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Are there really five bargains to research further?

With markets falling on fears that political brinkmanship in the US may result in an embarrassing default on the country’s extraordinary debt obligations (not to mention a reputationally damaging event), I wondered whether we could dig anything up with a more-than-slightly different approach to finding value.

As you would know from reading Value.able, I am not a fan of the Price to Earnings Ratio. Nothing has changed on that front. Nevertheless, value may just be in the eye of the beholder and not only is the P/E Ratio common in literature about investing and in market commentary, it is, whether rightly or wrongly, in wide use.

Indeed, if you are like many Baby Boomers now on the cusp of selling your business, you will be spending a great deal of time in negotiations and assisting in due diligence to arrive at a simple multiple of earnings.

The humble P/E Ratio may be misused, misunderstood and relied on far too heavily, but popular it remains.

One version of the earnings multiple that is adopted for comparison purposes by private equity buyers is the enterprise model. The enterprise model takes the market value of the equity (market cap) and debt, less cash, and divides the whole lot by the EBITDA (earnings before interest tax depreciation and amortisation). Of course, if you have a company with high operating margins but lots of property, plant and equipment (PP&E) to maintain, you may find the results a little optimistic.

Simply take a standard price to earnings approach, but subtract the cash the company has in the bank.

If you were to buy a business outright, you may take into account the cash the company has in its bank accounts. After buying the business you may be able to access this cash and withdraw it to lower the purchase price. Alternatively, if you are selling a business, in an IPO for example, you may be just as keen to take the cash out before selling it to maximise the return to you and reduce the return available to otherwise anonymous share market investors (this latter strategy is very popular).

The arithmetic result of taking out the cash is a lower P/E multiple. And that is what I thought you may be interested to discuss.

Are there any companies listed in Australia that are trading on very low multiples of earnings once their cash is taken into consideration? The broad based market declines have ensured there are indeed a few.

Step 1

My search began by opening our next-generation A1 service (Value.able Graduates – your exclusive invitation to pre-register is not far away). I applied a filter to discover those companies whose shares were trading at a P/E-less-cash ratio of less than 6 times. From the more than 2000 companies reviewed, there are 18 such companies that meet the criteria today. Keeping in mind some businesses have cash on their balance sheet that would NOT be accessible to a buyer (legislated, regulation or simply working capital needs), here are the eighteen:

Step 2

Next, I retained only those companies that have a current estimated forecast increase in intrinsic value of 10% or more. This filter reduced the field to just 11 companies, removing ASX, OZL, CGS, CFE, BTA, PBP AND MOC. Here are the eleven:

Step 3

Finally, I removed companies whose previous year’s ROE was less than 15%. I also removed any companies with a C1-C5 Quality Score. Low ROE stocks removed were; CLQ, CLH, SVW AND STS and C-rated companies removed were; SFH AND PEM. That left just five companies. Here they are:

And there you have it, companies trading at enterprise multiples that may be attractive to a buyer who could potentially use the cash on the balance sheet to reduce their purchase price.

Amazing, incredible simple. No manual calculations required (ever again).

Remember, this exercise did not incorporate any of the traditional Value.able investing considerations we usually discuss at the Insights Blog… safety margin, intrinsic value.

For the record, only two of the listed businesses look cheap on the Value.able score today. With reporting season about to begin in ernest, keep in mind the results and cash balances of these companies will all change.

You must do your own research into their prospects and remember to seek and take personal professional advice.

Very soon, finding extraordinary A1 companies offering large safety margins will become simple and even fun. Our next-generation A1 service that my team and I have been tirelessly working on will inspire your investing and re-energise your portfolio.

Value.able Graduates – stay tuned. Your exclusive invitation to pre-register will arrive in your inbox very soon. If you are yet to join the Graduate Class, click here to order your copy of Value.able immediately. Once you have 1. read Value.able and 2. changed some part of the way you think about the stock market, my team and I will be delighted to officially welcome you as a Graduate of the Class of 2011 (and invite you to become a founding member of our soon-to-be-released next-generation A1 service).

Back to the program… this reporting season, who do you think will surprise with better than expected earnings?

Who do you think will struggle?

And what stocks are looking cheap to you right now?

Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 29 July 2011.

Posted in A1, Company Valuation, Floats, Insightful Insights, Takeovers, Value Investing, Value.able

87 Comments Leave a Comment

How does Roger Montgomery construct his share portfolio?

A couple of weeks ago Tony and Stevo made the following suggestion at my Facebook page: If given $100,000 to invest in the stock market, would I spread my money equally across the portfolio or invest a larger percentage in the very best stocks that are trading at prices less than they’re worth?

Here are the highlights from that appearance on Peter’s Switzer TV.

Peter has invited me to join him again this Thursday from 7pm on the Sky Business Channel (Channel 602).

What’s your portfolio construction strategy?

Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 12 July 2011.

Posted in Insightful Insights, Value Investing, Value.able

181 Comments Leave a Comment

What did Ash and the team talk about?

Yesterday we had the pleasure of meeting Ash in person. If you scroll through any of the threads on our blog, you will no doubt find some extraordinary insights from one of Value.able’s founding Graduates.

Indeed, Ash’s generosity and willingness to share his experience and insights with new investors has fostered a spirit of camaraderie that has become integral to the Value.able community.

What did we talk about? It’s been a hot question at the Facebook page!

…Matrix, the recovering Lockyer Valley, cotton, gas explorers, an exciting new float, Lloyd, rugby and the 2GB podcast about a small cap gold stock that resulted in 170 comments and the thought to shut this blog down!

Thanks again Ash. We look forward to catching up with you again when you are next in Sydney.

Now to the photo… can you spot some familiar faces?

The first four of six framed artworks are now featured at the entrance of our office.

It was a proud moment indeed. We will publish some more photographs of the artworks in coming days.

Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 7 July 2011.

Posted in A1, Insightful Insights, Value.able

81 Comments Leave a Comment

How are the A1 twins performing?

For those who may not know, Value.able Graduate Scott wanted to know just how useful this A1 to C5 quality rating stuff, that my team and I talk about so much, really is. With our next-generation A1 service not far away, its a worthwhile question.

A1 is the highest quality rating a company can receive. A company that earns an A1 has the lowest chance of catastrophe, a C5 the highest chance. Of course it is possible that something bad could happen to an A1, but the probability is a lot lower. As a Value.able Graduate you may, like many, consider A1 companies the truest of ‘Blue Chips’.

Take for example the recent announcement of an impairment charge by Transpacific (ASX: TPI). ‘Impairment charges’ are a loss in any other language. TPI is another example of the process working – Transpacific has long received a score of C4 or C5. The shares have fallen 50 per cent recently, but more importantly, are now at or close to all time lows.

Our Quality and Performance Rating is applied without any subjectivity. That means there is no human intervention. There is no ‘tinkering’. All companies are judged according to the metrics they generate. A1s have the lowest probability of a liquidity event and C5’s have the highest. A liquidity event includes a capital raising, debt default or renegotiation, administration, receivership, etc.

Another way to test the efficacy of our approach is to track the performance of the A1’s against, say, the ASX/S&P 200. The following chart, first published here, shows that sticking to A1s and avoiding C5s should, over time, produce better returns. The chart shows the performance of a portfolio of the 20 largest companies listed on the ASX rated ‘A1′. The red line is the poor old ASX/S&P 200.

Back to Scott…  he came up with a third way to test the approach. He’s been watching a portfolio of A1s and comparing it, in real time, to a portfolio suggested by a large investment bank. Take it from here Scott!

For new readers to the blog, welcome. Here at Roger’s Insights blog we are conducting a 12-month exercise measuring the performance of a basket of 10 stocks recommended by Goldman Sachs, against a basket of 10 A1 or A2 businesses that were selling for as big a discount to Intrinsic Value as we could find.

The original story that inspired this study can be found here.

The first chapter of our story was published earlier this year – Will David beat Goliath?

Six months has passed since our twin brothers each invested their $100,000 inheritance. The first quarter saw the ASX 200 (XJO) grow 2.0% and the two portfolios performed very differently to each other. At the end of the second quarter, the XJO is now 2.9% below the start of the year, and the impact of this sell off on the brothers, has been as stark as the impact on their portfolios.

Our Queensland regional accountant decided it was time to help his flood ravaged community and took six weeks annual leave. He went over to Grantham and helped rebuild the lives of so many flood ravaged families. Whilst physically taxing, it was an enormously rewarding experience, and reminded him of what life is really about. Upon arriving home six weeks later, in mid June, he was surprised to discover that the market had continued the decline it had begun before he left. Whilst his portfolio had taken a bit of a beating, he was very pleased to see it had outperformed the Index, and was still in the black.

His brother, on the other hand, was not feeling so grounded. Every morning he found himself starring at the CNN web page and shaking his head in disbelief… the Dow was down AGAIN (that almost inevitably led to a poor performance of his portfolio that day). Six weeks later, he found himself sitting in the office of the Departments Deputy Secretary, with a Human Resources specialist, being asked, “Is every thing alright at home?” There was a litany of concerns raised about the sudden deterioration in his performance, from missed meetings to reports that looked like someone very distracted wrote them. Having not really understood the quality of businesses he was invested in, nor understanding the importance of turning the market off, he was turning a market sell off into a major personal crisis.

In summary, for the six months to 30 June 2011:

The XJO is down 2.9%

The Goldman Sachs Portfolio is down 6.2%

The A1 and A2 Portfolio is UP 1.8%

Here are the portfolios in detail, including cash dividends received in the first half. (click to enlarge)

We will visit the brothers again at the end of September.

All the Best

Scott T

Thanks for that Scott.

Have you checked your portfolio for C5s? Are all the stocks in your portfolio worthy of the A1 rating? According to one Value.able Graduate, Charles Munger said; “If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return – even if you originally buy it at a huge discount.”

Sticking to quality is vitally important. That’s what my team and I do here at Montgomery Inc, and its what our amazing next-generation service is all about. We will invite Value.able Graduates to pre-register soon.

Good investing to everyone… including Goldmans.

Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 5 July 2011.

Posted in A1, Blue Chips, Company Valuation, Insightful Insights, Market Valuation, Value Investing, Value.able

147 Comments Leave a Comment

Who is being watched this reporting season?

Now on the cusp of reporting season, it is worth reviewing our expectations for Value.able intrinsic valuations and double-checking those that belong to higher quality (MQR: A1, A2, B1, B2) businesses.

There were more than 107 suggestions! Thank you.

Our new A1 service allows us to whip up all the data required for all your nominated stocks in less than a minute (soon you can too!). For now, let’s put stakes in the ground for those which achieved at least three nominations.

In order of mentions…

Matrix C&E, followed by JB Hi-Fi, Forge, Vocus, BigAir, Credit Corp, Woolworths, Thinksmart, BHP, M2 Telecommunications, Zicom, Oroton, ANZ, CSL, ARB Corporation, Thorn Group and Cash Convertors. The remaining companies received less than 5 mentions each. The companies with only a single mention (and therefore arguably least followed) were: ILU, RFG, SMX, KRS, AMA, LNC, RQL, COU, TBR, CPB, AVM, BDR, REA, AIR, CKL, AJJ, FXL, CTD, STU, MIN, TGR, CXS, CMI, CDA, CGX, DGX, RCO, MND, CIX, MOC, RHD, DLX, RMS, MYE, SEA, DPG, SFR, NCK, SRX, NCM, CLV, NFK, CLX, NOE, CMG, NST, IPP, CDD, WTF, OGC, KNH, DWS, FRI and KCN.

Well without further delay, here’s the list with our 2012 forecast Value.able intrinsic valuations.

<Temporarily removed for updating and additional stocks and data columns>

Over the next few weeks we will build on the list, include some additional useful information and data and generally prepare you for reporting season.

Stay tuned. This is a period when even developed markets can be inefficient.

Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 1 July 2011.

Posted in A1, Blue Chips, Company Valuation, Financials, Insightful Insights, Value Investing, Value.able

179 Comments Leave a Comment

Is shale gas ‘drilling fast and conning Wall Street’?

For those interested in Shale Gas stocks, an interesting article was published in the New York Times at the weekend.

Here’s an excerpt or two from the article…

“Money is pouring in” from investors even though shale gas is “inherently unprofitable,” an analyst from PNC Wealth Management, an investment company, wrote to a contractor in a February e-mail. “Reminds you of dot-coms.”

“And now these corporate giants are having an Enron moment,” a retired geologist from a major oil and gas company wrote in a February e-mail about other companies invested in shale gas. “They want to bend light to hide the truth.”

…and here is the link to the story: http://www.nytimes.com/2011 and a link to more than 480 pages of leaked insider emails and reports: http://www.nytimes.com/interactive

And more recently, in this e-mail chain from April 2011, United States Energy Information Administration officials express concerns about the economic realities of shale gas production.

I am not allowing any comments on this subject. Do your own research and seek personal professional advice.

Please continue contributing to the two prior posts, listing the companies you think we should be watching this reporting season (Scroll Down).

Posted by Roger Montgomery, author and fund manager , 27 June 2011.

Posted in Resources, Value Investing, Value.able

Comments Off

What are you cooking up Roger and team?

I am working tirelessly to generate superior returns for the Montgomery [Private] Fund. That is the number #1 goal. But stay tuned, because I am also writing a post for next week that will list some of the companies you should be seriously watching this reporting season (and there may be a few gems). Stay tuned and keep checking in.

Today’s earlier post (What if the sell off is just a Flash?) lists some out-of-favour A1 companies.

If you have a company that you believe investors should be watching this reporting season, please  start posting them here. Check in next week to see if  they’re on our list too.

Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 23 June 2011.

Posted in A1, Company Valuation, Insightful Insights, Value Investing, Value.able

241 Comments Leave a Comment

Tech Wreck MkII: Is this time different?

“If you’re playing a poker game and you look around the table and can’t tell who the sucker is, it’s you.”  Paul Newman

“Great men are not always wise” Job 32:9

“If one man says to thee, ”Thou art a donkey’,’ pay no heed. If two speak thus, purchase a saddle.”  ”Doubt cannot override certainty”  The Talmud

“The seed ye sow, another reaps; The wealth ye find, another keeps; The robes ye weave, another wears; The arms ye forge, another bears.”  Percy Bysshe Shelley

If you are watching events unfold in the US like me, you’re probably hearing a lot about the tech stock frenzy going on over there.  Stunning IPO successes this financial year are once again drawing a crowd. But are we looking at a Tech Bubble MkII? Are the big banks, without a suite of CDSs and CDOs to sell, now performing the same cup-and-ball trick on a different table? Or is this time genuinely different?

Read on – you be the judge (my mate Jim Roger’s is short “US Tech”, and I never ever allow myself to believe this time is different to the last).

YouKu

Based in Beijing and now listed on the Nasdaq, YouKu is China’s answer to YouTube. The stock closed at $33.44 on its first day of trading in December 2010 (its now $28.04) – that’s 160 percent above its offer price of $12.80! The company offered 15.8 million shares of American Depository Receipts (ADRs), representing 16 percent of the total shares, giving it market cap of $3.3 billion or 71 times revenue. Youku generated revenue of $35 million in the first nine months to 31 December 2010 and lost $25 million during the same period.

Founded in November 2005 and launched in December 2006, YouKu never really relied on user-generated content. More than 60 per cent of its videos are from traditional media companies in China. The company has 40 per cent penetration amongst China’s 420 million internet users. YouKu claims 200 million unique visitors a month in China, however independent comScore estimates a smaller 78 million.

LinkedIn

LinkedIn was priced at $45 per share but traded between $80 and $120 for more than a week after listing, giving the company a market ‘valuation’ as high as $11 billion. Unlike many of the tech stocks that tempted investors in 1999 and early 2000, LinkedIn is profitable.

The company reported its first quarter revenue in 2011 was up 110 percent to $93.9 million compared to pcp (previous corresponding period) and ‘Net income’ increased to $2.08 million for the same period, compared to $1.81 million for pcp.

But there is profitable and there is ridiculous. An $11 billion valuation, or more than 22 times revenue for a business that earns 2 per cent on its revenue, seems, at best, unconnected to the underlying financials. Even someone like me that pays no attention to price or revenue multiples can see that.

Yandex

On 26 May 2011, Yandex NV (YNDX), owner of Russia’s version of Google and the country’s most popular Internet search engine, listed on the NASDAQ. Yandex sold 52.2 million shares (or 16.2 percent) at $25 per share, raising $1.3 billion and valuing the company at $8 billion. On their first day of trading the shares rose $13.84, to $38.84, giving the company a market capitalisation of $12.4 billion or a multiple of 43 times next year’s forecast earnings. For those seeking a reference point (not a valuation), Google trades at about 13 times estimated 2012 earnings.

Total online advertising in Russia climbed 51 percent from 2008 through 2010, but still amounts to just $940 million! Private equity accounted for seventy per cent of the shares sold in the Yandex float.

Renren Network

The demand for shares in Renren – the Facebook of China with 117 million users* – was clear days before it floated on 2 May 2011 (the company raised the expected price range of its IPO of 53.1 million shares by 30 percent to $12 to $14 per share from a previous range of $9 to $11). The float raised about $743 million and gave the company a valuation of more than $4 billion, or 52 times sales. Renren’s net revenues were $76.5 million in 2010, up 64 per cent from $46.7 million in 2009 and up from $13.8 million in 2008. Renren had a net loss in 2010 of $64.1 million, down from $70.1 million in 2009.

The head of Renren’s audit committee, who is also a board member, quit after allegations of fraud against Longtop Finanicial Technologies. The company also revised down its unique user numbers to a rise of 19 per cent (it originally advised 29 per cent).

Renren said in its prospectus that it operates under a prohibition against posting content that, “impairs the national dignity of China” or is “superstitious”, or content that is “socially destabilising.”

If Renren fails to comply, the company says its websites could be shut down. Clearly that could put it out of business.

The company also has a “material weakness” and a “significant deficiency” in its internal financial controls: it doesn’t have enough people with knowledge of U.S. GAAP (Generally Accepted Accounting Principles). Eighty seven per cent of Renren’s leased office floor area did not have the proper title documents.

*Renren doesn’t really seem sure how many users it has. According to its April 27 revised IPO filing, monthly unique log-in user base grew by only 5 million, or 19 per cent, in the first quarter of 2011 – not the 7 million, or 29 per cent, it reported in its first filing only 12 days earlier.

Pandora (not the charms)

Online radio operator Pandora runs an online personal music service – with applications for the iPhone and Google’s Android mobile operating system - that lets users pick songs, styles/genres and bands from which to build a personal radio station. As at the end of April, Pandora has about 94 million registered users, of which 34 million are considered active. This is up from 18 million at the same time last year.

Pandora offered 14.7 million shares, or just 10 per cent of the total float at $16, raising around $235 million and putting a valuation of $2.6b on the whole shebang. Pandora was priced at about 19 times revenue for last year. Revenue Value.able Graduates, not NPAT.

Pandora has not reported any profits in 2010 or 2011. Indeed in the last three years, Pandora has lost $46.7 million and the company said in its IPO filing that it doesn’t expect to be profitable this year or next. Worryingly, it doesn’t say when it expects to be profitable.

In the weeks prior to listing, the lead manager, Morgan Stanley, raised the expected price range from $7-$9 to $10-$12. Then, after the marketing period ended, priced the shares at the final listing price of $16.

And it gets more fascinating. On its first day of trading, Pandora shares rose as much as 63 per cent to a high of $26, giving it a market capitalisation of $4.2b. A competitor listed on the Nasdaq, Sirius XM, trades at 2.6 times revenue.

According to documents filed with the SEC just six months ago, Pandora’s own board reckoned its stock’s value was/is $3.14 a share, or a market capitalisation of about $500 million.

Pandora generated revenue of $51 million in the first quarter ending April 30 – more than double the $21.6 million for the pcp. The company however lost $6.8 million in the first quarter this year, up from around $3 million in the same quarter last year.

Until recently advertising has represented more than 90 percent of revenue, however revenue from subscriptions (which lets subscribers skip the advertisements the company’s other customers pay for to appear between songs) has been growing. At the end of April, subscription revenue was about 15 per cent and is growing at more than 100 per cent per annum.

But more than 50 per cent of total revenue is paid for song rights and the more people that listen to music through Pandora, the higher this royalty grows. Pandora has an agreement with SoundExchange for its streaming rights that expires in 2015. Between now and 2015, the rates Pandora pays are expected to go up by 37 per cent for songs streamed by free listeners, and by 47 per cent for songs streamed by paid subscribers. In addition to these fees, Pandora has deals with BMI and SESAC to pay 1.75 per cent and 0.38 per cent of gross revenue respectively. In order to become profitable, Pandora will need revenue per user to go up. And it will need a new deal with the music labels.

The share price is now below $16.

Bubbles? This Time is Different!

Ok. Enough of the fundamentals, no one is paying attention to those anyway. From what I have been reading there are many experts who are saying… what exactly? That this time is different!

Those who believe this time is different to the tech boom of the late 90’s point out that 90’s technology companies never generated profits or even revenue. Pandora however has a revenue model, and it’s rare to see today’s tech IPO without one. Effectively the ‘experts’ are suggesting the tech stocks listing today are more mature. Some investors and analysts even brushed off red flags like Renren revising down its user and user growth numbers just before its float, saying China is still the biggest internet market in the world and its rapid growth will continue. They suggest that figures reported by Chinese companies should be used for directional guidance, rather than as quantitative truths.

And that’s pretty much their argument.

My team and I have the ability to analyse every single listed company, globally (and the indices on which they are based), with fundamental data that is updated daily (very soon you will have the opportunity to use our extraordinary A1 service for every Australian company too, so don’t be tempted by all those end of financial year special offers).

Our intrinsic value analysis for the companies described above, and many of their more mature peers in the US and elsewhere, reveals gullible investors are once again being taken for a whimsical ride accompanied by a flagrant disregard for value.

Bubbles can go a long time before popping, and given that bubbles are best identified by credit excesses, not solely valuation excesses, we may be only in the very early stages of the bubble in technology stocks (but very close to the bubble bursting in US TBonds).

Your thoughts?

Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 19 June 2011.

Posted in A1, Company Valuation, Financials, Floats, Insightful Insights, Value Investing, Value.able

14 Comments Leave a Comment

…You can’t touch this?

“Yet you do not know about what may happen tomorrow. What is the nature of your life? You are but a wisp of vapor that is visible for a little while and then disappears“. James 4:14

“Suddenly a mist fell from my eyes and I knew the way I had to take.” Edvard Grieg

“Fog and smog should not be confused and are easily separated by color.” Chuck Jones

With apologies to 90’s rapper M.C Hammer, today I plan to lift the lid, ever so slightly, on a misconception about the value of tangible assets. I’ll throw in a few Value.able intrinsic valuations for you too.

Were you as fascinated recently, as I was, to read Harvey Norman suggesting that the price premium to book value of JB Hi-Fi compared to that of itself was unjustified? The company pointed out – and allow me to paraphrase – that the market capitalisation of JB Hi-Fi ($1.9 billion) against just $365 million of book value is high, when Harvey Norman’s market capitalisation is $2.7 billion and its book value is expected to be $2.2 billion at the end of this financial year.

The attachment to physical assets held by many is not unusual, nor is the belief that intangible assets are akin to a puff of smoke. Premiums to book value however are justified when that ‘book’ generates above average rates of return. And it is assets of the intangible variety – the economic goodwill (rather than the accounting variety) – that are more valuable anyway. Physical assets can be replaced, imitated and replicated. Any competitor (with deep enough pockets) can purchase almost all of them. Ultimately, any unusual returns these generate will be competed away as competitors secure the same machines, tools, equipment etc. Many in the printing game experience this phenomenon. A new machine gives them a marginal advantage only for as long as it takes their competitor to make the same investment.

Assets of an intangible nature are less easily copied and so high rates of return can be sustained longer, and are therefore worth more.

A company’s book value is the net worth of its assets. Book value is made up of both tangible assets and intangible assets. Tangible assets are physical and financial and include property, plant & equipment, inventory, cash, receivables and investments. Intangible assets aren’t physical or financial and may include trademarks, franchises and patents.

To demonstrate the difference in value between intangible and tangible, have a look at Google;  That company’s market capitalisation is US$165.5 billion and yet its book value is just US$48.6 billion. Its price to book value is 3.42 times. JB Hi-Fi’s price to book value is 5.2 times and Harvey Norman’s is 1.22 times. But Google’s ‘book’ generates returns of 19.16%, JB Hi-Fi; 41.5% and Harvey Norman; 11.6%. There is indeed a relationship between the price premium to ‘book’ and the profitability of that ‘book’ (‘ROE’). A business is worth much more than its net tangible assets when it produces profits well in excess of market-wide rates of return.

I wrote about the capital intensity of airlines in Value.able (re-read Pages  60-63, 122, 164, 172-3), so you should know my thoughts about this already (You can also read any of these articles and transcripts for a refresher: Taking-off or crash-landing?, Qantas cuts costs to stay in profit, Qantas cuts staff, flights to counter fuel price hit and Flights reduced, jobs cut at Qantas).

When it comes to physical assets, less is more. For a business to double sales and profits, there is frequently the requirement to increase the level of physical assets. The higher the proportion of physical assets compared to sales that are required, the less cash flow available to the owner. This is the antithesis of the intangible-heavy business that continually produces profits without the need to spend money on maintenance, upgrades or replacements.

Let me demonstrate with an admittedly rudimentary example. Take two companies Rich Pty Limited and Poor Pty Limited. Both companies earn a profit of $100,000. Rich Pty Limited has net assets of $1 million. Intangible assets, such as patents and a brand, represent six hundred thousand dollars while physical assets, including machinery running at full capacity and inventory, represent $400,000. Poor Pty Limited also has a net worth of $1 million, but this time the intangible/intangible mix is reversed and eight hundred thousand dollars represents tangible assets and $200,000 is intangible.

Rich P/L is earning $100,000 from tangible assets of $400,000 and Poor P/L is earning $100,000 from tangible assets of $800,000.

If both companies sought to double earnings, they may also have to double their investment in tangible assets. Rich P/L would have to invest another $400,000 to increase earnings by $100,000. Poor P/L would have to spend another $800,000.

For many investors a large proportion of physical assets – also reflected in a high NTA – is seen as a solid backstop in the event something catastrophic should befall a company. I would suggest that the opposite may just be true. A high level of physical assets may be a drag on your returns.

Physical assets are only worth more if they can generate a higher rate of earnings. Any hope that they are worth more than their book value is based on the ability to sell them for more, and that, in turn, is dependent on either finding a ‘sucker’ to buy them or a buyer who can generate a much higher return and therefore justify the higher price.

With these ideas in mind, its worth looking at a list of companies that further investigation may show have very high levels of tangible assets compared to their profits. Let’s also throw in those companies that have highly valued intangible assets too. If they are generating low returns on these, the auditors should arguably take a knife to their stated ‘book’ values.

Starting with those companies whose market captitalisation is more than $1 billion (156), I then ranked them by return on equity (return on book value) in ascending order. 49 (31 per cent) companies generate returns less than your bank term deposit. The 16 largest (based on market capitalisation) companies with low ROE, possibly indicating either high levels of tangible assets or possibly overstated intangible assets carried on the balance sheet, are:

I have excluded resource companies. For while there are plenty that qualify, their returns are dependent on commodity prices.

Something to remember about the Quality & Performance Rating…

Rated A1 to A5, B1 to B5 and C1 to C5, every listed company is rated based on a series of over 30 discrete metrics, measured at both a point in time and over time. Most importantly, the Quality and Performance Rating is applied without any subjectivity. All companies are judged according to the metrics they generate. A1s have the lowest probability of a liquidation event. “Lowest probability” however doesn’t mean a liquidity event won’t occur. It just means far fewer A1s will have a liquidity event imposed on them compared to C5s. A liquidity event includes a capital raising, debt default or renegotiation, administration, receivership etc. An A1 company could of course raise capital if it needs to fast track construction of a new factory. MCE is an example of a high quality company whose cash flow has needed supplementation for this reason. Sticking to A1s and avoiding C5s should, over time, produce better returns. I demonstrate in the following chart:

The above chart shows the performance of a portfolio of the 20 biggest companies listed on the ASX rated ‘A1′. The red line is the poor old ASX 200.

There is merit with sticking to A1s (just as those who like the taste of Coca-Cola don’t settle for Pepsi). My team and I are fine-tuning something that will make the identification of A1s extraordinarily simple. So ignore those ‘Beat-the-tax-man’ pre-June 30 ‘special’ offers from various investing experts and other ‘helpers’. Avoid the temptation of an extra one, two or three month ‘subscription’, a show bag full of tips, a free magazine, DVD, or even a set of free steak knives.Wait for an A1 opportunity instead. Your patience will be rewarded.

Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 13 June 2011.

Posted in Airlines, Company Valuation, Insightful Insights, Value.able

80 Comments Leave a Comment

Is The Price Now Right?

There’s a lot in this post. So sit back and relax. Put up your feet, pull down the blinds and get comfortable.

Billionaire Oilman J. Paul Getty famously advised; “Buy when everyone is Selling and Hold until everyone is Buying”. Knowing what price to pay most certainly helps to enhance returns in the long run.

An investor without the knowledge to estimate Value.able intrinsic valuations is surely blind to the opportunities presented by a sea of red ink. Without it, one cannot see beyond today. And without intrinsic values one sees only falling prices and fears further declines – frozen in the spotlight of a market collapse.

Even though they told themselves they would buy if prices dropped, now they can’t. Tomorrow, they reassure themselves, will be a better day.

Focus instead on business quality. Seek out those whose prospects are bright and whose Value.able intrinsic values you expect to rise 10, 15, 20 per cent over the years. Identify those whose returns on equity puts your term deposit to shame and whose balance sheet can survive the next GFC, should it occur.

With the downturn in the US’s business cycle triggering fears of recession, I would like to share with you a list. It’s not a list of A1s, and it’s not a list of all companies trading at prices less than they’re ‘worth’.

It is instead a Value.able watchlist of companies that achieve some of our higher quality and performance ratings – A2 or B1 (I shared a list of A1s here a couple of weeks ago) and includes CSL, Data#3, David Jones, Decmil, Mortgage Choice, Oakton, Saunders International, Treasury Group, West Australian Newspapers, Wridgways Australia, Austin Engineering, Myer and Woolworths.

Each business reported return on equity greater than 20 per cent last year and may or may not be demonstrating a safety margin. Some have a track record of extraordinary performance; whilst others, well, won’t (p.s. that’s a clue)

Your Long Weekend Study Guide

The watchlist forms part of your Value.able education. Like the Insights blog itself, it is for educational purposes only. If you haven’t reviewed Value.able lately, I encourage you to spend some time over the long weekend (between periods of relaxation of course) reviewing Part Two – Identifying Extraordinary Businesses, then research your answers to the following questions for each company.

1. Extraordinary prospects: Does the future look bright? Or, if you don’t believe the future will be as extraordinary as the past, why not?

2. Competitive Advantage: What sets this business apart from its competitors?

3. Debt/Equity: How has management managed capital? What is the evidence?

4. Cashflow: Track record of cash flow? Use my quick back-of-the-envelope calculation to asses the true cash power of the business.

5. Which three are going straight to the top of your Value.able watchlist, and why?

Lets build a body of ideas under this post that adds value. If you complete the questions for one or all the companies listed, or if you have identified another company you would like included, go ahead and add it in. Please try and keep your comments under this post consistent with the above, five-part format.

And if all that seems like too much work, keep calm. My team and I are fine-tuning something that will knock your value investing socks off.

Those who have already had a private screening don’t want to be without it, and some Graduates are happy to pre-pay for it, sight unseen!

So ignore those ‘Beat-the-tax-man’ pre-June 30 ‘special’ offers from various investing experts and other ‘helpers’. Avoid the temptation of an extra one, two or three month ‘subscription’, a show bag full of tips, a free magazine, DVD, or even a set of free steak knives.

Wait for an A1 opportunity instead. Your patience will be rewarded.

If you like the taste of Coca Cola, you don’t settle for Pepsi. Even if Pepsi throws in more – an extra 300ml, an extra can or bottle, or even a free holiday – it’s just not the real thing.

Nothing matches what we are putting the finishing touches on for you.

We have been told it is the ‘next-generation’. Actually, its five generations ahead of anything else we have seen. It is A1, it is world leading with global plans and soon it could be yours.

So save your pennies because it won’t be discounted and we won’t need to fill a show bag full of other stuff to convince you.

If Value.able is the menu, then our next-generation A1 is the entire fine-dining kitchen.

Value.able Graduates will be offered first priority, followed by the loyal Facebook community.

So if you haven’t yet ordered your copy of Value.able, now is not the time to procrastinate. Remember, Value.able Graduates will be offered first priority.

Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 9 June 2011.

Posted in Company Valuation, Value.able

130 Comments Leave a Comment

Have you submitted your photograph to the Value.able Graduate Album?

Jesse, Michael, Young Les, Justin, Matt, Rad, John, Ron, Young Max, Gary, Dan’s mum, Gary, George, Steven, JohnM, Paul, Steven and Sophie, Michael, Alya, Martin, Bernie, Amit, RBS Morgans Gosford, Jim Rogers, Daniel, Keith, Gavin, Graeme, Nick, Gelato Messina, Chris, Rodger, Phil, Vikki, Mark, Hien, Kenneth, Greg, Peter, Bernie, Paul, John, Bill, Bryan, Di and Lesley, Craig, Scotty, Chris, Main Amigo Stan, Charles, Fred, David, Mark, Collin, Nevada Cody and Winston, Peter, John, Nathan, Mal, John, Tony, Les, William Grant, Greg, Mike, Paul, Roger, Mike, David, Paul, Sinaway, Anders, Frank, Jake, Johan, Mark, Rob, Ian, Joan, Claude, Toni, Richard, Matt Jnr, Indrash, Sara, Garry, Jonathan, Ganesh, James, Kevin, Jim, Peter, Greg, Stuart, Craig, Eric, Robert, Ermin, Mike, Syed, Wilma, John, Alf, Tony, Phillip, Robyn, James, Carolyn, Roy, Peter, Jack, Kevin, Howard, Leo, Jonathan, Carole, Eileen, James, John, Martin, Ordan, Warren, Andrew, Liz, Jim, Anthony, Bob, Douglas, Christine, Frank, Martyn, Michael, John, Dave, Peter, Darrell, Jeffrey, David, Joof, Tom, Leigh, Mervin, Paul M, Paul K, Noel, Bob, George, Leigh, Bob, Steve, Monica, Richard, Frank, Brett, Steven, Colin, Wayne, Joanne, Dan, Garry, Lin, Judi, Allan, Stephen, Garth, John, Joab, Phillip, Kevin, John, Robert, Tweety and Bert, Peter, Mike, Patrick, Eugene, Brian, Harold, Russell, Brad, Rajest, Tim, Gemma, William, Bill, Robert, Geoff, Gary, Emily, Kent, Lucas, Neil, Peter, Rowley, Jason, Simon, Charles, Russell, Grahame, Lester, David, John, Richard, Mitra, John, Dave, Peter, Geoff, Paul, Derek and Rod have already submitted their photographs for inclusion in the Graduate album. My team – Russell, Vanessa, Rachel and Chris, will add theirs shortly.

Have you emailed yours?

We plan to frame the album and hang it at the entrance of our office, next to another invaluable piece – Stay Calm and Carry On.

Posted by Roger Montgomery and his A1 team, fund managers and Value.able Graduates, 9 June 2011.

Posted in A1, Insightful Insights, Value Investing, Value.able

13 Comments Leave a Comment

Is it time to sell?

If you take your cues from price rather than values, fear may have recently set in. For Value.able investors, a market correction is a reason for celebration rather than consternation. Roger Montgomery explains why holding on may be the wiser decision. Read Roger’s article

Posted in Media Room, Off the Press, Value.able

29 Comments Leave a Comment

Where to next?

You may have noticed my recent posts are not filled with stock ideas. Don’t worry. The drought will end, once the market resumes serving up mouthwatering opportunities

For many businesses, Australia may not seem like the ‘lucky country’ right now. A litany of evidence suggests the economy is cool. Recent bank results reveal credit growth is slowing, if not stalling. Significantly fewer homes are being put to auction and of those that are, clearance rates are not inspiring.

Australia’s savings rate has risen and thanks to rising fuel costs and utility bills, we haven’t got as much to spend as we used to. Then there’s the prospect of rising interest rates. I wonder, given all anecdotal evidence of weakness, whether an interest rate cut would be more justified?

Some of Australia’s ‘blue chips’ have reported weakness or downgrades. Seven West Media reported a softer advertising market, which has also affected Fairfax and APN. OneSteel cited a strong Aussie dollar, as did BlueScope. And you can almost guarantee food manufacturers are going to complain about higher commodity input prices.

Indeed higher input prices, combined with pressure on consumers to pay more for daily essentials – gas, electricity and petrol – means many companies have lost their ability to pass on rising costs. Naturally, this leads me to think that this is precisely the combination of influences that will reveal which companies have a true competitive advantage?

The Value.able community has spent a great of time exploring, discussing and naming competitive advantages – retailers, Apple, your insights. The current economic headwind will reveal who actually has one.

Take a look at the companies in your portfolio. Can they pass on rising costs in the form of higher prices, without a detrimental impact on unit sales? Can they grab market share from competitors whose margins are slimmer, by cutting prices? Is your portfolio overflowing with A1 businesses, or are there some C5s in there that may struggle through post-reporting season?

Now despite current pressures, which of course you must refrain from believing is permanent (and indeed cease focusing on), analysts haven’t brought down their earnings expectations.

Macquarie’s equity analysts are forecasting aggregate profit growth of 19 per cent and according to JP Morgan, non-resource companies are expected to grow profits by 13 per cent this year. These growth rates are a significant revision down from 6 months ago. Are more downgrades to come? Thirteen to nineteen per cent does seem more appropriate for a rosier economic environment…

Lower profits have a real impact on intrinsic values. For companies generating attractive rates of return on equity (at last count, 187 listed on the ASX generate a ROE greater than 20 per cent. Of those 103 are A1/A2), lower profits reduce the quantum of that return, as well as the amount of retained earnings and therefore the rate of growth in equity. All of those changes are negative. If Ben Graham was right and in the long run, price does follow value, that means either lower prices or prices that cannot justifiably rise much more.  And this is where Value.able Graduates’ attention should be focused, not on the bailout of Greece or Portugal.

What does this all mean?

I don’t have a crystal ball, so I simply don’t know where the market is headed. Thankfully it isn’t a brake on market-beating returns.

What I do know, is that of approximately 1849 listed entities, 1175 made no money last year. Of the remainder, 56 are A1s and of those, just 13 are trading at a discount to our estimate of intrinsic value. Six are trading at a discount of more than 20 per cent and of those six, The Montgomery [Private] Fund owns two. We have been decidedly slothful in buying and, as a result, while the market has been falling, the Fund’s value hasn’t.

Steven wrote on my Facebook page yesterday “Who cares? this market is… only ugly!” It’s only natural to want to throw up your hands in dismay, but this is where the rubber hist the road – Keep Calm and Carry On Value.able graduates. Look for extraordinary businesses at prices far less than they’re worth.

Just under 11 per cent of The Montgomery [Private] Fund is invested in extraordinary businesses. Even with 89 per cent of the Fund in cash, we are outperforming the S&P ASX/200 Industrials Accumulation Index by 5.29 per cent since inception.

My team and I continue to be inspired by the 1939 poster in which England advised its citizens to “Keep Calm and Carry On”.

Low prices should not bring consternation, but salivation. As sure as the sun rises, low prices for A1 companies will not be permanent.

Beating the market does not mean positive performance every week, every month or even every year. I have no doubt that some investments I will make for myself and the clients we work for will not perform as expected. Not every A1 at a discount will prove spectacular. We can however mitigate some of the risks of course. Sticking to a diversified basket of the highest quality companies (A1s perhaps?) purchased at big discounts to intrinsic value, won’t prevent the market value of the portfolio declining in the short term, but it can help to generate an early, eventual and more satisfying recovery.

With a falling market (and falling prices for A1 companies too) the daggers will come out, so also be prepared for those of weak resolve. They may try to discredit our Value.able way of investing.

A contest isn’t won by watching the score board, looking in the rear view mirror or mimicking those with a demonstrated track record of success. You have to play. And play your own game. Over long periods of time, sticking to good quality A1 companies works. Given that returns are dependent on the price you pay, lower prices (and greater value) works even better!

The issue of course is not the reliability of the Value.able approach, but the patience required to execute it. Remember the ‘fat pitch’?  Irrespective of the turmoil that impacts markets, we must Keep Calm and Carry On.

So what do you think? Where do you think the market is headed? What are the factors you are watching? Have you picked up something in your research that you’d like to share? Go for it!

Posted by Roger Montgomery, author and fund manager, 18 May 2011.

Posted in Company Valuation, Insightful Insights, Market Valuation, Value Investing, Value.able

370 Comments Leave a Comment

What new business has caught Roger Montgomery’s Value.able eye?

Roger Montgomery and Ross Greenwood talk about the Federal budget and the legalities of the compulsory acquisition of shares in a takeover situation. Roger also shares his thoughts about the tidal wave of new floats. Has a new business caught Roger’s Value.able eye? Listen to podcast.

Posted in Media Room, Podcasts, Value.able

3 Comments Leave a Comment

Can relationships be the foundation of business?

Back on March 10 here at my Insights blog I pieced together a little jigsaw puzzle that served as a warning to Value.able Graduates researching Carsales.com.au:

“…Relationships it seems, matter. And so they should.

“In the end, it is not cars, boats and planes that bring joy, but the quality of the relationships you develop.

“This week (commencing 7 March 2011) I read that Carsales.com.au had been sold out of Nine Entertainment Co, the rebadged PBL Media (which is owned by CVC Asia Pacific).

“Reading Terry [McCrann's] article caused a rumour I heard last year to become louder in my mind.

“The rumour was that a group of customers of Carsales.com.au (ASX:CRZ, MQR:A1, Value.able Margin of Safety; -24%) were thinking of leaving to start a rival that would be funded by News. You could understand News’ interest, given it is losing the online automotive classifieds race to Drive (Fairfax) and Carsales.

“If this is true, and if Terry is also on the mark with the intimacy of the relationships amongst Australia’s media barons, both individual and corporate (excluding Fairfax), then it would be reasonable to assume that the status quo should be maintained until after Carsales had been spun out of the former PBL, finding itself completely owned by institutions and private investors.

“Now that hurdle is out of the way, let’s see if Carsales does lose any major customers.”

That was the crux of my 10 March blog post – that Carsales’ biggest customers were about to leave to start a rival with Newscorp.

Just 2 months have passed and if you didn’t already know, guess what? Splitsville.

The Carsguide brand, owned by News Limited and a consortium of foundation dealers that includes Automotive Holdings Group Limited, A.P Eagers Group and Trivett, plus a few other dealerships representing a quarter of Australia’s car dealers, will hop into bed together in a joint venture and share Carsguide’s revenue.

Chairman and chief executive of News Limited John Hartigan told one journo, “We will be investing in the new company, doubling the number of staff and throwing our combined resources and expertise behind the joint venture, with the intent of aggressively growing the business.”

Please refrain from posting any banter as comments, just your highest quality thoughts and experiences investing in online businesses. How have you faired investing in online businesses?

Posted by Roger Montgomery, author and fund manager, 13 May 2011.

Posted in Insightful Insights, Retail, Takeovers, Value.able

37 Comments Leave a Comment

Is it time to clean up your portfolio?

Stuart sent me an email yesterday that provides some insight into what investors are experiencing right now.

Stuart wrote “…each time the level at which I would like to sell has seemingly been within short striking distance, somewhere around the world there has been an earthquake, tsunami, nuclear meltdown, Eurozone bailout, currency fluctuation, credit downgrade, flood, famine, pestilence, war or some other extraneous event – that spooks the markets and triggers another backslide in the portfolio valuation. The investment headwinds just don’t seem to be letting up…”

I hear you [Stuart], but what is anyone doing about it? Many investors hold verrucose portfolios of A5/B4/B5/all ‘C’ MQR companies, waiting for the price to rise back to some psychologically relevant level – their purchase price, for example.

But the market does not recognise such nostalgia. By holding onto stramineous stocks, you not only miss out on hoped-for gains. You also miss out on the gains from companies you could otherwise own – an opportunity cost! At best, the existing portfolio thus produces occultation, if not obfuscation. What are you doing this weekend? Re-reading Value.able?

When I was young, I spent time on the land fox hunting, under the tutelage of my friend’s father. I remember I had a tough time pulling the trigger. John and Ray explained to me that a single feral cat can devour more than a 100 lizards, birds and native mice in a week. The destruction wrought on native fauna by the fox is not dissimilar.

John and Ray then explained; don’t think of the fox you are aiming at, think of the many thousands of other animals you are saving. It’s a harsh reality and surprisingly, it applies to your share portfolio.

Don’t think about a perfect exit from the rubbish in your portfolio. Think about the extraordinary companies you could own if you no longer held the rubbish. The best time to clean your portfolio is always ‘now’.

What would you prefer? A portfolio of A1 businesses whose value is forecast to rise from $170.00 today to $211.39 in 2013 (yielding $8.98 this year, rising to $12.41 in 2013)? Or a portfolio of so-called ‘blue chips’ whose value has decreased 30 per cent over the past ten years and is forecast to increase just five per cent over the next three?

Take a look at the following chart. It’s the A1 Index from January 2009 to today. The constituents are the 20 biggest A1’s listed on the ASX by market capitalisation. The red line is the poor old ASX 200. As you can see, there is genuine merit to sticking with quality.

So who are A1s?  It’s been a while since I last published a list of A1s with conservative valuations… Go and research the companies in this list, then return and share your comments with our Value.able community.

* MIN 2012 valuation substantially higher ($9.78). 2011 is low here because of the capital raising’s impact on ROE that year.

What makes Matrix Composite, Nick Scali, JB Hi-Fi, Oroton, ARB Corp., Centrebet, DWS Advanced, Mineral Resources, Platinum Asset Management, M2 Telecommunications, Monadelphous, Wotif, Fleetwood, GUD Holdings, REA Group, Thorn Group, Carsales.com, Blackmores, Cochlear and Reckon extraordinary?

Re-read Part Two of Value.able then come back and share your insights. Go right ahead and share whatever you know or think, but only about the companies in the  above list.

Just as your portfolios need a clean out, so does my Insights blog.

Please refrain from posting any banter as comments on this post. Just your highest quality thoughts only.

1) Please keep your comments to the format below and we will build a useful library of insights.

2) Do not post any questions to me or other bloggers at this post.

Here’s the format to follow:

COMPANY NAME

Insights: If you work in the industry or have before, or perhaps you work for one of the companies or a competitor. Do you have a special or unique insight. ONLY comment if your insights are of the genuine industry variety.

Extraordinary prospects: Why does the future look bright for this business? Or if you don’t believe the future will be as extraordinary as the past, why not?

Competitive Advantage: What sets this business apart from its competitors? Don’t debate other’s comments, just post your own thoughts without reference to others.

Debt: How has management managed capital? What is your evidence?

Cashflow: Track record of cash flow?

The Value.able community, Graduates and I look forward to reading your insights.

Posted by Roger Montgomery, author and fund manager, 11 May 2011.

Posted in A1, Insightful Insights, Value Investing, Value.able

62 Comments Leave a Comment

Are we in bubble territory?

Less than an hour ago, Microsoft Corp. agreed to buy the Internet telephone company Skype SA for $8.5 billion. The company was started by Niklas Zennstrom (who remained CEO until September 2007) and Janus Friis (one of Time Magazine’s 100 Most Influential People 2006) in 2002 and they sold it to eBay in 2005 for $3.1 billion.

eBay bought Skype in 2005 for $3.1 billion and sold 70% to private equity for $2 billion in late 2009. Up until yesterday, it was owned by private equity, the Canadian Pension Plan Investment Board and eBay. Now Microsoft is buying the company for three times what private equity paid —an increase in value of more than $5.5 billion in about 18 months. Skype’s original founders also ended up in the syndicate through their company Joltid.

It is the biggest deal in Microsoft’s history. Some of that 36-year history includes a friendship between former CEO Bill Gates and Warren Buffett. One wonders if Warren was consulted because the initial metrics are staggering. Some may argue the high price is because Microsoft was competing against an imminent IPO. With more than $50 billion in cash (much held offshore for tax purposes), Microsoft merely needs to beat the aggregate cash return, which in the US is somewhere just north of zero.

Skype’s ‘customers’ made 207 billion minutes of voice and video calls last year – up 150% on 18 months ago. Most of those calls however are free. Less than 9 million customers per month, or a little more than five percent, paid Skype anything.

The company did produce revenue of $860 million last year, but Skype lost $7 million. $8.5 billion is quite staggering. I think Skype is great and I know many who use it to avoid paying anyone for phone and video calls.

You may recall Microsoft has previously bid $47.5 billion for Yahoo Inc. Yahoo rejected Microsoft’s advances and Microsft dodged a bullet; Yahoo is now available at half the price.

Perhaps we are not in bubble territory? Perhaps it all works out? Perhaps its just a repeat of Foster’s purchase of Southcorp – on a much grander scale? Or perhaps Microsoft will start charging everyone for a call? A charge of 1 cent per minute – and no loss of customers – would be worth $2.07 billion in revenue… What percentage of Skype’s free riders do you think would submit credit cards etc. to subscribe and be willing to be charged?

Posted by Roger Montgomery, Value.able author and fund manager, 11 May 2011.

Posted in Company Valuation, Insightful Insights, Market Valuation, Takeovers, Value Investing, Value.able

55 Comments Leave a Comment

Are Australian CEOs asleep at the wheel?

Have Australia’s lauded CEO’s earned a good reputation when it comes to the impact of their bigger-is-better ambitions on the shareholders for whom they work?

According to Richard Puntillo; “in theory, publicly traded corporations have shareholders as their kings, boards of directors as the sword-wielding knights who protect the shareholders and managers as the vassals who carry out orders. In practice, in the past decade, managers have become kings who lavish gold upon themselves, boards of directors have become fawning courtiers who take coin in return for an uncritical yes-man function and shareholders have become peasants whose property may be seized at management’s whim.”

When a listed company announces an acquisition, commerciality is often cited as the reason for failure to disclose the purchase price. But with Australia’s corporate graveyard littered with the writedowns of overpriced acquisitions past, it is about time companies treated their shareholders like kings.

I have long advocated the idea that companies should retain profits and reinvest them, provided they can achieve high rates of return on equity. The result? Much higher returns  – indeed returns that ultimately match the rate of return on equity being achieved by the company. But the rather worse-than-patchy record of Australian Merger & Acquisitions (M&A) in creating shareholder value, gives shareholders plenty of ammunition in their calls for companies to ‘hand the money back’.

Here’s a couple of examples…

Where, MQR: Montgomery Quality Rating; Value.able IV: Value.able Intrinsic Value; Today: Value.able Intrinsic Value as at today (5 May 2011); Ten Year IV Change: Ten year change in Value.able Intrinsic Value.

Foster’s

MQR: C5; Value.able IV 2001: $2.99;  Today: $3.50; Ten Year IV Change: 1.6%p.a.

Foster’s Share Price 2001 $5.71; Today: $5.51

Last week, Foster’s shareholders voted to spin off the company’s wine business. After buying Southcorp for $3.1 billion in 2005 (my valuation using the steps in Value.able was closer to $2.30 per share than the $4.17 Foster’s paid) Foster’s rejected a $2 billion private equity bid for its wine business, saying it “significantly undervalues” the Treasury Wine Estates.

When they bought Southcorp the execs were lyrical in their praise. Trevor O’Hoy said “The combination of our two great companies will create the world’s leading premium wine company”.

If you came to me to buy Southcorp in 2005, the year after it earned just $46 million in profit (the same profit as it earned ten years earlier by the way) and you wanted a margin of safety, I would advise that the right price to pay for Southcorp would be less than 65 cents. Try it yourself – plug 5% return on equity, $1.17 of equity per share and a payout ratio of just over 60 per cent into the Value.able formula. In 2005, when you came to me, the share price was $4.20 and using the price as a reference point, you would have thought I was crazy. The $3.5 billion in writedowns however since then, suggests it is the ‘too-cheap’ price for a copy of Value.able that is crazy!

PaperlinX

MQR: B2; Value.able IV 2001: $2.29; Today: $0.17; Ten Year IV Change: -23%p.a.

PaperlinX Share Price 2001: $4.93; Today: $0.28

On 9 September 2003, PaperlinX announced that it had purchased Buhrmann Paper for $1.1 billion. In June of that year Paperlinx’s share price was $3.77.

At the time, Ian Wightwick, Managing Director of PaperlinX said, “It is very pleasing that the hard work put in by our team undertaking due diligence has confirmed our initial view of the quality of Buhrmann’s Paper Merchanting Division business, its people and its assets. This business has great potential, and we are confident that the acquisition will deliver strong earnings per share growth for our shareholders.”

Ten days after the announcement the share price had shot up to $4.93. My Value.able Intrinsic Value estimation suggests it fell from $2.50 to $1.82! Nine hundred million was borrowed that calendar year and $150 million of capital was raised, to fund the acquisition.

For the year prior to the acquisition, PaperlinX earned $147 million. Since then profits have generally declined every year, and in 2009 PaperlinX lost $197 million and another $29 million in 2010. The share price has fallen from $4.93 to 28 cents today. Worse, there were 447.9 million shares on issue in 2003 and now there are almost 50% more.

AMP

MQR: A3;  Value.able IV 2001: $4.01; Today: $3.97; Ten Year IV Change: 0%p.a

AMP (adjusted) Share Price 2001: $13.90; Today: $5.29

AMP launched a cash and scrip bid for AXA Asia Pacific in late 2010. Under the deal with AXA’s French parent, AMP paid more than $4 billion for AXA Asia Pacific’s New Zealand and Australian businesses. The deal valued the entire AXA company at $13.3 billion, but the Value.able intrinsic value of AXA is significantly lower.

AMP bid about $5.40 per share. And just like Southcorp shareholders, AXA shareholders wanted a higher bid. Well of course they did, and as I have said previously, I would rather receive a few million more for my house too. But AXA’s performance doesn’t justify it.

AMP’s chief executive Craig Dunn said that the deal would create an effective competitor to the big four banks and makes AMP the biggest player in all segments of Australia’s $1.2 trillion wealth management sector with 20 per cent market share.

In a bout of déjà vu (reminiscent of PaperlinX), AMP’s shares rallied after the deal was announced.

According to analyst estimates at the time, AXA would generate a return on equity of about 13 percent over the next two years. With the exception of the 2008 loss, the return on equity for the last ten years has ranged between 6.8% in 1999 and 27% in 2003. Based on the forecast ROE and a payout ratio of between 61% and 67%, AXA’s 2010 equity of $2.58 per share is worth a little more than $3.00 per share. At the time of the bid, AXA’s shares traded at $5.84.

When Oxiana and Zinifex merged to form OZ Minerals, the market capitalisation of the two individually amounted to almost $10 billion. Today the merged entity has a market cap of $4.6 billion.

The above examples are not rare. With more space, we could go through many, many more.

Overpaying for assets is not a characteristic unique to ‘mum and dad’ investors. CEOs in Australia have a long and proud history of burning shareholders’ funds to fuel their bigger-is-better ambitions. PaperlinX, Fairfax, Foster’s – the past list of companies and their CEOs that have overpaid for assets, driven down their returns on equity and made the Value.able value of intangible goodwill carried on the balance sheet look absurd, is long.

Nothing gets the blood racing more than a takeover and when blood leaves the head for other regions, common sense usually follows. You should be on your guard when your company announces an acquisition.

Posted by Roger Montgomery, author and fund manager, 3 May 2011.

Posted in Value.able

112 Comments Leave a Comment

How do your Easter holiday homework results compare?

Your Easter holiday homework was published mid morning on Thursday 14 April. Two hours later Andrew correctly completed the cash flow component – well done Andrew.

Many Graduates have posted comments here (and sent even more emails to me) asking why Telstra made the cut. Then there’s Aristocrat with all that debt, Fortescue’s recent capital raisings, The Reject Shop’s declining Return on Equity, Coca-Cola’s dwindling competitive advantage…

I’m passing the mic to Rob, a member of the Value.able Post-Graduate elite:

“Roger usually gives us homework which contains a mix of stocks. As he said he used his discretion to come up with 14. He also said 
“This homework is not about finding cheap stocks – it is about understanding businesses, return on equity, debt, cashflow and identifying extraordinary prospects”.
The only way for us to achieve this is to look at some B3s such as Telstra, and as Andrew said early the odd “basket case”.
Working through the good and bad can be eye opening but you do need to examine all the stocks to compare how they fair according to the criteria mentioned in the above quote.”

And from Chris B:

“It has been my opinion for a while that it is kind of hard (and almost pointless) trying to assign an estimated value on a business unless you have done a lot of research about the business in question first…”

Leon was the first Value.able Graduate to post his answers, quite late in the evening on April 15. Whilst Leon’s valuations don’t match my calculations exactly, they are close. Remember your primary aim is to buy extraordinary A1 businesses at BIG discounts to your estimate of their Value.able intrinsic value. A difference of twenty cents is neither here nor there if the business is worth $8 and you can buy shares for $5!

The Results

Assignment One: Calculate the 2010 Value.able intrinsic value and 2011 forecast Value.able intrinsic value – download the results

Assignment Two: Re-read Value.able Chapter 9 on Cashflow (from page 152) and analyse the cashflow of each company using the balance sheet method – download the results

Here are Andrew’s insights on the Cashflow homework:

“Based on a simple look, Retail Food group has the best cash position of the three followed by the reject shop and then loads of daylight and then Aristocrat.

However on further digging for RFG I can see that the 85,852 worth of borrowings are now a current liability and therefore will be due in the next 12 months. They do not appear to have the assets or the cash generating abilities to service this and will therefore probably need to raise capital in some form.

Aristocrat is a basket case where cash flow was declining and borrowings rising. Doesn’t take a genius to see what is going to happen here. ROE might be high but it is debt fueled. Kind of get the feeling that Aristocrat is about as lucrative as gambling on one of their machines in the pub.

Therefore the last one standing and my pick of the three overall is actually the reject shop. It is generating positive cashflow and should be able to adequately meet its future needs.

Thank you to all who participated and if your answers where close… well done! It is vital that you continue to practice your technique. With repetition you’ll get to the point where you can simply ‘eye-ball’ Value.able intrinsic value.

Before I sign off, I would like to officially welcome Alex, Yong-Chuan, Matty, Leon, Andrew, Geoff, Justin, Peter and Margaret to the Value.able Graduate Class of 2011. If I have omitted your name, please accept my apologies. I am delighted to welcome you as a Graduate. Please send your photo with Value.able to roger@rogermontgomery.com for inclusion in the 2011 album.

For those wondering, the woman screaming in fright was looking at the stock market on Friday!

Posted by Roger Montgomery, author and fund manager, 3 May 2011.

Posted in A1, Company Valuation, Insightful Insights, Value Investing, Value.able

172 Comments Leave a Comment

What did Ben Graham get right?

If you are new to our Value.able community, Ben Graham’s concepts may be foreign to you. Ben is the author of Security Analysis. He is regarded as the father of security analysis and the intellectual Dean of Wall Street.

I support Ben’s revered status and what he has to say on the subject of investing, but perhaps controversially, I also believe that, had he access to a computer that allowed him to properly test his ideas, he may not have reached all of the same conclusions.

It is exactly one year since I first penned some of my thoughts about Ben Graham on this blog here: http://blog.rogermontgomery.com/should-a-value-investor-imitate-ben-graham/

There are many things that Ben said that not only make sense, but has also made significant contributions to investment thinking. Indeed they have become seminal investment principles.  These are the things to which Value.able investors should hold firm.

Ben Graham authored the Mr Market allegory and also coined the three most important words in value investing: Margin of Safety. In fact Ben said this:  ”Confronted with the challenge to distill the secret of sound investment into three words, I venture the motto: Margin of Safety”

These are two concepts that value investors hold dear and which have, in many different ways, become a formal part of our Value.able investing framework.

Mr. Market is of course a fictitious character, created by Ben to demonstrate the bipolar nature of the stock market.

Here is an excerpt from a speech made by Warren Buffett about Ben Graham on the subject:

“You should imagine market quotations as coming from a remarkably accommodating fellow named Mr Market who is your partner in a private business. Without fail, Mr Market appears daily and names a price at which he will either buy your interest or sell you his.

“Even though the business that the two of you own may have economic characteristics that are stable, Mr Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains…

“Mr Market has another endearing characteristic: He doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow.

Transactions are strictly at your option…But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr Market is there to serve you, not to guide you.

“It is his pocketbook, not his wisdom that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence.”

If you have read Value.able you will understand Margin of Safety, know exactly what a suitable Margin of Safety is and also how to apply it to Australian stocks.

Despite the high profile of these two enduring lessons, I believe there is a third observation of Graham’s, which is equally important. Fascinatingly, with the benefit of computers, I can also demonstrate that Graham was spot on.

Graham was paraphrased by Buffett in 1993 thus:

“In the short run the market is a voting machine – reflecting a voter-registration test that requires only money, not intelligence or emotional stability – but in the long run, the market is a weighing machine”

What Graham described is something that, as both a private and professional investor, I have observed myself; in the short term the market is a popularity contest – prices often diverge significantly from that which is justified by the economic performance of the business. But in the long-term,prices eventually converge with intrinsic values, which themselves follow business performance.

Have a look at the amazing chart below.

(c) Copyright 2011 Roger Montgomery

Its Qantas (ASX:QAN, MQR: B3, MOS-44%):  – its my ten-year history of price and intrinsic value (and three year forecast of intrinsic value which updates daily). Now right click on the chart and open it in a new tab. Zoom in. Now stand back from your computer screen. What do you see?

First you will notice two intrinsic values – a range is produced. Next you might notice that there have been short term bouts of both optimism and despondency and this is reflected in the short term share price changes.  The final observation you might make and which the charts make most powerfully, is that since 2001, the intrinsic value of Qantas, which is based on its economic performance has, at best, not changed. Look closer and you will notice that the intrinsic value of Qantas today (2011) is lower than it was a decade ago. Even by 2013, intrinsic value is not forecast to be materially different from that of 2002.

Just as Ben Graham predicted, the long-term weighing machine has correctly appraised Qantas’ worth. Unsurprisingly, the share price today of Australia’s most recognised airline, is also lower than it was a decade ago.  And unbelievably, the total market capitalisation of Qantas today is less than the money that has been ‘left in’ and ‘put in’ by shareholders over the last ten years!

These charts aren’t just easy or nice to look at, they are incredibly powerful.  If you can calculate intrinsic values for every listed company, you can turn the stock market off and simply pay attention to those values.  Then, during those times that the market is doing something irrational, you can take advantage of it or ignore it, just as Ben Graham advised.

Unless you can see a reason for a permanent change in the prospects of Qantas, the long-term trend in intrinsic value gives you all the information you need to steer well clear of this B3 business.

Now have a look at the second chart.  What does it tell you?

(c) Copyright 2011 Roger Montgomery

There have been short-term episodes of price buoyancy, but over the long run the weighing machine has done its work. The intrinsic value has not changed in ten years so, over time, the share price has once again reflected the company’s worth and gradually but perpetually fallen until it reaches intrinsic value.  This is my ten-year historical price and intrinsic value chart (and three year forecast) for Telstra (ASX:TLS, MQR: B3, MOS:-32%).

What about an extraordinary A1 business?

Sally Macdonald joined Oroton (ASX:OTN, MQR: A1, MOS:-17%) as CEO in 2005/06. Observe the strong correlation between price and value since Sally’s appointment.

(c) Copyright 2011 Roger Montgomery

I acknowledge that there are critics of the approach to intrinsic value we Value.able Graduates follow. But like me, you should be delighted there are.  Indeed, we should be encouraging departure from this approach!

The critics are necessary. Not only do they help refine your ideas, but without them, how else would we be able to buy Matrix at $3.50, Forge at $2.60, Vocus at $1.60 or Zicom at $0.32! And how else would we be able to navigate around and away from Nufarm or iSoft, and not fall into the trap of buying Telstra at $3.60 because the ‘experts’ said it had an attractive dividend yield? If it was universal agreement I was after, I would just keep writing about airlines.

The Value.able approach works. If you have been visiting the blog for a while, you will know this only too well.

The above charts (automatically updated daily – and I have one for every, single, listed company) confirms what Ben Graham had discovered without the power of modern computing; In the short run the market is indeed a voting machine, and will always reflect what is popular, but in the long run the market is a weighing machine, and price will reflect intrinsic value.

If you concentrate on long-term intrinsic values and avoid the seduction of short-term prices, I cannot see how, over a long period of time, you cannot help but improve your investing.

…And in case you are wondering about the link between Ben Graham and the photograph of Comanche Indian ‘White Wolf’… the photo of White Wolf was taken in 1894 – the year Ben Graham was born.

HOMEWORK RESULTS: I will publish the holiday results homework on Monday. Thank you to all who participated. It is vital what you continue to practice your technique. With repetition you’ll get to the point where you can simply ‘eye-ball’ Value.able intrinsic value.

Posted by Roger Montgomery, author and fund manager, 29 April 2011.

Posted in Company Valuation, Insightful Insights, Retail, Telecommunications, Value Investing, Value.able

317 Comments Leave a Comment

How should investors read a prospectus?

I read recently that Kerry Stokes didn’t understand his company’s prospectus. What hope do retail investors have?

Kerry’s revelation emphasises the need for ASIC to intervene and make prospectus documents clear and concise. Last Thursday evening I shared my thoughts with Peter on Switzer TV. If you kept your copy of the Myer prospectus, watch the interview then flick past the first 28 pages of glamorous photography to the Pro Forma balance sheet.

What Value.able IPOs have you uncovered recently?

Posted by Roger Montgomery, author and fund manager, 28 April 2011.

Posted in Floats, Value.able

79 Comments Leave a Comment

Who asked for Easter holiday homework?

My team tell me that this year’s combination of Easter and Anzac Day has produced a once-in-a-lifetime succession of public holidays. I have encouraged them to use the time wisely – practicing Value.able intrinsic value calculations. In addition to spending precious time with family and friends, I encourage you to do the same.

We have an extraordinarily generous community of Value.able Graduates here at the blog and on my Facebook page.  Special thanks to Ashley, Kent B, Lloyd, Rob, Matt R, Steve, Andrew, Gavin, Ken, William (Bill), Greg, John M, Ron, Joab (whom we will miss dearly – please keep in touch), Jonesy, Brad, Ann, O’Reilly, James, Trav, Omar, Michael, Costas, Emily and Anthony.  If I have left anyone out please let me know. Thank you for sharing your wisdom with our community!  I am sure there are many others who are delighted to help recent Graduates.

Before I reveal your Easter homework, here are a couple of links you may find helpful:

Webinar – I guide you, step-by-step, through a valuation

Data sources – The Value.able community’s guide to finding the data you need to calculate your own valuations.

Now to the homework…

I began with 1847 businesses and removed the 1168 that didn’t make any money last year (put $0 into the Value.able formula and you will get $0 out). That cut out 63 per cent of the Australian market… a useful first filter.

Then I applied the following criteria;

1) ROE > 20 per cent: (Chapter 6 – The ABC of Return on Equity)

2) Debt/Equity Ratio < 50 per cent: (Chapter 8 – Debt Is Not Always Good)

And then I refined the list further as follows;

3) 2011 forecast Earnings and Dividends are available: (Chapter 5 – Pick Extraordinary Prospects)

4) Must achieve one of the following Montgomery Quality Rating (MQR) – A1, A2, A3, B1, B2, B3: (Part Two – Identifying Extraordinary Businesses)

That left 255 stocks as the subject of your holiday homework. Using my discretion, I reduced the list to 14: The Reject Shop (ASX:TRS/MQR:A2), West Australian Newspapers (ASX:WAN/MQR:A2), Computershare (ASX:CPU/MQR:A2), Mermaid Marine (ASX:MRM/MQR:A3), Flexigroup Limited (ASX:FXL/MQR:A3), Cedar Woods Properties (ASX:CWP/MQR:A3), SAI Global Limited (ASX:SAI/MQR:B2), Fortescue Metals Group (ASX:FMG/ MQR:B2), Coca-Cola Amatil Limited (ASX:ASX:CCL/ MQR:B2), Retail Food Group (ASX:RFG/ MQR:B3), Telstra (ASX:TLS/ MQR:B3), McMillian Shakesphere (ASX:MMS/ MQR:B3), Bradken Limited (ASX:BKN/ MQR:B3) and Aristocrat Leisure Limited (ASX:ALL/ MQR:B3).

This homework is not about finding cheap stocks – it is about understanding businesses, return on equity, debt, cashflow and identifying extraordinary prospects. Effort calculating intrinsic value should only be exerted once you’re satisfied the business is extraordinary.

If you are keep to improve your investing with some useful examples, your holiday homework is as follows:

1. Download the 2011 Easter holiday homework worksheet – click here.

2. Calculate the 2010 Value.able intrinsic value and 2011 forecast Value.able intrinsic value (populate into the worksheet)

3. Then answer the following questions and perform the following tasks:

A. Of the 14 companies, list those demonstrating a rising value over the next twelve months.

B. The stocks of which companies, if any, are offering a margin of safety?

Important things to note:

  • For consistency, use 10% Required Return
  • 2011 Forecast Earnings Per Share and Dividends Per Share numbers are included in the Easter holiday homework spreadsheet. Use these numbers.
  • You will have to get the 2010 ending equity (which is also the 2011 Beginning equity – from the annual reports)

If you need some guidance about how to calculate future valuations you can also read this post.

For those seeking a real challenge, re-read Value.able Chapter 9 on Cashflow (from page 152) and analyse the cashflow of each company using the balance sheet method. Click here to download the Cash Flow homework worksheet. At Montgomery Investment Management we only invest in businesses with strong cash flow. I will produce the cash flow analysis for The Reject Shop (TRS), Retail Food Group (RFG) and Aristocrat Leisure (ALL) after Easter.

My team and I wish you a happy Easter. I really do hope you have an enjoyable and rewarding break and that you enjoy the tasks I have set for you. I look forward to reviewing your results after the break.

Posted by Roger Montgomery, author and fund manager, 14 April 2011.

Posted in A1, Company Valuation, Insightful Insights, Value Investing, Value.able

403 Comments Leave a Comment

10,000 Comments and Counting

Early this month we hit a milestone worth celebrating.  Thanks to your incredible interest in the value investing approach advocated and discussed here we hit 10,000 comments.

Thank you for your interest, your passion and your generosity. It is amazing and I cannot be more proud of the incredibly diverse directions you have all headed with the new found knowledge from Value.able.

Thank you also for your encouragement and taking the time to share with me just how much you have been impacted by Value.able. My team and I are delighted to hear your amazing stories of investing success.

Speaking of stories, here is one of my recent favourites. It’s from Craig, a Graduate from the Value.able Class of 2010. It’s the story of Eddie and his bike…

Twelve year old Eddie has a paper round.

He bought a bike for $10,000 (its a bloody good bike) and earns $1,000 a year, after all expenses (new tyres, chewing gum) and tax (there’s no tax as the bloke who owns the newsagency pays him cash).

Eddie’s happy, but he wants a new playstation, so he offers a 50% share in his operation to family members.

His brother’s keen but the $10 he gets for mowing the front lawn (the backyard is fake grass) means he doesn’t have the money.

His teenage sister is keen but she’s running up huge mobile phone bills which accounts for all of her pay from McDonald’s.

His old girl’s keen but she just bought a new Apple product, so she’s got no money to spare.

His old man however, has squirreled away $5,000 by doing some overtime at work, and had been shopping around for somewhere to put it to work. ING are offering 8% (this is 2013), so the old man says to Eddie: “Look son, I can get 8% at the bank.”

“You can get 10% with me dad, if you hand over that 5 grand.”

“Yeah but you might want to do something else one day, or your bike could need replacing, or you could – god forbid son – have an accident. With all that risk involved, I wan’t 12.5%, so I’ll give you $4,000 for me half share.”

“Four large? You’re killing me dad. Don’t you know banks can go broke?”
“Not in this country son. I want 12.5%.”

“There’ll be another GFC, you wait, but people will still want the paper delivered.”

At that point, the boy’s mother approaches, holding her new iPad.

The husband looks at her, then back to his son: “Make it $2,500… I want 20%.”

What is your funny or amazing Value.able story?

Go ahead, Share, Encourage and Inspire. And thank you for helping so many investors value the best stocks and buy them for less than they are worth!

Did you contribute your photo to the Value.able Graduate Class of 2010? The Class of 2011 is open and accepting Graduates. Email your photo and join Bernie, Martin, Alya and Jim Rogers.

Posted by Roger Montgomery, author and fund manager, 13 April 2011.

Posted in Insightful Insights, Value Investing, Value.able

40 Comments Leave a Comment

Is Oroton Australia’s best retailer?

Oroton, JB Hi-Fi, The Reject Shop, Woolworths, Nick Scali, Cash Converters. If you have seen me on Sky Business or visited my YouTube channel recently, these names will be familiar. David Jones, Country Road, Harvey Norman, Myer, Super Retail Group (think Super Cheap Auto), Strathfield Group (Strathfield Car Radios), Noni B and Kathmandu also spring to mind, albeit for different reasons.

As a business, retailers are relatively easy to understand. The best managers are easy to spot (think Oroton’s Sally MacDonald) and it is also easy to separate the businesses with earnings power from those without (compare JB Hi-Fi and Harvey Norman).

But generally speaking even the best retailers may not be companies you want to hold forever. Why? Because they quickly reach saturation and so must constantly reinvent themselves.

Barriers to entry are low. There are always new concepts with young, intelligent and energetic entrepreneurs eager to develop a new brand and offering. Big red SALE signs are replacing mannequins as permanent window fixtures in Australian shop fronts, driving down revenue and margins. And for those who choose to defend brand value, sales revenue is also often sacrificed.

Then there’s the twin-speed economy, a string of natural disasters, soaring oil prices, growing personal savings, higher interest rates, Australia’s small population and one that is increasingly adept at shopping online for a getter price. Hands up who wants to be a retailer?

Retailers are attractive businesses – at the right price and the right stage in their life cycle. So, in retailing, who is Australia’s good, bad and just plain ugly?

Remember, these comments are not recommendations. Conduct your own independent research and seek and take professional personal advice.

Harvey Norman
ASX:HVN, MQR: A3, MOS: -19%

A decade ago Gerry’s retail giant earned $105 million profit on $484 of equity that we put in and left in the business. That’s a return of around 19 per cent. Fast-forward to 2010 and we’ve put in another $117 million and retained an additional $1.5 billion. Despite this tripling of our commitment, however, profits have little more than doubled to $236 million. Return on equity has fallen by a third and is now about 12%. One decade of operating and the intrinsic value of Harvey Norman has barely changed. HVN is a mature business, but be warned… Harvey Norman is what JB Hi-Fi and The Reject Shop would see if they used a telescope to look forward through time.

OrotonGroup Limited
ASX:ORL, MQR: A1, MOS: -21%

Sally MacDonald is a brilliant retailer. I highly recommend watching this interview – click here. Sally took over Oroton in 2006. In just five years she has cut loss making stores and brands, sliced overheads, improved both the quality and diversity of the range. The result? Surging revenues and return on equity in 2010 of circa 85 per cent. Try getting that in a bank account or even a term deposit! Asia offers even brighter prospects for Oroton while their product offering is sufficiently attractive and appealing that the company has the ability to weather the retail storm and protect its brand.

Woolworths Limited
ASX: WOW, MQR: B1, MOS: -17%

You don’t get any bigger than Woolworths (its one of the 20 largest retailers on the planet!). It has a utility-like grip on consumers only, with earnings power that would put any utility to shame. The latter can be seen in the near 30% annualised increase in intrinsic value. Competitive position and size means suppliers and customers fund the company’s inventory. Challenges included professed legislative changes to poker machine usage (WOW is the largest owner of poker machines and any drag in revenue will have an exponential impact on profits), and the rollout of a competitor to Bunnings.

David Jones Limited
ASX: DJS, MQR: A2, MOS: -35%

A beautiful shop makes not a beautiful business. I remember when David Jones floated. Shoppers who enjoyed the ‘David Jones’ experience and were loyal to the brand bought shares with the same enthusiasm as scouring the shoe department at the Boxing Day sales. Since 2007 DJS has reduced its Net Debt/Equity ratio from 108 per cent to just under 12 per cent. We are yet to see if Paul Zahra can lead DJs with the same stewardship as former CEO Mark McInnes but as far as department stores can possibly be attractive long-term investments, DJs isn’t it.

Myer
ASX: MYR, MQR: B1, MOS: -27%

In 2009, following the release of that gleaming My Prospectus, I wrote:

“With all the relevant data to value the business now available and using the pro-forma accounts supplied in the prospectus, I value the company at between $2.67 and $2.78, substantially below the $3.90 to $4.90 being requested [by the vendors]. It appears to me that the float favours existing shareholders rather than new investors.”

My 2011 forecast value for Myer is just over $2. According to My Value.able Calculations, Myer will be worth less in 2013 than the price at which it listed in September 2010. If competitors like David Jones, Just Jeans, Kmart, Target, Big W, JB Hi-Fi, Fantastic Furniture, Captain Snooze, Sleep City, Harvey Norman, Nick Scali and Coco Republic were removed, Myer may just do alright.

Noni B
ASX: NBL, MQR: A2, MOS: -51%

Noni B’s intrinsic value is the same as when Alan Kindl floated the company in 2000 (the family retained a 40% shareholding). Return on Equity hasn’t changed either. Shares on issue however have increased 50 per cent yet profits have remained relatively unchanged.

Kathmandu Holdings Limited
ASX: KMD, MQR: A3, MOS: -56%

Sixty per cent of Kathmandu’s revenues are generated in the second half of the year. Will weather patterns continue to feed this trend? I sense premature excitement following the implementation of KMD’s newly installed intranet. The system may streamline store-to-store communications, reducing costs and creating inventory-related efficiencies for the 90-store chain, however what’s stopping a competitor replicating the same out-of-the-box system?

Fantastic Furniture
ASX: FAN, MQR: A3, MOS: -24%

Al-ways Fan-tas-tic! Once upon a time it was. Low barriers to entry are seeing online retro furniture suppliers like Milan Direct and Matt Blatt are forcing Fantastic and other traditional players to reinvent the way they display, price and stock inventory.

Billabong
ASX: BBG, MQR: A3, MOS: -49%

Billabong’s customers are highly fickle, trend conscious and anti-establishment. Like Mambo, as one of my team told me, Billabong is “so 1999 Rog”. Apparently Noosa Longboards t-shirts fall into the “cool” category, now. Groovy!

Eighty per cent of Billabong’s revenues are derived from offshore. Every one-cent rise in the Australian dollar has a half percent negative impact on net profits. Fans of the trader Jim Rogers believe the AUD could rise to USD$1.40! Then there’s the 44 stores affected by Japan’s earthquake (18 remain closed) and another three in the Christchurch earthquake.

Country Road
ASX: CTY, MQR: A3, MOS: -63%).

Like the quality of their clothing, Country Road’s MQR has been erratic. So too has its value. Debt is low however cash flow is not attractive. Very expensive.

Cash Convertors
ASX: CCV, MQR: A2, MOS: +26%.

Value.able Graduates Manny and Ray H nominated CCV as their A1 stock to watch in 2011. Whilst its not yet an A1, Cash Convertors is a niche business with bight prospects for intrinsic value growth.

Other retailers to watch

I have spoken about JB Hi-Fi, Nick Scali and The Reject Shop many times on Peter Switzer’s Switzer TV and Your Money Your Call on the Sky Business Channel. Go to youtube.com/rogerjmontgomery and type “retail”, “JBH”, “TRS” or “reject” into the Search box to watch the latest videos.

In October 2009 the RBA released the following statistics:

16 million. The number of credit cards in circulation in Australia;
$3,141. The average monthly Australian credit card account balance;
US$56,000. The average mortgage, credit card and personal loan debt of every man, woman and child in Australia;
$1.2 trillion. The total Australian mortgage, credit card and personal loan debt;
$19.189 billion. The amount spent on credit and charge cards in October 2009.

Clearly we are all shoppers… what are your experiences? Who do you see as the next king of Australia’s retail landscape?

Posted by Roger Montgomery, author and fund manager, 12 April 2011.

Posted in Company Valuation, Insightful Insights, Retail, Value Investing, Value.able

80 Comments Leave a Comment

Is that Jim Rogers’ copy of Value.able?

I’ve been following and chatting to Jim Rogers for many, many years. And, if your pockets are deep enough to ride out the inevitable bumps (“nothing goes up in a straight line Roger”), his commodity calls have been on the money.

Last night I was delighted to catch up with him again, after being invited by CBA to celebrate the first birthday of their Institutional Equities business (the invitation (picture below) read “If you were smart in 1807 you moved to London, if you were smart in 1907 you moved to New York City, and if you were smart in 2007 you moved to Asia“, Jim Rogers 2007). I was impressed by how many of my friends in the funds management industry have employed the Institutional Equities desk of CBA. They are obviously not restricting their excellent service to me!

Jim arrived and I had the opportunity to catch up before he went on to speak to the audience. For those who missed it, he remains extremely bullish on commodities and in particular Cotton, Sugar, Oil and Gold. The audience were perhaps most in agreement with a bullish view on wheat and while this wasn’t discussed, I can tell you the expansion of deserts in China and the depletion of water reserves there will cause a fundamental step-change in the world’s agricultural markets and the price of food.

But if you really want to get a sense of how bullish Jim is try this on for size: Oil = $200/barrel or more (see my January 2011 Post), Gold $2000/ounce (January 2011 Post) sometime in the next decade and the Aussie dollar? Wait for it…..US$1.40!!!!  Jim didin’t say it in so many words, but it was being whispered between the salt and pepper prawns, lime and coconut marshmallows, and for the late night revellers, a 2001 Noble One.

As you can see Jim was delighted to receive a personally dedicated copy of Value.able to read on the flight back to Singapore. I hope that he gets as much out of it as I have from his.

Posted by Roger Montgomery, author and fund manager, 8 April 2011.

Posted in Value.able

95 Comments Leave a Comment

Another warning Roger?

Last night on Peter’s Switzer TV I shared five stocks moving up the Montgomery Quality Ratings (MQR) – B3 to A3, C4 to B3, A4 to A3, C5 to A2 and A4 to A2.

There are about thirty-seven ratios that contribute to the Montgomery Quality Rating. Like the Value.able method for valuing businesses, the MQR is my own unique system of assessing the quality and performance of businesses. Its objective is to weed out those with a high risk of catastrophe and highlight those with a very low risk.

I also spoke about Zicom, a very thinly traded micro-cap that we began buying for the Fund at $0.32, up to $0.42. Yesterday Zicom closed at $0.52 – my estimate of its Value.able intrinsic value.

If you read my ValueLine column for Alan’s Eureka Report on Wednesday evening you will recognise the following warning:

A WARNING FROM ROGER MONTGOMERY: The subject of today’s column is a thinly traded microcap in which I have bought shares because it meets my criteria. It may not meet yours. It is therefore information that is general in nature and NOT a recommendation or a solicitation to deal in any security. The information is provided for educational purposes only and your personal financial circumstances have not been taken into account. That is why you must also seek and take personal professional advice before dealing in any securities. Buying shares in this company without conducting your own research is irresponsible. Buying shares in this company will drive the price up, which will benefit me more than you. The higher the price you pay the lower your return. If the share price rises well beyond my estimate of intrinsic value, I could sell my shares. A share price that rises beyond my estimate of intrinsic value is one of my triggers for selling. I have no ability to predict share prices and despite a margin of safety being estimated, the share price could halve tomorrow or worse. There are serious and significant risks in investing. Be sure to familiarise yourself with these risks before buying or selling any security. Further, my intrinsic value could change tomorrow, if new information comes to light or I simply change my view about the prospects of a company. This could be another trigger for me to sell. Value investing requires patience. You must seek and take personal professional advice and perform your own research.

I reiterated these same concerns last night with Peter (and early last year I wrote a blog post specifically about the problem).

With those warnings in mind, here are the highlights from Peter’s show.

What stocks are on your ‘Improving MQRs’ watchlist? Thank you in advance for sharing your ideas with our Value.able community.

Posted by Roger Montgomery, author and fund manager, 8 April 2010.

Posted in Company Valuation, Insightful Insights, Value Investing, Value.able

52 Comments Leave a Comment

Will David beat Goliath?

I am deviating from my regular style of post, handing over the stage to Value.able Graduate Scott T. Scott T has taken up a fight with conventional investing by tracking the performance of a typical and published ‘institutional-style’ portfolio against a portfolio of companies that receive my highest Montgomery Quality Ratings. I reckon in the long run the A1/A2 portfolio will win, but let’s not get ahead of ourselves.

Over to you Scott T…

In December 2010, a large international institution released their “Top 10 stockpicks for 2011”. Click here to read the original story.

I thought it would be interesting to compare the performance of these suggestions against an A1 and A2 Montgomery portfolio.

So I imagined this scenario…

Twin brothers in there 30’s each inherited $100,000 from their parent’s estate. One was a conservative middle manager in the public service; he had little interest in the stock market or super funds and the like, so he decided to go to an internationally renowned, well-credentialed and highly respected firm to gain specific advice. Goldman Sachs advised him of their top ten stocks for 2011, so he decided to achieve diversification by investing $10,000 in each of the ten stocks he had been told about.

His twin had a small accounting practice in a regional Queensland and was a keen stock market investor. Specifically he was a student of the Value Investing method, and liked to think of himself as a Value.able Graduate. He too thought diversification would be a suitable strategy so decided to invest $10,000 in each of 10 stocks that were A1 or A2 MQR businesses and that were selling for as big a discount to his estimate of Value.able intrinsic value as he could find.

For this 12-month exercise, running for a calendar year, we shall assume that neither brother is able to trade their position. One brother has no inclination to, and his regional twin is fully invested, and more inclined to hold long anyway.

For the companies who have declared dividends in this quarter, most are now trading ex-dividend, but only 2 or 3 have actually paid. Dividends will be picked up in Q2 and Q4 of this study.

Now after just 3 months let’s look at the how the two portfolios have performed…

Institutional Bank Top 10 Picks for 2011


Montgomery Quality Rated (MQR) A1 and A2 Companies

We will visit the brothers again in 3 months on 30/6/2011 to see how they are fairing.

All the best

Scott T

How has your Value.able portfolio performed compared to the ASX 200 All Ords?

Posted by Roger Montgomery, author and fund manager, 6 April 2011.

Posted in A1, Company Valuation, Insightful Insights, Value Investing, Value.able

94 Comments Leave a Comment

Why idolise the iPad2?

It’s an amazing story… Man creates computer. Man overcomplicates computer. Man strips back computer and creates a brand that has revolutionised the way we are entertained.

Did you know Apple has sold over 300 million iPods and iPhones over the past decade? That’s 300,000,000 products. According to the World Bank, in 2009 the world’s population stood at 6,775,235,741. The World Bank also notes that 80 per cent of the world’s population lives on less than $10 per day. Of the remainder, every 4th man, woman and child has purchased an Apple products in the last decade. Not a bad competitive advantage, (postscript: but perhaps not a sustainable one?)

Apple is also infiltrating the way we work. The Montgomery office is all Mac (and for your information, we have never had to call an IT professional to fix anything). Our iPhones are synced with our iMacs and our MacBooks synced with our iPhones.

You have heard the stories of Apple fans setting up camp on the footpath outside Apple’s flagship store on Sydney’s George Street. Australians don’t do that for coal or iron ore.

And don’t forget the accessories market. There’s no special concessions for development partners. Privately held companies that manufacture the sleeves, cases and connectivity devices that enhance our Apple experience don’t get hold of new devices until we do – on launch day.

Apple has the X-factor. Its product is unique. Its experience is unique and there is an almost religious fervour toward the brand. Competitors don’t stand a chance. The result? High, durable rates of return on equity and a rising Value.able intrinsic valuation – an A1 business.

Return on Equity is just one of dozens of metrics I uses to produce the Montgomery Quality Rating (MQR). Re-read Chapter Eleven, Step C on page 188 of Value.able for the Value.able ROE calculation.

Who is the Aussie equivalent? The Australian market may be much smaller than the US, but there are a handful of extraordinary businesses, A1 businesses. And its worth finding tem. They may not be listed yet. They may not even have launched yet…

Posted by Roger Montgomery, author and fund manager, 29 March 2011.

Postscript: The data used to calculate intrinsic value is available here: https://www.apple.com/investor/

Posted in A1, Company Valuation, Value Investing, Value.able

187 Comments Leave a Comment

Who makes your A1/A2 small cap list?

Time was a rare commodity on Peter’s show last night. Whilst I managed to list a few A1 and A2 small cap stocks that I consider make the Value.able grade, there just wasn’t time for details. So, as promised, I have put together a quick precise of two stocks (in boring businesses) I listed last night.

Remember: DO NOT rush out and buy shares in any company I discuss with Peter or any other media outlet (or here at the blog) without conducting appropriate research and seeking personal and professional advice FIRST!

These insights are not a solicitation to trade any security. I may own shares in the companies mentioned. I cannot predict share price directions – they could all fall by 80% or more after you buy. Finally, I am under no obligation to keep you updated with any change of my view, my estimate of the Value.able value of the company or my Montgomery Quality Ratings (MQRs).

Before I begin, here are the highlights from last night.

Zicom Group (ZGL)

In 2007, the first reported results after purchasing the Zicom Group, the company earned $6 million on equity of $21.6 million (ROE 27.7%).  Since then another A$8 million has been raised from owners and profits have risen to A$8 million. Return on additional capital is 25%.

In the HY11 results, the company announced a profit A$7 million. Revenue grew from $47.75 million in the previous corresponding period to $71 million. A buyback of $4 million shares occurred in the half.

Company forecasts are for a full year profit of $12.9 million, which would representing a return on equity of 18%. Growth in equity is exceeding growth in profits, however the ‘growth’ has been through retained earnings.

Zicom has four divisions; Offshore Marine Oil & Gas (43% of revenue, makes winches and ROV’s/oil rig boom to help – think winches on ships that lift ROV’s off deck and into water), Construction Equipment (39%, concrete mixers/marginally profitable & foundation equipment), Precision Engineering & Automation (14% constructs automated production lines, ink cartridges for HP, semi conductor and medical devices and associated components) and Industrial and Mobile Hydraulics (4%).

ZGL’s order book stands at $83.2 million, up from $68.9 million. Cash flow was negative $10 million, however $5 million was spent seeding two start-ups and another $5 million was spent on acquisitions ($700k of PP&E and $4 million on buying back shares).

Click here to read Roger’s latest insights on Zicom, published 6 April 2011 in Alan Kohler’s Eureka Report.

Codan Limited (CDA)

Codan Limited designs and manufactures a diversified products range for the international high-frequency radio, satellite and metal detection markets (think Minelab metal detectors).

Shares on issue are virtually unchanged from a decade ago and borrowings, which surged from $2 million in 2007 to $73 million in 2009, fell to $52 million last year and another million in the latest half year.

CDA’s 2007 profit of $11 million fell to $8 million in 2008, then rose to $24.4 million last year. The company forecasts profit of $20-$22 million in 2011 (optimistic analysts believe this figure will be higher, circa $24 million).

Since 2001, CDA’s profits have increased by 10.13 per cent per annum, from $10.268 million to $24.472 million

To generate this $14.2 million increase in profit, shareholders have put in equity of $21.859 million and left in earnings of $23.150 million (32%). The company has also borrowed $8.615 million net, in addition to the $43.483 million of debt held in 2001, resulting in current debt outstanding of $52.098 million and a net debt to equity ratio of 46.66 per cent.

Return on Equity is the best measure of economic performance, and CDA has averaged 31.02 per cent since 2001. Recently, CDA generated a return on equity of 37.94 per cent.

Finally, I also mentioned a small number of small cap stocks that are high quality and appear to be trading at a discount or close to my estimate of intrinsic value at the moment – Forger Group, ThinkSmart and Matrix Composites and Engineering. Here is my list:

Over at  facebook.com/montgomeryroger Unc Dev’s list includes Thorn Group, Reckon, Iress, Nick Scali and Fleetwood. Shuo nominated PFL and Kristian proposed FSA, SWL & RQL. Which stocks make your A1/A2 small cap list?

Posted by Roger Montgomery, author and fund manager, 25 March 2011.

Posted in A1, Company Valuation, Insightful Insights, Value.able

312 Comments Leave a Comment

When to sell? Matrix and other adventures in Value.able Investing

In August 2010 Matrix Composites & Engineering, when we first began commenting on the company, was trading around $2.90. Thirty days later the share price was at $4.48. Today MCE is trading at just over $9.00 and has a market capitalisation of more than half a billion dollars. It’s no longer just a little engineering business. Like the Perth industrial precinct of Malaga in which its headquarters are based, MCE is growing rapidly (according to Wikipedia there are currently 2409 businesses with a workforce of over 12,000 people in Malaga. The 2006 census listed only 28 people living in the suburb).

But has MCE’s share price risen beyond what the business is actually worth?

Stock market participants are very good at telling us what we should buy and when. When it comes to selling, it seems silence is the golden rule.

If you receive broker research, take out a report and turn to the very back page – the one beyond the analyst’s financial model. You will often find a table that lists every company covered by that broker’s research department. Now look to the right of each stock listed. What do you notice?

Buy… Buy… Hold… Buy… Buy… Accumulate… Hold…

What about sell?

There aren’t many companies in Australia worthy of a buy-and-hold-forever approach. And if you have invested in a company with a previous BUY recommendation, the luxury of a subsequent Ceasing Coverage announcement by the analyst is not helpful.

So then, when should you sell? It is a question I have been asked, to be honest, I can’t remember how many times. Because I have been asked so many times, it’s a question I answered in Chapter 13 of Value.able – a chapter entitled Getting Out.

Value.able Graduates will recognise a sell opportunity. Yes, it is an opportunity. Fail to sell shares and you could eventually lose money.

Of course, any selling must be conducted with a certain amount of trepidation, particularly when capital gains tax consequences are considered. But not selling simply because of tax consequences is unwise.

We pay tax on our capital gains because we make a gain. Yes, its difficult handing over part of our investment success to the Tax Man for seemingly no contribution, but without success our bank balance would remain stagnant forever.

When then should you sell? In Value.able I advocate five reasons. For now I would like to share with you a possible reason.  Based on any of the other reasons I may be selling Matrix so make sure you understand this is a review based on one of five reasons.

Eventually share prices catch up to value. In some cases it can take ten years, but in the case of Matrix, it has taken far less time for the share price to approach intrinsic value.

One signal to sell any share is when the share prices rise well above intrinsic value.

There are no hard and fast rules around this. And don’t believe you can come up with a winning approach with a simple ‘sell when 20% above intrinsic value’ approach either.

What you MUST do is look at the future prospects. In particular, is the intrinsic value rising? I believe it is for Matrix (and I am not the only fund manager who does – you could ask my mate Chris too).

Here’s some of his observations:  Risks associated with the timing of getting Matrix’s facility at Henderson up and running are mitigated by keeping Malaga open. And Malaga is producing more units now than it was only a few months ago. Matrix could also produce more units from Henderson than they have suggested (the plant is commissioned to produce 60 units per day) and I believe the cost savings will flow through much sooner than they say. Recall the company has indicated Henderson could save circa $13 million in labour, rent and transport costs (see below analyst comment). Excess build costs are now largely spent and if the company can ramp up to 70 units a day, HY12 revenue could double.

Why do I believe this? Because a recent site visit for analysts suggested it. As one analyst told me: “Production of macrospheres has started from Henderson with 7 of the 22 tumblers in operation. This is a good example of the labour savings to come as it’s now a largely automated process – there were only 3 people working v >20 on this process at Malaga.”

(Post Script:  My own visit to WA at the weekend revealed a company capable of producing just over 100 units per day – Henderson + Malaga)  Moreover, the sad events unfolding in Japan will force a rethink on Nuclear.  If nuclear energy – recently hailed as a green solution to global warming – reverts to being a relic of an old world order, demand for oil will increase.  Oil prices will rise.  Deep sea drilling will be on everyone’s radar even more so.

And the risks?  Well, one is pricing pressure from competitors. This is something that needs to be discussed with management, but preferably with customers!

Some Value.able Graduates may be reluctant to place too much emphasis on future valuations. Indeed I insist on a discount to current valuations. If it is your view that future valuations should be ignored, then you should sell.

Personally I believe one of my most important contributions to the principles of value investing is the idea of future valuations. Nobody was talking about them at the time I started mentioning 2011 and 2012 Value.able valuations and rates of growth. They are important because we want to buy businesses with bright prospects. And a company whose intrinsic value is rising “at a good clip” demonstrates those bright prospects.

If you have more faith and conviction that the business will be more valuable in one, two and three years time, you may be willing to hold on. On the basis of this ONE reason I am currently not rushing to sell Matrix (of course I may sell based on any of the other four reasons), however notwithstanding a change to our view (or one of the other four criteria for selling being met) I do hope for much lower prices (buy shares like you buy groceries…)

I cannot, and will not, tell you to sell or buy Matrix and I might ‘cease coverage’ at any time. As I have said many times here, do not use my comments to buy or sell shares. Do your own research and seek and take personal professional advice.

What I do want to encourage you to do is delve deeply into the company’s history, its management, their capabilities, recent announcements and any other valuable information you can acquire.

And in the spirit demonstrated by so many Value.able Graduates, feel free to share your findings here and build the value for all investors.

When the market values a company much more highly than its performance would warrant, it is time to reconsider your investment. Looking into the prospects for a business and its intrinsic value can help making premature decisions. Premature selling can have a very costly impact on portfolio performance not only because the share price may continue rising for a long time, but also because finding another cheap A1 to replace the one you have sold, is so difficult. At all times remember that my view could change tomorrow and I may not have time to report back here so do your own research and form your own opinions. Also keep in mind that we do not bet the farm on any one stock so even if MCE were to lose money for us (and we will get a few wrong) we won’t lose a lot.

Posted by Roger Montgomery, author and fund manager, 18 March 2011.

Posted in A1, Company Valuation, Resources, Value Investing, Value.able

294 Comments Leave a Comment

Are relationships more important than cars?

In last weekend’s Weekend Australian, Terry McCrann wrote an excellent piece explaining the possible nature and motivations behind the relationship between Murdoch, Stokes and Packer. ‘Hiatus after Packer’s bombshell’ was both enlightening and entertaining. I quote:

“From the day Stokes seized control of the West Australian Newspapers boardroom three years ago, it was always a case of when, not if, he would move to join it with his Seven Network.

“There was the sheer irresistibility of the gains to be extracted from such a me…There was also the requirement to provide an exit to … the KKR private equity group…There was also the need, and indeed opportunity, to solve a couple of Stokes’ tax issues…It also preserves liquidity in the enlarged WAN-Seven, which becomes the premier listed media vehicle in Australia. That will enable KKR to be taken out in due course and, when it does, further cement the stock’s appeal…”

“It also highlights – and partly explains – a missing piece in the Stokes media set. The merger doesn’t bring together all of the Stokes media interests.

“Left out is the Stokes holding company’s 23 per cent stake in – what do you know – Packer’s Consolidated Media Holdings. And it has linkages into the Packer partnership with Rupert Murdoch’s News Corporation in Foxtel and Foxtel Sports.

“Its absence could be explained by the complication it would have brought to the merger proposal. Also, its inclusion would have given Stokes more shares in the merged entity. That would have rendered the new company less tax and investment efficient.

“But it’s an absence that raises the question of whether there is a Stokes shuffle part deux – or trois if you count the Seven-WesTrac deal. And that brings Packer and his partnership with the other Murdoch, Lachlan, back into the building.

“He walked out of the Ten boardroom because Lachlan poached budding TV star James Warburton from Stokes’ Seven to be chief executive of Ten. In the most public, and indeed shocking, way Packer signaled his disagreement with that, and to Stokes that it was not his doing.”

Relationships it seems, matter. And so they should.

In the end, it is not cars, boats and planes that bring joy, but the quality of the relationships you develop.

This week I read that Carsales.com.au had been sold out of Nine Entertainment Co, the rebadged PBL Media (which is owned by CVC Asia Pacific).

Reading Terry’s article caused a rumour I heard last year to become louder in my mind. The rumour was that a group of customers of Carsales.com.au (ASX:CRZ, MQR:A1, Value.able Margin of Safety; -24%) were thinking of leaving to start a rival that would be funded by News. You could understand News’ interest, given it is losing the online automotive classifieds race to Drive (Fairfax) and Carsales.

If this is true, and if Terry is also on the mark with the intimacy of the relationships amongst Australia’s media barons, both individual and corporate (excluding Fairfax), then it would be reasonable to assume that the status quo should be maintained until after Carsales had been spun out of the former PBL, finding itself completely owned by institutions and private investors.

Now that hurdle is out of the way, let’s see if Carsales does lose any major customers.

Posted by Roger Montgomery, author and fund manager, 10 March 2011.

Posted in A1, Company Valuation, Media, Value.able

95 Comments Leave a Comment

How has my Switzer Christmas Stocking Selection performed?

On the last show of 2010, Peter Switzer asked me to list six of my A1 businesses that, at the time, were displaying the largest margins of safety. Tonight Peter has invited me to join him once again to review how those six A1s have performed (and chat about Telstra’s result no doubt). Tune into the Sky Business Channel (602) from 7pm (Sydney time).

Here’s the article/transcript from that appearance.

Click here to watch the latest interview and discover how my A1 picks performed.

A1 stocks are the cream of the crop, but how do you know which stocks measure up? To find out, Roger Montgomery joins Peter Switzer on his Sky News Business Channel program – SWITZER.

Montgomery explains he classes companies from A1 down to C5.

“A1 is a business, I think, that has the absolute lowest probability of what I call a liquidity event – the lowest chance of having to raise capital, the lowest chance of needing to borrow more money, the lowest chance of defaulting on any debt that it has, breaching a banking covenant or a debt covenant, the lowest chance of needing money or going bust,” he says.

Montgomery says he’s interested in consistency of performance – A1s that he think will be A1 in the next 12 months.

“I’m looking for the companies that have been consistently A1s or A2s over a longer period of time,” he says. “They’re the ones that I think are most likely to be next year as well.”

Montgomery stresses that it’s important to diversify and get professional advice.

“Make sure you don’t bet the farm on any one company,” he says. “That’s why you need personal professional advice, because you’ve got to make sure that you’re doing the right thing for you and everybody has different risk tolerances.”

Montgomery’s A1 stocks

Platinum Asset Management – he says this is an “obvious A1 – a great performer, has no need for debt, pays all of its cash out.” The company is trading at about its intrinsic value, so it’s not a bargain, but it’s good quality. The intrinsic value is expected to rise around 14 per cent over three years.

Cochlear – “It’s been an A1 for years,” he says adding that its current share price is not cheap enough. Its intrinsic value is expected to rise around 13 per cent over the next three years.

Blackmores – “Expensive at the moment,” he says. “The intrinsic value is only expected to rise about five per cent over the next three years.”

Real Estate.com – “It’s expensive again – it’s trading at about 15 per cent above its intrinsic value.” The intrinsic value is expected to rise 15 per cent in a year. Its intrinsic value is forecast to rise by about 15 per cent a year. “In a year’s time, its intrinsic value will be its current price.”

M2 Telecommunications – This company is trading at a 10 per cent premium to its intrinsic value, Montgomery says. “It’s not cheap, but its intrinsic value is forecast to rise by eleven and a half per cent.”

Mineral Resources – This is a mining services business and is trading around its intrinsic value. The intrinsic values are forecast to increase by around 30 per cent a year over the next three years – “So that’s not bad.”

DWS Advanced – Montgomery says this IT services business is trading at a three per cent discount to intrinsic value and its intrinsic value is expected to rise by about 13 per cent.

Centrebet – Montgomery explains that people tell him there’s not many competitive advantages with the company because barriers to entry to the industry are low. “The owners of the licenses for these things would say they disagree – barriers to entry are quite high,” he says. Centrebet is at a six per cent discount to intrinsic value and it’s forecast to rise around five per cent a year, Montgomery says.

ARB – “Trading at about 11 per cent discount to its intrinsic value. Forecast intrinsic value is going to rise by about three-and-a-half per cent,” he says.

Oroton – “There’s been some talk about the CEO selling shares. The issue is I’ve bought shares from CEOs and founders who’ve sold shares and the share price has gone up a lot since then. I’ve also seen situations where the CEO has sold and that’s been the best time to have sold.”

Montgomery says there hasn’t been research to show CEOs selling shares indicated anything, but there has been research to suggest CEOs buying shares may indicate something. Oroton is trading at a 13 per cent discount to intrinsic value and is expected to rise 13 per cent per annum.

Companies trading at premiums to their intrinsic value

Reckon

Thorn Group

GUD Holdings

Fleetwood

Wotif

Monadelphous

The intrinsic value on these companies are rising anywhere from six per cent to around 17 per cent per year over the next three years, Montgomery says.

Montgomery says it’s important to do further research on the companies – “you can’t just go out and buy them – some of them, as I’ve pointed out, are expensive, so I wouldn’t be buying them. Some of them are A1s but that doesn’t mean that they’re amazing businesses and they’re the best businesses to buy. They’re the least chance of having a liquidity event.”

Companies trading at discount to intrinsic value

Montgomery explains he isn’t predicting share price; he’s valuing the company.

“Valuing a company is different to predicting where the share price is going to go”.

In descending order – biggest discount to smallest discount:

Matrix

Composite and Engineering

Nick Scali

JB Hi-Fi

Oroton

ARB

Centrebet

DWS

“We’ll come back in the New Year, we’ll have a look at how the index has gone, and we’ll have a look at how that little group of companies has performed.”

Important information: This content has been prepared by www.switzer.com.au without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek and take appropriate professional advice.

Posted by Roger Montgomery, author and fund manager, 10 February 2010.

Posted in Insightful Insights, Value Investing, Value.able

112 Comments Leave a Comment

Will your portfolio repeat its 2011 performance?

If you are new to my stock market Insights blog, welcome. And to the Value.able community, thank you for your many comments and encouraging words. It gives me great encouragement and motivates me to hear how your investing and returns have improved as a result of reading Value.able and the collection of comments posted by Graduates here at my blog. Thank you also for spreading the word and purchasing additional copies for family and friends.

Taking a look back over the stocks we discussed last year, it appears the Value.able approach to investing in the highest quality businesses, with a true margin of safety, has been doing quite well.

In addition to the blog, I also wrote about many of the stocks that achieve an A1 Montgomery Quality Rating (MQG) in my Value.able stocks for Money magazine over the last six months of 2010.

The stocks are listed in the table below. The column titled ‘Gain’ demonstrates you can do well without exposing yourself to lots of risk – for example the risk that is inherent in speculative stocks.

The returns exclude the dividends received, which would obviously boost results materially. The correct comparison therefore is the All Ords price index rather than the All Ordinaries Accumulation Index. Since 30 June 2010 the All Ordinaries has risen 12%. That is a stark contrast to many of the returns produced by the high quality businesses listed above.

The returns stand even higher above the Index when the selection is ranked by those that I regarded as offering the greatest margin of safety at the time the stock was mentioned: Oroton (up 37.5%), ARB Corporation (up 29.8%), JB Hi-Fi (bought and then sold the next month (up 5%), Monadelphous, Forge, Decmil and Matrix (up 44%, up 59%, up 35%, and up 37% respectively). The average, six month, price-only return of these businesses is 34.8%. And some of these A1 businesses, a margin of safety still exists.

If you are new to value investing you will, when searching around, find many commentators, portfolio managers and investors who may disparage value investing generally. They may question the method of calculating intrinsic value or even dismiss the valuations produced, but quite seriously, the proof is in the eating. And the returns offered have been nothing short of mouth watering.

But six months is NOT enough to hang your hat on, as Tony and Adam recently pointed out on my Facebook page. So if you have been an investor in any of these companies, following a conversation with your adviser of course, remember that the change in price over a year or two shouldn’t excite or concern you. It’s the change ahead in the Value.able intrinsic value of the company that matters.

If you haven’t already purchased your copy of Value.able, I commend it to you. It will change the way you think about investing in the stock market for the better, and as the many independent comments elsewhere here on the blog can attest, it may also materially improve your results. Value.able is available exclusively at www.rogermontgomery.com

Posted Roger Montgomery, author and fund manager, 2 February 2011.

Posted in A1, Company Valuation, Insightful Insights, Value Investing, Value.able

173 Comments Leave a Comment

After some extra help with your holiday homework?

Happy new year! I trust you had a safe, peaceful and Happy Christmas.

To the Value.able Graduates, thank you for sharing your knowledge and taking the time to help the Undergrads with their holiday homework.

If you are seeking a little extra guidance, this Masterclass video I recorded for Alan’s Eureka Report may just do the trick. Think of it as Value.able’s Chapter 11, Steps A-D and Steps 1-4, live.

If you have not already secured your copy of Value.able and want to kick 2011 off the Value.able way, go to www.RogerMontgomery.com. The First Edition sold out in just 14 weeks and with so many private and professional investors now buying multiple copies for friends and family, the Second Edition is set to sell out just as quickly. Don’t waste another minute!

Posted by Roger Montgomery, 6 January 2011.

Posted in Company Valuation, Value Investing, Value.able

87 Comments Leave a Comment

Thank you and Happy Christmas

I am delighted that, in 2010, so many investors have found Value.able useful. Many Graduates have said the Value.able approach to investing is at once easy to understand and rational. And according to John, Scott, Brian, Peter, Andy, Martin and Steve’s feedback, Value.able!

Merry Christmas Roger!

And a big thankyou for writing your book.

It never ceases to amaze me just how few professional investors actually stick to a winning investment formula. I recently reviewed the portfolio holdings of many well known Australian Equity managed funds available through a major online broker and could not find one “leading” fund manager that only invested in stocks that would come anywhere near to passing the MQR (Montgomery Quality Rating) test. Virtually all major funds hold stocks that are low ROE, highly capital intensive and debt laden. Unfortunately, I was not surprised to see that many of these funds holding large positions in non-investment grade stocks proudly highlight their 5 star ratings from asset consultants.

Have a well-earned break and may 2011 be an in-value.able year for you and yours,

Warmest regards,
John
Merry Christmas everybody!

And to you Mr Montgomery, a massive thank you.

Thanks to your wonderful book, and your insightful and thought provoking articles, posts and appearances. My SMSF has had the best year ever (that’s with 10 years of history).

In a lack lustre sideways market I was able to pinpoint and cut out the dead wood from previous poor decisions, and focus on quality businesses trading at a big discount to IV.

The difference in fund performance is simply startling.

Again thank you, I hope to be able to shake your hand again in 2011.

All the best
Scott T
Hi Adam & Roger,

… I’m pleased I’m getting the hang of these valuations. I’ve bought a few other A1’s also, MCE, SWL (A3) & FGE on my research following your valuation criteria Roger, as well as JBH. I’m getting rid of some rubbish (AMP,BFG,VMG,BYL) & feel confident I’m replacing them with quality shares. Thanks so much for sharing Roger, my retirement looks a little more hopeful now following the devastation of the GFC.

Brian
Hi Roger,

Thanks for writing the book and your diligence in keeping the blog up to date. You’ve made a massive contribution to my awareness and knowledge. The book has already been paid for hundreds of times over.

Cheers, Peter
Roger,

Thanks for all the great insights over the last year. I really had no idea how blindly I had been investing prior to reading your book and this blog. I’m still learning but at least I know what I should be looking at now.

Thanks again

Andy
Hi Roger,

Just wanted to thankyou for sharing your knowledge and insights with everyone, your book was amazing to say the least!!! I’ve made a return of close to 20% in less than 6 months and your Value.able book has paid itself off by more than 200 times!!! Now that is what I call ROE. I would like to wish you and your family a Merry Christmas and a happy new year. Thank you so much for an extremely valuable year, congrats and best wishes.

Regards,

Martin
Hi Roger,

I see many comments on the blog congratulating you on your book, but they don’t actually say why it is great. So I have done a book review.

Regards,

Sapporo Steve


If you have not already secured your copy of Value.able and want to kick 2011 off the Value.able way, go to www.RogerMontgomery.com. The First Edition sold out in just 14 weeks and with so many private and professional investors now buying multiple copies for friends and family, the Second Edition is set to sell out just as quickly. Don’t waste another minute!

To the Value.able Graduates, thank you for taking the time to share with me just how much you have been impacted by my book. I am delighted to hear your amazing stories of investing success and I am pleased we can sign off 2010 with such an extraordinary investment track record.

I wish you all a safe, peaceful and Happy Christmas and my sincere best wishes for 2011. I have always been enthralled by Caravaggio’s work. The Adoration was painted in 1609.

My office will close today and reopen on Monday 10 January. I will return in late January. My team will continue to publish your comments here at the blog, post new videos to my YouTube channel and reply to your emails. Most importantly, my website will continue to accept your Value.able orders and my distribution house is working through the holiday season.

Posted by Roger Montgomery, 23 December 2010

Posted in Insightful Insights, Value Investing, Value.able

43 Comments Leave a Comment

Have you done your homework?

As my last official day at the office draws near, I am delighted with the results we have achieved from combining my approach to quality (The Montgomery Quality Ratings “MQRs”) with Value.able’s method of calculating intrinsic value. There will always be conjecture and disagreement with these, but that doesn’t matter to me and it shouldn’t bother you either. The market is wide enough and deep enough to cater for us all.

I am very proud of how far you – the Value.able Graduate Class of 2010 – have come and encourage you to continue questioning and challenging the things you read and learn. It was Elbert Hubbard who said “The recipe for perpetual ignorance is: Be satisfied with your opinion and content with your knowledge.”

Some of the most memorable results of 2010 for me where the gains in Matrix, Decmil and Forge, as well as the gains in Acrux, Thorn, Fleetwood, MMS, Data#3, and Oroton. I was also delighted to have left QR National alone – missing out on an 11.8% return, but selecting MACA instead, which has produced a 70 per cent return.

Elsewhere, fund managers have reported good results. But as one Graduate noted via email, when some portfolios, filled with debt-laden, low ROE businesses, rise, it is generally a function of a rising tide rather than sound investing principles. Of course when investing the Value.able way, it matters not what anyone else is doing. All that matters is that your analysis is right and that you are consistent.

There have been plenty of questions about the Value.able valuation formula this year and perhaps even a little obsession over the source of, reason for and disagreement with the formula/tables. If that resonates with you, I urge you to re-read pages 193 and 194 and consider the following parallel; In the sport of mountain biking, some riders obsess with the weight of their bicycles. Many shop around for a ceramic or titanium rear derailleur pulley so that they might save as few as 5 grams! Paying thousands for their obsession, they fail to realise that the weight of their fettucini carbonara the night before, the water bottle they carry with them and the mud that sticks to their tyres is far greater than the savings they make and that strength, fitness, endurance and momentum are all far more important.  Don’t become too obsessed by the math when its the competitive advantage that is more important and, in any case, value slaps you in the face when it is obvious.

There are very good reasons why my valuations have differed from those you have produced, and I explain a major source of the difference on pages 193 and 194.

Far more important is that you are now carrying out your own analysis and focusing your attention on high quality companies, sustainable competitive advantages and intrinsic value. I believe you will continue to do well – as so many of you have shared with our community  - if you stick to the disciplines outlined in Value.able. And if you haven’t purchased your copy yet, do it now!

Before I leave for the annual Montgomery family holiday, I promised to give you some homework. There are three tasks with a total of two challenges. You can choose those you’d like to complete. You are under no pressure to complete them all. It is the holidays after all!

Challenge 1, Task 1

The first task is to print out the Notes to the Financial Statements: Contributed Equity for the number of shares on issue, Balance Sheet, Profit and Loss statement and Statement of Changes in Equity for The Reject Shop for 2010. Links to the statements are below:

Notes to the Financial Reports: Contributed Equity for the Number of Shares on Issue – click here

Balance Sheet – click here

Profit and Loss – click here

Statement of Change in Equity (Dividends) – click here

Using the numbers circled on each of the statements and a Required Return of 11%, try your hand at calculating The Reject Shop’s 2010 Value.able Intrinsic Value. Follow Steps A through D on page 195 of Value.able. Be sure to list your outputs for Equity per Share, Return on Equity and Payout Ratio. Click here to download my Value.able Valuation Worksheet. Ken has also provided a great list of guidelines - click here.

Challenge 1, Task 2

If you want to obtain extra marks you can have a go at also calculating the 2010 cash flow for The Reject Shop using the method I outline in Value.able on page 152.

If you haven’t purchased Value.able, don’t worry. My website will continue to accept your orders and my distribution house is working through the holiday season.

Challenge 1, Task 3

The final task involves completing one or both challenges on the Christmas Holiday Spreadsheet. The first challenge is for Value.able Undergrads. Use the worksheet to fill out the spreadsheet, then rank the companies by their Safety Margin. The spreadsheet will download automatically to your computer. When I return in late January I will publish my table and we can compare results.

Challenge 2

The second challenge is for the Value.able Graduate Class of 2010 (and any Undergrads that fancy a challenge). Your task is to calculate the historical change in intrinsic value and price over the last ten years.

Don’t worry. You don’t have to calculate ten intrinsic values, just two. Estimate the intrinsic value a decade ago (2001) and compare it to the 2011 intrinsic value. To make things a little less onerous, maintain the same RR for a company for the two years. You can then rank the five companies by their rate of change and you can use the following formula in excel if you like:

((IVn/IVn-10)^(1/10))-1

Where, IVn is Intrinsic value for 2011 and IVn-10 is Intrinsic Value for 2001 and ^(1/10) is ‘to the power of 1/10′.

I expect it will take a few weeks for you to get all the your submissions and I will consider some form of recognition for the winners.  In the meantime enjoy a peaceful and Value.able Christmas and all the very best to you and your loved ones.

Posted by Roger Montgomery, 22 December 2010

Posted in Company Valuation, Insightful Insights, Value Investing, Value.able

152 Comments Leave a Comment

Merry Christmas from the Value.able Graduate class of 2010

It is my great pleasure to present a very special tribute (thank you to my team) for the Value.able Graduate Class of 2010.

Thank you Jesse, Michael (Bali), Young Les, Michael (Aussie Battler), Matthew, Justin, Lior, John, Rad, Gary in Paris, George, Dan’s Mum, Steven & Sophie, the Master Chefs, John and Paul for sharing your Value.able journey with our community. And a second thank you to Steven for posting his Value.able 12 Days of Christmas at Facebook!

Thank you for your support this year. We have created an incredibly valuable community of investors that share sound ideas and mentor those just beginning their value investing journey.

Thanks to you – the Value.able community – 2010 year has been a year of firsts…

The First Edition of Value.able was released, went global and sold out in just 14 weeks.

Most excitingly, Value.able Graduates have applied their new skills and produced over 6,000 extraordinarily insightful comments here at the blog!

And one more thing…  for those who have requested holiday homework, my soon-to-be-released blog post will most certainly provide a challenge.

Thank you once again for joining the Value.able community. I wish you and your family a safe and peaceful Christmas and a prosperous 2011.

Posted by Roger Montgomery, 21 December 2010

Posted in Insightful Insights, Value Investing, Value.able

55 Comments Leave a Comment

What are your Twelve Stocks of Christmas?

CONTRIBUTIONS ARE NOW CLOSED.

I have an assignment for you.

Before we start, two things…

1. If you are looking for a gift that keeps on giving in 2011, give your loved ones a copy of Value.able. To guarantee your gift makes it into Santa’s sleigh, you must order before 5pm next Monday, 13 December.

2. Put Thursday 16 December @ 7pm in your diary. Sky Business has invited me to appear on their Summer Money program.

Within Summer Money, Sky is running a series called The Twelve Stocks of Christmas and I have been asked to present one of the twelve stocks. What I would like to do is let everyone on Sky Business know about you – the Value.able Graduate class of 2010!

You have been instrumental in contributing to the knowledge and awareness of value investing and I would like to say thank you by reviewing your suggestions on air.

So, what will it be? You can nominate one of the companies we have already discussed. More points can be earned by contributing a company of which you have industry-level knowledge. Think about your industry or business:

- Who is the strongest [listed] competitor in your industry?

- Who would you like to see out of business because they are an emerging threat?

- What are their competitive advantages, their opportunities for growth and why do you think they will sell more of their product or services in the future or at higher prices?

- Perhaps they are out of favour in the share market, but you believe it’s a case of a temporary set back being treated like a permanent impairment?

I encourage you all to post your contribution. There are just two rules:

1. One stock (your best pick) per Value.able Graduate. The more detailed your information, the better; and

2. Ideas must be submitted by Wednesday 15 December

Before the live show at 7pm next Thursday, 16 December, I will run my valuation eye over every suggestion and give each my Montgomery Quality Rating (MQR). But the list will be yours – a contribution from the Value.able Class of 2010.

Whilst only one stock will make it to the show, EVERY SINGLE STOCK  contributed on this post with sufficient supporting detail will be subsequently listed in my final pre-Christmas post for 2010, complete with MQRs, current valuations and prospective valuations (I have decided to called these MVEs – see below).

Embrace this opportunity to practice what you have learned over the past twelve months, and get the official Montgomery Quality Rating (MQR) and Montgomery Value Estimate (MVE) for your favourite stock. You never know, your stock may just be the one I contribute on national television to The Twelve Stocks of Christmas.

Post your suggestion here at the blog by Wednesday 15 December 2010.

I look forward to reviewing your insights and hearing what you think of your classmates’ suggestions. Simply click the Leave a Comment button below.

Posted by Roger Montgomery, 9 December 2010.

Postscript: thank you for your kind words and birthday wishes. I’m thoroughly enjoying my time away and am very much looking forward to reading and replying to your comments when I return to the office next Monday.

Postscript #2: Steven posted his own Value.able 12 Days of Christmas at my Facebook page last Friday – brilliant!

On the twelfth day of Christmas,
My independent analyst’s blog gave to me
12 A1s humming
11 valuations piping
10 C5s a-sleeping
9 forecasts prancing
8 capital raisings milking
7 floats a-sinking
6 CEOs praying
5 golden A1s!!
4 C5 turds
3 emerging bubbles,
2 editions of Value.able
And a market leader with a high ROE!

Here is Steven with his daughter Sophie.

Roger, you were good enough to sign my book…

“To Steven, Your guide to avoiding the dogs you told me you were so worried about, RM”.

Here I am reading Value.able to my little two year old Sophie at bedtime, holding her toy dogs. The moral of the story for Sophie? Roger shows dogs make fun toys and pets but must be avoided at all costs when investing in great businesses!”

Steven

Posted in A1, Company Valuation, Insightful Insights, Value Investing, Value.able

159 Comments Leave a Comment

Why aren’t you answering my comments or emails Roger?

At 7.30am this morning after inspecting a property, I found myself on the street being presented with a sealed envelope and cryptic directions to a taxi suspiciously parked just 10 metres from where I was standing.

Turns out my family thought my upcoming 40th was a pretty good reason to celebrate and surprise me! They have whisked me away for a few days, as one of mates put it, for a ‘birthday soriee’.

I am completely unprepared. My laptop sits idle on my desk and iPhone charger is still in the power point (not turned on). I have been told there is an internet café where we are staying, however I’m not certain how reliable the connection will be.

I was planning to publish a new post today: What are the twelve stocks of Christmas? Thankfully all the post requires is one final proof read and then a click on ‘Publish’. I’ll venture down to the internet café this evening.

Please keep posting your comments here at the blog and on Facebook over the next few days and I will reply upon my return. I will be back in the office on Monday 13 December

Thank you in advance for your understanding and patience.

Posted by Roger Montgomery, 8 December 2010.

Posted in Insightful Insights, Value.able

42 Comments Leave a Comment

Has 2010 been a good year for Value.able investing?

Christmas is about sharing and joyful memories. With just 18 days to go, I thought it would be educational, if not insightful, to share the performance of some of the securities Value.able Graduates have discussed here at my blog.

Does the Value.able approach to investing, as advocated some of the world’s leading investors, have merit?

First Edition Graduates may not be surprised by the results posted below. The higher quality businesses, those scoring A1 and A2 Montgomery Quality Ratings (MQRs), and those at larger discounts to intrinsic value have, in aggregate, beaten the index. Some have trounced it. And with the exception of QR National, the companies that were labeled as poor quality (C4 and C5 MQRs) and overpriced, have under-performed. Some of the maturing higher quality companies (think JB Hi-Fi) have indeed performed.

The following tables present some of the blog posts and the stocks that I have listed, mentioned or discussed in them. I have consistently suggested investigating an approach that seeks the highest quality businesses and prices that offer the biggest discounts to value.

Whilst the results are short-term (therefore nothing should be taken from them), they are nevertheless encouraging. The approach advocated in Value.able is worth investigating.

Many Value.able Graduates have suggested I start a newsletter or a stock market advice service. Thank you for the encouragement. I do enjoy the cross pollination of ideas and look forward to 2011 attracting even more investors to the patient and rational approach shared here at my blog.

Here are the tables (DO YOUR HOMEWORK AND RESEARCH. ENSURE YOU ARE COMPREHENSIVELY INFORMED. SEEK AND TAKE PERSONAL PROFESSIONAL ADVICE).

Do these three companies represent the last of good value? Oroton, JB Hi-Fi, DWS, Cogstate, Cash Converters, Slater & Gordon, ITX, Forge, Decmil and United Overseas

Which 15 companies receive my A1 status? CSL, Worley Parsons, Cochlear, Energy Resources, JB Hi-Fi, Navitas, REA Group, Carsales, Mondaelphous, Iress, Fleetwood, ARB, McMillian Shakesphere, Sirtex, Oroton.

Is Apple an A1? What A1 companies does Roger Montgomery think are the best value right now? Apple, Forge and Decmil.

Where are my valuations Roger? Cabcharge.

JBH’s years of fast growth has slowed.

What do you think of the QAN, JBH and ITX results Roger? Qantas and ITX

Telstra profits will continue to drop

Who is in front of the reporting season avalanche? Navitas, JB Hi-Fi, Cochlear and Matrix.

Part II: What else has the reporting season avalanche uncovered? Ross Human Directions, Monadelphous, Forge, Carsales, DWS, Finbar, SMS Management, CSL, Consolidated Media, Integrated Research, McMillian Shakesphere, Count Financial, Domino’s Pizza, The Reject Shop, Credit Corp, Chandler Macleod, Primary Healthcare, Slater & Gordon, Noni B, Embelton and Tamawood.

Retailing Maturity – Roger Montgomery now has reservations about JB Hi-Fi.

Part III: The avalanche is over – where should you be digging for A1s? Lycopodium, REA Group, Fleetwood, K2 Asset Management, Acrux, Hunterhall, Macquarie Radio, Blackmores, ISS Group, Thorn Group, GUD Holdings, Webjet, Kresta Holdings, Kingsgate, Fiducian and Euroz.

Foster’s turns down $2b bid.

How does cash flow through Decmil?

Part IV: Where should you focus your digging?

Will Roger Montgomery invest in QR National?

I thought the performance of Fosters after the wine bid was knocked back was interesting, but only another year or two will confirm whether the opportunity to add value was passed up. Some higher quality businesses also underperformed the market, thanks in part to deteriorating short-term prospects rather than deteriorating quality.

Remember to look for bright long-term prospects. Of course, in the short-term prospects will swing around – that is business, but longer-term prospects of businesses with true sustainable competitive advantages tend to win out.

Keep an eye on the blog before Christmas as I will be posting a couple of very handy lists (and possibly some homework) before the annual Montgomery Family Christmas break.

Posted by Roger Montgomery, 7 December 2010.

Posted in A1, Company Valuation, Insightful Insights, Value Investing, Value.able

40 Comments Leave a Comment

Is Value.able Valuable?

‘Sapporo Steve’ sent me this message in early December. He wrote:

Hi Roger,

I see many comments on the blog congratulating you on your book, but they don’t actually say why it is great. So I have done a book review. You may use any part for promotional purposes.

Regards,

Steve

Here is Steve’s Review. Is Value.able Valuable?

If you are starting out in the stockmarket there is probably no better place than at the feet of the “Oracle of Omaha” – Warren Buffett. The world’s most successful investor has for the past 50 odd years given away his advice on how to make money in the share market. One problem is that 50 years of successful investing can add up to a lot of reading. Thankfully some of Buffett’s disciples have written investment books to assist others with their forays into the sharemarket. Luckily for Australian investors, we have our very own Warren Buffett.

Many investment books often state that there is something in the book for the beginner and the advanced investor – that is….. something for everyone. However, after reading many investment books and many on Buffett, this is rarely true. The reality is that it is a challenge to cover beginner subjects without losing the advanced investor and vice versa.

Value.able is Roger Montgomery’s first book, one which he has adeptly and succinctly taken Buffett’s style and principles and developed them into a very practical framework for investing in the share market. For beginners, the book is a great way to get the “condensed Buffett”. For more experienced investors, the formula for working out the intrinsic value of a company is a piece of gold. So, although it is a cliché, Value.able does actually have something for both the beginner and advanced investor.  Be Patient

“You won’t run out of opportunities. But if you swing too often and miss, you will run out of money”. (Montgomery, p.58)

One of Buffett’s attributes and one extolled by many value investors is the necessity “to wait for the fat pitch” – that is, the opportunity to maximise your chances of succeeding with an investment is intimately tied to your ability to be patient and simply wait for the opportunity to arise. Many investors including those managing managed funds on behalf of others have shown little ability to be patient, a problem that leaves many of their clients poorer.

The structure of Value.able cleverly assists the beginner in taking this patient path (and building patience along the way). Part 1 (Think Like An Investor) and Part 2 (Identifying Extraordinary Businesses) take the beginner through what needs to be considered before actually calculating the share price of any company – just like Buffett does.

Buffett has stated that he first looks for good companies, then calculates what he believes are their intrinsic value and then finally look at the price. Of course this means looking at many companies but with experience a good investor can assess fairly quickly whether a company is worth further research. Part 1 and 2 greatly assists in providing what one needs to look for in identifying a potentially good investment. “If you are not in a hurry then Value.able will be an essential companion” (page XXIII). I wholeheartedly agree.

Instead of just rushing to value a company (using the formula set out in Chapter 11), Montgomery ensures that you first gain a deep and thorough understanding of just what makes a good company and a good investment. Chapter 2 (Buy Businesses, Don’t Trade Stocks) and Chapter 3 (Value, Not Price) are excellent chapters for beginners to understand that the share market is more than just numbers.  But numbers seduce. Let’s face it, money is about numbers and so is much of the share market. Much of the talk revolves around the company’s share

price – is it cheap? Is it good value? What’s the P/E ratio? All numbers. Many “experts” seldom think or discuss whether the company is actually a good company, why it is a good company and other “non-number” issues. Montgomery uses JB Hi-Fi as an example of a company that according to some (via “the numbers”) was overvalued but using his valuation method it was undervalued and just as importantly possessed the attributes of a great company (See p.225).

For experienced investors, mistakes often come from not paying due attention to the intangible aspects of a business or by being too quickly seduced by what looks like very favourable numbers (a big margin of safety). Value.able’s chapter headings offer the experienced investor the opportunity to quickly source and recap on what the intangible aspects are.

Chapters such as Chapter 5 (Pick Extraordinary Prospects) and 7 (Competitive Advantages) in Part 2 offer a quick way to reference and revisit critical qualitative aspects that might need to be confirmed before purchasing shares. I believe the book’s practical application could be enhanced if there was a small section at the end of each chapter to summarise the chapter’s most salient points and act as a checklist.

Valuing a company can be a time consuming process and one that requires a lot of numbers. I have read many value investing books and many recommend using a company’s past 10 year financial records for assisting in determining the company’s valuation. The thought of trudging through a company’s past 10 year’s financial statements does not really thrill me. Others, of course may be different.

But for me, this is where Value.able really delivers. Value.able’s valuation methodology is extremely simple and so simple that one almost feels like there is something missing. It actually makes valuing companies fun.

For beginners, the methodology’s simplicity means that you can start valuing companies immediately and with a high degree of confidence. Of course you may choose to do more research regarding the qualitative (and quantitative) aspects of a company, but after a short time, and thanks to Montgomery’s book, you will be able to very quickly assess whether a company is a potential investment target.

Since reading the book 6 or so months ago, I have valued more companies than I have in the past 3 years. Because the process is so easy with 15 or 20 minutes to spare I have simply gone to my internet broking platform and punched in the numbers required for the valuation.

The valuation tables (you’ll understand when you read Chapter 11) allow you to develop a range of values which experienced value investors will tell you is crucial in developing a ‘margin of safety’.

The aim of the book is to allow individual investors to firstly, find good companies and then calculate their intrinsic value. I found myself tagging many pages that I thought were worthy of documenting to help make me a better investor.

The other wonderful aspect of Value.able is the website (www.rogermontgomery.com) where you can purchase the book and Roger’s Insights Blog (blog.rogermontgomery.com) where you can discuss and share valuations and thoughts on companies with others. Just like Buffett, Montgomery freely dispenses advice and wisdom and at the same time encourages everyone to develop their own investment capabilities. The blog is like having an open line to some great thinkers and provides an additional source of information for you to consider before actually making an investment.

Be greedy when others are fearful and fearful when others are greedy .

Value investing is usually described as buying a dollar for 50 cents. I believe there are two parts to this statement. One, an investor must be able to establish the true or intrinsic value of a company’s share. Secondly, one must have the emotional fortitude to buy when you have discovered a dollar selling for 50 cents.

The most difficult part of value investing is not working out the value of a share and it should be said that Montgomery’s formula is the best I have discovered so far in terms of simplicity and accuracy. But Buffett has stated that when it comes to value investing, most people either “get it” or they don’t. I have found many people who don’t “get it” even when the dollars are reining down and on sale for 50 cents like in 2008.

As Montgomery states (page 194) the best opportunities are usually when the fear is greatest and that is during times like the recent GFC. Using rationality and logic (understanding the dollar is on sale for 50 cents) is easy but actually placing your 50 cents on the table when the sharemarket is going to hell in a hand basket can be hard.  Thus to those who “get it”, it is easy to be greedy when others are fearful, but for many, including beginners to the market, fear and a lack of confidence are difficult emotions to overcome. The battle is to overcome your own emotions and irrationality and plunge in where others fear to tread. Value.able only touches on the emotional side.

Montgomery’s book is truly valuable for both the beginner and experienced investor. With some additional insights on the emotional and behavioural aspects of investing (a 2nd book maybe) Value.able would be truly invaluable.

Posted by Roger Montgomery (with permission from Steve), 2 December 2010

Posted in Value.able

1 Comment Leave a Comment

Where else has Value.able been?

It has been a month or so since I last shared with you photographs from Value.able Graduates. These pics are from Gary, who has been travelling through Europe. He wrote “Read the book while traveling through Europe. Have attached some shots you may be able to use in your where in the world has Value.able been? One at the Louvre and the other at a little coffee with the Eiffel tower behind. Enjoyed the book, hoping to pay for the trip with the knowledge, Gary“.

I was in Perth last month to speak for the ASX and Australian Investors’ Association. This picture is from Dan (with his Mum).

Dear Roger,

I just wanted to give a big Thank You for your presentation at the Wembley Tennis Club in Perth recently! I wasn’t able to attend because I live 450km North of Perth and have been busy with work, but I told my parents to attend and they said they had a fantastic night! Also, a huge thank you for signing my copy of your book and for taking the time to have a photo with Mum! We all love the book and have benefited greatly from your wisdom. I’m relatively new to the stock market (I’m 26 years old) but I feel as though I have learnt a great deal during the last year. I started getting interested in the stock market approximately 5 years ago, and back then I had the desire to own things that were (are still) considered to be “Blue Chip”, e.g. Incitec Pivot, Westfield, Santos, Babcock and Brown, Virgin Blue, etc. Now I have a far greater sense of how to approach investing in a more rational way, and how to identify companies that are actually of high quality. Now I spend my spare time on focusing only on quality businesses and have done really well using your solid and sensible approach. Thank you for the Value.able education! Maybe one day I’ll have the courage to post a comment on your blog (which is fantastic). I hope to see you when you’re next in Perth for a presentation so that I can thank you in person. All the best, Dan

And whilst Mark didn’t include photos of his Value.able journey, he has certainly impressed me with his enthusiasm.

“Hi Roger, Loved your book. You may be distressed or impressed but I have underlined highlighted and read separate chapters often. Dog eared sections etc. etc. I feel like I’m back in school and I’m 53. Seriously tremendous. Well done. Congrats, Mark”

A little ‘off topic’ was this email from Ken. Thanks Ken…

Roger,

Half the battle, getting started with any sort of analysis is being confident that one is not wasting one’s time going about things the wrong way.  You have indeed given me a ‘leg-up’ with a range of aspects of my investing and thank you. My early career (and still a component of my work) involved collecting field data to calibrate and validate a pasture model (I’m still collecting validation data each year – 25 years since starting and training people, although engaged in quite different work now). I have spent years working with this model and with the scientist who built the model. There was never, in the early days, a definitive manual – just a mutual sharing of insights, late hours, passion and pain.

The modelling is now second nature and I’m more concerned with the flaws with the model than anything.  But there was a huge barrier to entry – no manual could ever replace that research and effort that I put in to become confident and eventually proficient with what I was doing. It helped though, to have a more experienced person there for guidance – often just pointing out a reference to read etc. In turn I try to help people with their efforts where I can but it is up to the individual to get their own hands dirty, begin their own journey but, in our case, now as part of a ‘college’ of users. You are right in your approach – offering us a generous ‘leg up’ with your book and a means to share insights (your blog).  By putting things into practice for ourselves, the keen will learn both the art and the science and, hopefully, slowly, become better investors and more value.able to both you and fellow bloggers.  In many respects, this is how our team at work has operated for so long. As a team, we have become well respected both nationally and internationally - the college itself knows no institutional boundary.

In the preface to your book, Simon Hoyle notes:

“By helping to equip investors with the right set of skills, Roger is, either consciously or unconciously, waging a war against those who would seek to profit from the naivety or misplaced trust of others”.

Along the same lines, Alan Kohler, in “Why I started EUREKAreport” states:

“But it’s important to understand that investing is work. It is not gambling, or wishing and hoping, or trying to get the inside dope: it is work; a second job. Nevertheless with the right kind of support, you can do it and you can beat the pros. Eureka Report is the beginning of an attempt to provide that support and to redress the balance – to give ordinary people the tools and the knowledge to become independent and reclaim the control – and the money! – that is rightfully theirs.”

Roger, you are indeed forming an ‘investment college’ and it is good to be a part of it.  I look forward to your latest blog and happy for you to reference anything.

Cheers

Ken

Thank you to everyone who has gone to so much trouble to demonstrate just how profound an effect my book has been having on your travel plans – if not your investing plans. I am genuinely encouraged and humbled at the same time by your support. Thank you again.

Posted by Roger Montgomery, 1 December 2010

Posted in Insightful Insights, Value.able

125 Comments Leave a Comment

How many of your Chips are Blue?

If you are new to the stock market, I believe it is possible that you have been lulled into a false sense of security. I say this because I regularly hear well-meaning advice that goes something like this; “just buy a portfolio of blue chips and hold for the long term”

But what is a blue chip? Here are some of the definitions I have found around the place:

“a common stock of a nationally-known company whose value and dividends are reliable; typically have high price and low yield; blue chips are usually safe investments”

“A blue chip stock is the stock of a well-established company having stable earnings and no extensive liabilities. Blue chip stocks pay regular dividends, even when business is faring worse than usual. …”

“A large company. Blue chip shares are generally lower risk. FTSE 100 constituents are generally considered blue chips”

“Shares of companies that are considered to be particularly solid and with a high capitalisation level. Their purchase is presumably associated with minor risk when the Stock Exchange falls”

And my new favourite definition;

“Blue Chip is the third album by Acoustic Alchemy, released under the MCA Master Series label in 1989, and again under GRP in 1996.”

Clearly there is only rough consensus around what a ‘blue chip’ actually is, but I get the distinct impression that a lack of understanding about what truly constitutes ‘high quality’ has meant the resultant definitions are clumsy at best. And if advisors can’t define quality/blue chip with some consensus, then its quite possible new investors are plunging into a blind-leading-the-blind situation.

Here at my Insights blog, I don’t talk about blue chips. Why? Because they don’t exist. There is no such thing.

I define quality through my A1-C5 Montgomery Quality Ratings (the MQRs) using a raft of measures and scenarios, combined with measures of the financial relationship a company has articulated over the years with its shareholders and its competitive position.

Warren Buffett once observed that time is the friend of the wonderful business but the enemy of a poor one. You don’t want to put the shares of a bad business, even if it’s a big one, in the bottom drawer and forget about them. Long term buy-and-hold investing then should only apply to the truly high quality companies – A1 companies.

To that end I would like to share with you an early Christmas gift (until Value.able arrives under your Christmas tree).

One of the definitions noted above and a commonly held one is that blue chips have to be large companies. Companies that inhabit the S&P/ASX 50, for example, may be considered Blue Chips. Putting aside for a moment the fact that there are plenty of large companies that have gone to the wall, it is possible to re-rank the so called Blue Chips – the large capitalisation companies – and find out if any are more blue than the rest.

So in the pursuit of ‘blueness’, below you will find all companies with a current market capitalisation of more than $10 billion sorted by my MQR (followed by Safety Margin for good measure). I have also included my current expected (annual) rate of change in Value.able Intrinsic Value over the next three years and thrown in dividend yields because I know how adored they are.

Of course, all of this is purely didactic and not intended as advice. YOU MUST SEEK AND TAKE PERSONAL PROFESSIONAL ADVICE. Also remember that I do not know what share prices are going to do, they could all halve or double and my MQRs andValue.able Intrinsic Values could all change tomorrow, possibly by a lot. They could go up or down and I am under no obligation to keep you updated. So please DO NOT RELY ON THE INFORMATION PROVIDED.

Having made that clear, and I am not joking about such serious matters, here is the list:

So its seems not all blue chips are entirely blue. As one of my friends – who likes to occasionally catch the amber light – says, “there’s still a bit of green left!”

Lumping all large companies into the ‘Blue Chip’ camp may not lead you to secure returns. Indeed, it could more likely see you merely lurch from one crisis to the next. If that is an experience you would like to change or avoid, then understanding the factors that indicate good quality is vital.

Value.able Graduates would have read the chapters about identifying extraordinary businesses in my book. If you haven’t yet secured your copy of Value.able you can do so at my website, www.rogermontgomery.com.

Posted by Roger Montgomery, 26 November 2010.

Posted in A1, Blue Chips, Company Valuation, Insightful Insights, Value.able

144 Comments Leave a Comment

Is that the Second Edition of Value.able?

Walking into the stores of some of my ‘A1’ MQR companies lately, it is clear that Christmas is just around the corner. Here at Montgomery Inc, Value.able Second Edition has just arrived.

At under $50, Value.able is not only easy to wrap, it’s the gift that keeps on giving all year round (and you don’t have to brave the local shopping centre)!

Many First Edition Graduates have asked me the question “what’s new in the Second Edition?” Aside from an added Appendix, the Second Edition contains all the information of the First Edition that had such a positive impact on people like Graham, who wrote;

“I’m somewhat of a minimalist and love it when I get a book where it makes me feel like I can throw away all the other books I have on a subject – this is such a book!!”

Value.able Second Edition is $49.95. The price includes GST and postage to anywhere in Australia (allow 7 business days). You may be able to claim a tax deduction, although you’ll probably want to check.

Visit my website to purchase your copy. And after reading it, please share your thoughts about Value.able, at Leave a Comment here at the blog.

Posted by Roger Montgomery, 19 November 2010

Posted in Company Valuation, Value Investing, Value.able

60 Comments Leave a Comment

Have you been getting your daily dose?

If only it worked that well all the time!

Last Thursday evening (4 November) on Peter’s Switzer TV I listed, amongst other companies, Credit Corp and Forge Group as two I would have in the hypothetical Self Managed Super Fund Peter challenged me to set up that day.

Why did I nominate CCP and FGE? Both receive my A1 or A2 MQR and both have been trading at a discount to their intrinsic value.

If you are a regular reader of my blog you would have read my insights for some months on these companies. And if you saw today’s announcements, you can imagine why I am a little happier than usual.

Credit Corp’s previous 2011 NPAT guidance was $16-$18 million. Today the company announced FY11 would likely produce an NPAT result of $18-$20 million.

Forge Group’s announcement states “The Board wishes to advise that the company forecasts net profit before tax for the half year ending 31st December 2010 to be in the range of $25-$27 million. This represents an improvement on the previous corresponding period (pcp $19.04m) of up to 42%.”

As I fly to Perth for a presentation and company visit, I am encouraged that several of the companies Value.able graduates mentioned in our lists are also hitting new 52-week highs. In a rising market that lifts all boats, it is perhaps unsurprising, but nevertheless it should be an encouragement to Value.able graduates and value investors that companies like FLT, DCG, MIN, FWD, FGE, CCP, NCK, DTL, MCE, MTU and TGA have all hit year highs – some of them yesterday. More importantly those prices are perhaps justified by their intrinsic values.

Of course I am not here to predict where those prices will go next, because I simply don’t know. Short-term prices are largely a function of popularity and the market could begin a QE2-inspired correction, an Indian infrastructure-inspired bubble or a China liquidity-inspired bubble tomorrow. I have no way of telling and instead, I focus on intrinsic values and only pay cursory attention to share prices.

So, as I always say, seek and take personal professional advice before taking any action and remember that 1) I don’t know where the share price is going 2) I am under no obligation to keep you up-to-date with my thoughts about these or any company, my Montgomery Quality Ratings or my valuations and I might change my views, values and MQRs at any time so don’t rely on them and 3) I may buy or sell shares in any company mentioned here at any time without informing you.

And so I remind you one more time. Please seek and take personal professional advice and always conduct your own research.

Posted by Roger Montgomery, 9 November 2011.

Posted in A1, Company Valuation, Insightful Insights, Value Investing, Value.able

155 Comments Leave a Comment

Are you drowning in a sea of complexity?

I don’t know if you have noticed but some of my recent posts and comments have been getting a little technical. I am sorry about that, I get a bit carried away sometimes.

Of course on this blog, I am not alone. Joab’s brilliant heads-up on the forthcoming changes to the treatment of leases and the impact on the financial statements is exactly the sort of thing that excites those of us who make investing a full time occupation.

In this field it’s easy to want to prove how much detail one can accumulate about a company or what one knows about valuations or credit analysis. Then of course debates and polite but pointed arguments begin about whose mousetrap is better.

Yet for most of us, it’s a storm in a tea cup, and meanwhile someone has made a million dollars quietly accumulating a few shares in the recently listed company XYZ Ltd.

In most cases there is one pearl that counts and the rest is noise. Our job is to find the pearls. Of course with so much rubbish to sift through it can be challenging to pluck up the enthusiasm to even start searching. For many investors, time is of the essence and short cuts are needed.

Well, I am here to deliver. But this not a post about buying the next hot uranium or gold explorer – tips I do receive and some I even regret missing sometimes. Today’s post is about a shortlist of A1 companies, their proximity to intrinsic value, my expected change in those intrinsic values and the associated net debt to equity ratios.

Why? It’s about getting back to basics.

Investing is simple. Not easy, but simple. Much work went into the classification process to come up with my A1, A2, C5, etc Montgomery Quality Ratings using, for example, industry specific KPI’s to ensure that future sweat was reduced.

And recently one Value.able Graduate Ken, reinforced my resolve to keep it all very simple. Ken D wrote:

Hi again Roger,

Out of curiosity, last week I constructed 2 hypothetical portfolios: 1) with your A1 stocks in equal proportion; and 2) the same with your A2 stocks. I have attached some numbers. I was impressed by the average past performance (i.e. investment performance) from both portfolios and also noted quite a difference between the A1 and A2 portfolios (attached). I doubt whether the result is fortuitous. Without asking you to outline your ranking process, I was wondering whether the strong past performance might be expected as a direct result of criteria used in the A1, A2 classification process – e.g. reference to historical earnings growth for instance, or perhaps more interestingly, a product of the inherent quality of the business as measured by current performance measures.

Ken

In answer to Ken’s question and for everyone’s benefit, remember Ben Graham’s quote about short-term voting machines and long-term weighing machine? Over longer periods of time, price follows intrinsic value and because my Value.able method of calculating intrinsic value is related to the performance of the business, one should expect price to follow performance. Over time A1 businesses should do better and a portfolio filled with just A1s purchased at big discounts to intrinsic value, should, in theory, do best.

Ken looked at all the A1s that I had mentioned on the blog and went backwards (I’ll ignore survivor bias for now) to have a look at the annual returns a portfolio of A1s would have produced.

While there is more refinement required, the early results are impressive. Over the last ten years Ken’s portfolio of 16 A1 company stocks returned 24 per cent, per annum. The same 24 per cent per annum result was produced with a portfolio of 23 stocks over five years and there were 31 A1 stocks in the last year that combined, returned 31 per cent.

Thanks for putting in the time Ken.

With all that in mind, here is my latest list of A1 companies, their proximities to intrinsic values and a few other salient stats.

What I would like to see as comments here are your thoughts or insights about any of these companies. Go right ahead and share whatever you know or think. But only about the companies in the list. Keep the comments to the topic set and we will build a useful library of insights. Just click the Leave a Comment link below.

Posted by Roger Montgomery, 3 November 2010.

Posted in A1, Company Valuation, Value Investing, Value.able

304 Comments Leave a Comment

Where will Value.able appear next?

We have seen Value.able being applied on an offshore oil rig, in a deck chair on one young man’s private island and also a plunge pool in Bali. Here are two more stories from Graduates showing how they are applying Value.able in practice.

Roger,

I was recently in Galle, Sri Lanka, and was able to share some of your insights with a local spice trader, Yasiru. He was particularly interested in your comments on quality businesses and was happy to say that he maintained a competitive edge by controlling costs – he grinds and mixes the spices himself. I can report that his product is excellent and sells at bargain prices (I have no shares or other interest in his business).

Justin

And from Michael…

I felt compelled to shine light the legion of your followers that are not simply reading Value.able while sitting in lazy pacific island deck-chairs, exotic pools-with-a-view or even far reaching oil rigs. I give you the Montgomery Aussie Battler: An 8am-6pm, 5-day-week worker, traveling to and from work via a crammed and smelly public transport system (namely Brisbane’s CityCat). Who smiles to themselves knowing ‘the final salvation’ is possible – an early retirement thanks to Value.able, intrinsic value, margin of safety and high ROE to name a few. Thanks for starting a revolution!

Michael

P.S. Note the studious working scribbles underneath Value.able.

Please keep sharing your Value.able adventures with our community. We are enjoying the journey.

Posted by Roger Montgomery, 11 October 2010.

UPDATE: 13 October 2010

Here is another pic from Matt I received today… ‘Operating Value.Able’


Hi Roger, I don’t have a tropical or relaxing environment from which to share my experience of Value.Able – I send you this picture from the Trauma theatre at 2am after an emergency operation on a car accident victim. Not a place normally associated with relaxing thoughts. However, you may not know how good an operating theatre can be for reading. After all, it has the two most important ingredients: very good lighting and plenty of fresh air (via the ultra clean ventilation systems of course). Your book has been an excellent addition to my investing education and I look forward to meeting you at one of your upcoming presentations.

Cheers, Matt

P.S. the patient is doing just fine

UPDATE: 14 October 2010

Hi Roger,

I was just reading up on the “formula” when some of the guys were curious. Then, just before the game started I was trying to explain to my team mates the difference between a company’s yeild, PE and ROE. Told them to just get the book.

Cheers….Rad

Posted in Insightful Insights, Value Investing, Value.able

19 Comments Leave a Comment

No more Value.able Roger?

The First Edition of Value.able has sold out.

Thank you. Thank you for purchasing copies for your family and friends. And thank you for allowing me to share my way of investing with you.

If you haven’t yet purchased your copy, don’t worry. I plan to release a Second Edition paperback in November. The manuscript is with the designers and will soon be on the printing press.

You can pre-order and secure your copy at my website, www.rogermontgomery.com. Or if you haven’t yet done so, join up to my mailing list and I will let you know when then Second Edition is available.

I have received a few emails from investors who purchased their First Edition copies in early September and are patiently waiting for them to arrive. The books are delivered by Australia Post. If no one is home at the time of delivery, a parcel reminder will be left at your front door or in your letterbox and your book will be taken to your local post office. Unfortunately I have heard of occasions where no reminder note was left.

If you haven’t yet done so, please check with you local post office and if you don’t have any luck, please let me know.

Posted by Roger Montgomery, 7 October 2010.

Posted in Insightful Insights, Value Investing, Value.able

94 Comments Leave a Comment

Carsales.com.au is an A1 business, but is it cheap?

Each Wednesday I write my ValueLine column for Alan Kohler’s Eureka Report. Usually I post a link to my article the following day here at the blog. This week Alan has generously allowed me to republish my insights. Visit the Eureka Report website, www.eurekareport.com for more details about Alan’s newsletter.

ValueLine: Carsales.com

Ever noticed that the biggest and best online businesses are lists? Lists of websites, lists of houses, lists of flights, lists of jobs, lists of hotel rooms … even lists of people!

The business of curating and providing lists can be an extremely lucrative one because there is no need for a warehouse or a manufacturing plant. Nor is there a need for inventory and there is potentially very little maintenance spending required.

But because anyone with access to a server and knowledge of a programming language can imitate the business model, what is needed to be successful is a sustainable competitive advantage. More about that in a moment.

Last year nearly one million cars were sold in Australia; this year the figure is expected to be even higher. Of Australia’s adult population of 19.3 million, 5.3% buy a new car every year. Excluding January sales (when everyone is on holidays) and June sales (with end of financial year run-outs) about 85,000 new cars are sold each month.

That’s a lot of new cars being bought, and one suspects that just as many second hand-cars being sold too. One company leveraged to this industry without having to buy stock, lease a showroom or pay the wages of mechanics is Carsales.com (CRZ).

After a decade of business under private ownership, Carsales.com was floated at $3.50 a share in September 2009 in one of the most highly anticipated listings of the year. As is often the case with such floats, very few retail investors were able to get an allocation.

Today Carsales (CRZ) is Australia’s largest online list of cars, with about 205,000 units available for sale as of June this year.

For the year to June 2010, Carsales reported a profit of $43.2 million, which was $16.8 million less than listed car dealership Automotive Holdings (AHE). Automotive Holdings reported a profit of $60 million but required $1 billion of assets and $376 million of equity to produce it.

By way of comparison, Carsales required just $114 million of assets and $89 million of equity. Automotive Holdings generated a return on assets of 6.5%; Carsales’ figure was 39%.

If they were your assets, which return would you prefer?

For every dollar of sales, Automotive Holdings generates earnings before interest, tax, depreciation and amortisation (EBITDA) of 3.8¢. Carsales generates EBITDA of 52¢ from every dollar of sales.

If you could own one of these businesses, which would you prefer?

Carsales dominates Australia’s online lists of cars, capturing roughly half the market. Its next nearest competitor is the Newscorp-owned Carsguide with 93,000 cars for sale at mid-August, followed by the Trading Post with 69,000 cars.

For the full year to June 2010, Carsales’ revenues increased by 28%, with operating costs rising by less than 12% and net profits increasing by over 41%.

One of the keys to sustaining this kind of performance is a competitive advantage and while many conventional reports cite brands and systems as sources of competitive advantage, Carsales’s advantage comes from what is known as the network effect.

This is arguably one of the strongest sources of competitive advantage and it is evident when the value of a service increases for both new and current users as more people begin to use that good or service.

Think about it like this.

As more people list their cars/jobs/properties on a website, more people visit that website because it has the more cars listed. As more people visit the website, it justifies more people listing their cars there and this virtuous circle continues to work in favour of the dominant site, until an unbridgeable moat exists between Carsales.com and the other brands.

In an effort to break the cycle, one of Carsales’ competitors offered vendors the opportunity to list their cars for free but even that failed to put a dent the growth trajectory of Australia’s leading car classifieds website.

Carsales enjoys the same benefits of the network effect as Seek (SEK) does in job ads, REA Group (REA) does in real estate and Wotif (WTF) does in accommodation. This network effect is as visible and obvious as it is entrenched for Carsales.com and investors looking to buy a wonderful business would be hard-pressed to find many more attractive (for more of Roger’s thoughts on web-based businesses, click here).

Now the reality is that Carsales’ largest shareholder, PBL Media, owns 49% of the company and at some point that stake will be sold. But investors fearing the overhang should be less concerned by who buys and sells the shares and more concerned with whether the intrinsic value of the company is rising or not.

Carsales’ intrinsic value is rising. My forecasts suggest intrinsic value will rise 19% for each of the next three years and, let me assure you, there are few companies that can even promise that.

But a rising intrinsic value is just one of the characteristics the ValueLine portfolio seeks. The other is a discount to today’s intrinsic value. And that is the only test that Carsales.com. does not pass.

Carsales.com is an A1 business with a strong competitive advantage that is generating excellent returns on assets but, according to my calculations, its intrinsic value is $3.77. If we compare this to yesterday’s closing price of $4.72, it is approximately 25% overvalued.

In 2012, my estimated intrinsic value for Carsales rises to $4.65 and in 2012 to $5.24, but disciplined value investors need to make sure that everything lines up perfectly to pursue a successful investment strategy.

Carsales is not currently trading at a discount but it is a great business to keep in mind, should the market temporarily change its mind.

Posted by Roger Montgomery, 7 October 2010

Posted in A1, Company Valuation, Value.able

48 Comments Leave a Comment

Value.able review by Student2trader.com

Very few books get me this excited.

The anticipation I had when opening my package upon receiving Roger’s book was huge! Boy was I not let down!

Roger’s book literally reignited my interest toward fundamental valuation of firms. Investors should rejoice, finally a logical approach to valuing ANY company that literally ANY investor can use. I have put many friends and family on to this book! I have no doubt that Value.able is going to take the nation, possibly the world, by storm.

I really enjoy Roger’s simple approach to valuing companies and the way he explains his concepts in the book are commendable. Some of his best concepts involve seeking both qualitative and quantitative margins of safety when using his simple yet very effective valuation method.

Roger gives a lot of value to his readers in this book. I personally never accept anything I read unless I completely understand exactly what is happening, how the concept works and how the assumptions affect the outcome. Subsequently, Value.able was a fantastic read for those reasons; Roger leaves nothing to the imagination, makes no unjustifiable assumptions, and bases his methods on proven and simple logic. Best of all, you don’t need a degree in finance to understand his book.

I honestly recommend you read Value.able. Many people are already looking forward to the second edition of the book, which will no doubt add further value for readers, based on the feedback Roger received from the first release.

If you are an investor, a student, a simple person wanting an easier logical way to make your decisions or even if you are academically challenged, you will understand Roger’s approach.

Well done Roger, I look forward to reading your future books!

Damon Callaghan is the co-founder Student2Ttrader.com.

Posted in Value.able

4 Comments Leave a Comment

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