stock’s beta is lower than 1, it implies lower risk, but with lower potential returns. Defensive stocks, which are stocks that remain relatively stable regardless of business cycles, for example non-discretionary consumer stocks, tend to have lower beta. When assessing investment safety, it is important to recognise that during a downturn or market shock, stocks with high beta usually have a lower floor compared to stocks with a lower beta.
The NAV of a stock is one of the more recognised metrics when it comes to investment attractiveness, with investment safety as the key metric. The NAV shows the net assets per share, where net assets is the value of remaining assets of a company after deducting its total liabilities. Another commonly used metric is the NTA or net tangible assets of a stock, where NAV is deducted by the value of intangible assets of the company. Both these indicators are generally represented as Price to NAV or Price to NTA. A ratio of less than 1 indicates that the company is attractive, whereas anything above 1 denotes that the company’s share price is expensive relative to the net assets it holds. However, the NAV and NTA should be discounted. This is because assuming worst-case scenario where the company has to liquidate, it is unlikely that the company is able to sell its less liquid assets at prevailing prices to pay off creditors. Hence, the less liquid a company’s assets are, the more it has to be discounted. Furthermore, the quality of assets should also be incorporated into this metric. Receivables, for example, should be based on the quality of its debtors. In short, every asset must be discounted based on its liquidity and quality.
A company’s reserves can be used for various objectives, for example business expansion plans and dividend payouts, but assessing investment safety mostly looks at it being utilised for a rainy day. The operating expenses (OpEx) of a business refers to the expenses it incurs during its usual business operations. Ideally, the company’s reserves should last long enough to sustain its OpEx for a period of time to investment-safe. Capital expenses (CapEx) of a business refers to the expenses it incurs when investing into its business, mostly through upgrading its capital assets. A more conservative approach would assess whether a company is able to sustain both its OpEx and CapEx through its reserves for the given period of time.
Apart from the quantitative indicators, the qualitative aspect of market downturns or shocks is fairly important. This mostly involves the nature of the business and the industry it belongs to, which in turn will determine the extent to which they are affected. Specifically for the ongoing Covid-19, with investment safety as an emphasis, there are different tiers of sensitivity to the pandemic, based on the exposure of the business. Tier-1 would be businesses that are most affected — in the hospitality, leisure, tourism, food & beverages, retail and entertainment industry. Tier-2 would be businesses that are significantly affected — manufacturing and its supply chain, financial and the real estate industry. Tier-3 would be other industries that are affected, but to a lesser extent — communications, information technology and utilities.
The companies with the best overall safety are shown in Table 1.
