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Quality And Value Could Be Major Drivers Of This Small-Cap Stock

Shares in Dawnrays Pharmaceutical (holdings) (HKG:2348) are currently trading at 0.95 but a key question for investors is how the economic uncertainty caused by Covid-19 will affect the price.

Part of the answer comes down to judging whether the stock is well placed to withstand economic shocks and ride out market volatility. To do that, it's worth looking at its profile to see where its strengths are.

The encouraging news is that Dawnrays Pharmaceutical (holdings) has at least some of the traits that are often associated with two influential drivers of investment returns: high quality and a relatively cheap valuation.

Buying Quality At A Fair Price

Good quality stocks are loved by the market because they're more likely to be solid, dependable businesses. Profitability is important, but so is the firm's financial strength. A track record of improving finances is essential.

One of the quality metrics for Dawnrays Pharmaceutical (holdings) is that it passes 6 of the 9 financial tests in the Piotroski F-Score. The F-Score is a world-class accounting-based checklist for finding stocks with an improving financial health trend. A good F-Score suggests that the company has strong signs of quality.

While quality is important, no-one wants to overpay for a stock, so an appealing valuation is vital too. With a weaker economy, earnings forecasts are unclear right across the market. But there are some valuation measures that can help, and one of them is the Earnings Yield.

Earnings Yield compares a company's profit with its market valuation (worked out by dividing its operating profit by its enterprise value). It gives you a total value of the stock (including its cash and debt), which makes it easier to compare different stocks. As a percentage, the higher the Earnings Yield, the better value the share.

A rule of thumb for a reasonable Earnings Yield might be 5%, and the Earnings Yield for Dawnrays Pharmaceutical (holdings) is currently 39.8%.

In summary, good quality and relatively cheap valuations are pointers to those stocks that are some of the most appealing to contrarian value investors. It's among these shares that genuine mis-pricing can be found. Once the market recognises that these quality firms are on sale, those prices often rebound.

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