What you need to know about investing in stocks

PSE TOWER There are 284 companies and 356 issues listed on the local bourse. —INQUIRER FILE PHOTO

Stocks can be the most rewarding share of your portfolio of investments.

If you had bought 100 shares of Ginebra San Miguel Inc. (GSMI) last year (Sept. 29, 2021, at P105.60 per share), you would have received cash dividends of P537.50, or P5.375 per share.

At the Sept. 29, 2022, price of P105 per share, the market value of your investment would have been 0.57 percent lower. But considering that you received P537.50, you would have gained 4.48 percent, versus the 23.7-percent average loss of the 284 companies that trade at the Philippine Stock Exchange (PSE).

If you had bought the 100 shares two years ago, your gain would have been 51.7 percent a year, versus the 2.1-percent average loss of all PSE-traded shares.

If you had bought the 100 shares five years ago, your gain would have been 53.5 percent a year, versus the 5.4-percent loss of the overall market.

When the company began to earn more than enough money to compensate its stakeholders, it distributed cash dividends every three months or so, since, without fail.

How should you look for the companies to invest in?

Look for companies that earn, at least 15 percent every year as compensation to their stakeholders for the capital that they have invested, the risk they were exposed to, and the time or years spent to get their money back.

Only one out of every 27 companies listed on the PSE earns a return equal to or greater than 15 percent every year. GSMI earns 21 percent.

Look for companies whose operating incomes grow most of the time. Operating income (what’s left after the company subtracts the cost of goods that it sells and other operating expenses from revenues) does not grow every single year.

Bloomberry Resorts Corp.’s operating income grows 65 percent of the time; Semirara Mining and Power Corp., 53 percent of the time; Aboitiz Equity Ventures Inc., 65 percent; Metro Pacific Investments Corp., 63 percent; LT Group Inc., 55 percent; Universal Robina Corp., 60 percent; San Miguel Corp., 65 percent; PLDT Inc., 40 percent; Acen Corp., 50 percent; Security Bank Corp., 60 percent; GT Capital Holdings Inc., 53 percent; JG Summit Holdings, Inc., 55 percent; SM Investments Corp., 63 percent; and Metropolitan Bank and Trust Co., 60 percent.

Not surprisingly, Manila Electric Co.’s operating income grows 75 percent of the time, because the local consumption of energy increases 90 percent of the time.

You should adopt “75 percent of the time” as your standard for what is “most of the time.” Only one out of every 14 companies listed on PSE reports operating incomes that grow at least 75 percent of the time. GSMI’s operating income grows 80 percent of the time.

Why is it so important for operating incomes to grow year after year? Operating income is the source of cash from which bondholders and stockholders can benefit.

Look for companies with cash left after they subtract the interest (amount they need to pay to the banks) and money (amount they reinvest in working capital and fixed assets, e.g., repairing a roof, purchasing a piece of equipment, building a new factory, etc.) from their operating incomes.

GSMI needed to pay P41 million only from its operating income of P5.55 billion in the last 12 months.

There are as many as 40 companies at the PSE that need to pay interest above or greater than operating income! In these 40 companies, little or no cash is left for stockholders. Avoid these companies.

Look for companies that are trading well below their intrinsic value.

Intrinsic value is the monetary value that you expect to benefit from the company in the future.

GSMI’s intrinsic value is equal to P129 per share or well above its stock price (at the time of this writing).

Not every company that earns at least 15 percent—whose operating income grows at least 75 percent of the time and which has more than enough cash left for stockholders—trades lower than its intrinsic value.

Price to earnings ratio (the result of dividing a company’s stock price by how much income it makes for each share it issues) may be a formula that everyone understands but it is a dangerous tool to use in approximating intrinsic value. If your friend cannot explain this, he is not less of a friend, but he may not be qualified to give you advice on stock investing.

When should you invest?

Invest when you find a company in the manner I found GSMI and other companies. If you cannot find one, you should not invest.

When should you sell? Sell when the price of the stock is higher than the company’s intrinsic value.

What’s the risk?

The growth of operating income may be at risk from time to time, usually during a period of economic contraction.

The period June 2020 to June 2021 is an excellent example. In the months following COVID-19, the operating incomes of most companies contracted, along with the Philippine economy.

In 2020, our gross domestic product contracted 9.6 percent —an event that is unlikely to be repeated.

As capacity utilization in manufacturing dipped to its all-time low of 67 percent, 4.8 million Filipinos added to the unemployed of 7.2 million.

Income from abroad shrank by 27.3 percent. In nominal terms, the money earned by individuals and businesses, or gross national income, narrowed by P2 trillion. Therefore, it is important to look for companies whose operating incomes grow most of the time.

What do you need to invest?

You need a coherent way of thinking—investment philosophy—about how the stock market works and what does not work. It is not the same as “investment strategy,” or plans to implement your investment philosophy.

An investment philosophy is a set of beliefs that you draw from to think about your strategy. If you do not have it, you may end up with a strategy that is not appropriate to your investment objective and appetite for the risk that you are taking.

Invest with the objective that I have—to deliver a positive investment return, regardless of whether markets are rising or falling. Any other investment objective will result in taking far, far greater risk than you think or can stomach or be happy with.

An equity fund that I managed and ranked No. 1 in the Philippines in categories one, three and five-year investment returns exemplified this objective.

The investment objective of 99 percent of investment funds is to beat a benchmark—not to deliver a positive return. Even if the markets are falling or Company X is trading above its intrinsic value, the investment fund’s portfolio manager will invest in Company X if he expects it to outperform the benchmark.

Retail investors need to be aware that they are taking far, far greater risk than they think when their investment objective is different from the investment objective of their investment fund.

In relatively “illiquid” stocks, I advise investing in what the market can sell to you so that you can divest what the market can buy from you. Investing in these stocks will add value to your portfolio of investments—they will not subtract. —contributed

The author had worked for big financial institutions as a professional fund manager for 25 years before retirement. He can be reached at [email protected].