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How has my Switzer Christmas Stocking Selection performed?

Insightful Insights, Investing Education, Value.able | Comments (112)

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.

INVEST WITH MONTGOMERY

Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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112 Comments

  1. Ian Bartley
    :

    Roger

    Have you any thoughts on the half year accounts of MCE. The NPAT looks great at $19M but the cashflow from operating activities is -$6.2M. I cannot see any increase in Receivables to reconcile this difference. What may explain this?

    Ian

    • Roger Montgomery
      :

      These are prepayments from customers. Because the purchase order has not been delivered upon, the amount received remains a liability rather than recorded as revenue, The laibility is reversed upon delivery or progress. Also Chris adds…”MCE has reported a strong accrual profit but operating cash flow is negative by -6.2m. This is due to a reversal of an approximately $30m deposit which was received in FY10. Think of the deposit like a deferred revenue item – cash is received prior to revenue being booked in the P&L. So the revenue was booked in the current period but the cash had been received in the previous period. This can be seen under current liabilities; ‘Progress Claims and deposits’. My understanding is that this came about as a customer was willing to pay a substantial deposit to move up the order book as Malaga was running at full capacity last year and the customer wanted to ensure their order would be filled in a timely fashion.” Thanks Chris. It will be good to confirm the frequency of the treatment and its impact on reputation (what do other customers in the queue think – or are monopolistic behaviours tolerated, indicating MCE is a price maker) during the conference call next week.

      • Wing
        :

        Thanks, coz I had the same query about the -ve Operating CF before for MCE.

        Also did the huge jump of Financial Liabilities under Non Current Liabilities from 5+m in Jun 10 to 28+m in Dec 10 a concern? or it is simply the Fx hedges?

        Cheers,
        Wing

  2. Peter K
    :

    Hi Roger,

    I heard you on the Business Channel last week saying that Maca Limited (MLD) is trading a bit over its intrinsic value of $2.70 at the moment .

    I have a valuation on it rising to about $4.00 at June 2011 based on a net profit of $28m. Do I have the figures wrong, or would you agree?

    Cheers,
    Peter K

    • Ash Little
      :

      Hi Peter,

      I can’t guarantee this but I am fairly sure that The Montgomery crew don’t have $4 on MLD but 2011.

      With the upgrade I have about $2.50 for 2011.

      You may be using too low of a RR.

      I have $3 for 2013 if it helps

  3. Greg W
    :

    Hi Roger

    Thanks again for a wonderful forum that you have made available to us novice investors.

    I am interested in your and other bloggers thoughts on CSL. I love the company and todays report was in line with expectations and the company expects to hit previous guidance for the full year.

    I may be wrong but I recall you valuing the company a liitle lower than the current price however based on my calcs I have 2011 at about $25.09 based on:
    NPAT $946m
    Opening equity $4215
    Closing equity $4736
    Dividends $425 (payout ratio 45%)
    Equity per share $8.91
    ROE 21.1%

    Would appreciate your thoughts.
    RR 10%

    • Roger Montgomery
      :

      Hi Greg,

      Its $9 higher than my 2011 valuation and $5 higher than 2012. I am not budging at the moment. Value has been disappearing quickly in the ten days. That of course does not mean it won’t keep going up. As long as the yield curve in the US remains positive and Bernake has his hands on the printing presses, its the only way it can go.

    • Roger Montgomery
      :

      Hi again Greg,

      CSl is on the list to cover. I listened to some very short term TV commentary by analysts on the flight back from Adelaide today. It caused me to want to jump up and take a close look. IT will be a few days though.

      • Greg W
        :

        Thanks Roger, I look forward to reading your more detailed comments on CSL in due course.

        I know I keep saying it mate but your book and this blog are by far and away the best investing information I have ever read or been involved in. You have certainly changed the way I look at investing. I now take the words and predictions of analysis with a grain of salt. Some of their 12 month targets for stocks are just riduculous however they are great at talking up a good story.

        I am more than happy to keep buying quality shares at discounts to their IV.

        One company that has come under my radar is only a micro stock of $40m but looks to have turned the corner and starting to deliever good results and sign good contracts especially in Korea. The company is Icash (ICP). I have their IV increasing at a good clip over the coming years.

      • Tim
        :

        Hi Greg,

        What are your inputs for FY2011? I had them trading at round about intrinsic value at the end of FY2010, but am yet to get any 2011/12 figures. Where did you source your data from, I’d like to take a look at ICP myself.

        Cheers

        Tim

  4. ken fraser
    :

    Tim P, From Stock Broker forcasts or from Com. Sec. or from E-trade or you can work it out from the company forcasts or Australian Stock Exchange announcements. Roger mentions these in his book.

  5. ken fraser
    :

    Andrew, The reason MCE is trading so high is because they look like they could double their Net Profit in 2011.

    • Scott
      :

      Yes and I kick myself that I missed adding Matrix to my portfolio already. However having invested my then available funds into MLD, FGE and others I have no need to cry,

      However with a small recent inflow of cash I am in the market again and trying to listen to the numbers instead of my heart. Should I head into the MCE register due to them winning best on ground over the summer season, or has the MOS gone as of this time (for the moment)?

      Doing the maths is not a problem for many of the Value Able graduates, but I still find my interest and background in behavioural studies brings up the key factor of market moves. The failure of the investor to take the best available option still causes me grief. Coupled with my natural ability to display patience I sat and watched Matrix price rise (albeit without funds waiting to enter the market at the time).

      So I ask myself tonight, does it still offer a margin of safety?

      • Matthew R
        :

        Looking at MCE’s 1st half report I was amazed by that result, that order book just keeps expanding despite them having a real crack at it. It won’t expand faster than they can produce forever but life is good while it does

      • Ash Little
        :

        Hi Scotty,

        Don’t look at the price

        Look at the value……I bought a fair amount at lower prices so no drama for me but I am getting IV higher than here

      • Ash Little
        :

        Hi MattR,

        Never be suprised be this company.

        They have spent alot of money on henderson and it is still not operational.

        Given this new build you would expect ROE to declince then rebound after the new facility is established.

        I am not getting this.

        ROE & Margins should only inprove from here.

        I must say though that I do own MCE. (Thanks to Mae West)

  6. DOM
    :

    Hi roger and regulars,

    I only just had the chance to watch your biz channel appearance last night, and as such i’m sorry if this has been already mentioned,
    could you please expand as to why DWS is now off your top picks list and why the IV will not grow, my last reading i think u had it +13% in fwd projections.
    i see that the telstra freeze on contractors is over and the mkt seemed to like the mixed interim fin report yesterday with a nice rally..

    cheers

    Dom

    • Roger Montgomery
      :

      Hi Dom,

      The context of that discussion was a review of last year’s list, which was not exhaustive. Please keep in mind I don’t mention every stock. I am delighted to see so many doing well out of FGE, MCE et al…

  7. Ilya
    :

    I have a question about historical performance. Roger rates Matrix (MCE) as his red-hot favourite. I look at MCE’s financial on CommSec and I can only see one year of financial performance. Where do you go to to judge the company’s historical performance? I assume nobody here would make a company their A1 based on just one year worth of data. Regards, Ilya

    • Roger Montgomery
      :

      Hi Ilya,

      Go to the company’s website. While its relatively new to the ASX, it has been in businesses for quite a long time. You should find some discussion about this in my Money Magazine column from late last year.

  8. jc
    :

    One thing to be aware of is the effect of high debt levels on ROE – Return on Equity is equal to a return on assets multiplied by a leverage factor (i.e. how much debt the company has).

    This can artificially inflate the ROE to levels above what I call a businesses “future sustainable return on equity”. In effect, screening for companies with low debt eliminates two problems – one, that they aren’t at risk of going under, and two, that their ROE is actually representative of the businesses actual returns.

    I can’t actually recall if Value.able mentions the dupont equation at some point, but for those that are interested you can google it. I’ve found it a useful tool for evaluating the “quality” of the returns on equity over time

    cliffs: companies with high debt levels will often have “intrinsic values” much higher than they deserve, in my opinion.

  9. Tim P
    :

    Hi Roger,

    I am new to the stock market and am very pleased to have come across your investing philosophy so early in my career. Congrats on the book, I am sure it will come in very handy now and in the future.

    This may sound like a silly question, but would you or one of your wonderful bloggers be able to tell me where to find good forecasts for future shareholders equity and net profits? Are they readily available or do we need to manipulate data to get good estimates?

    Many thanks
    Tim

  10. William Gill
    :

    HI Roger,
    There has been a lot of discussion over the last 6 months regarding Seymour Whyte, Driving from the Gold Coast to Cape York numerous times over the last few years, most of the roadworks bridges and civil construction seemed to be carried out by BMD a private company that has been established longer than SWL,
    and what appears to be about 400% higher revenue.
    Being a private company the financials are not available but I don’t think SWL gets everything its own way.
    They also do joint ventures, on some projects.

  11. Andrew
    :

    Hi Roger,
    I’m new to investing but am doing my best to gain some understanding before I take the plunge. I valued MCE at $5.74 using your methods and it was trading at $7.14 last time I checked. Am I missing something?

    Figures used (from 2010 annual report):

    Equity: $59,893,247
    NPAT: $18,155,336
    Shares on issue: 69,964,098
    Dividend ratio: 0.124

    This gives me a RoE of 30.3%, Equity per share of $0.86 and a value of $5.74 as I mentioned before.

    Any help is appreciated.

  12. Christopher
    :

    Hi Everyone,

    Any thoughts on Count Financial Limited (COU)? They’re an accounting/financial company, with basically no debt, consistent ROE in the 40% range and steady (if not stellar) growth.

    I have them trading at around a 10-15% discount, rising to around 30% in 2012. Interesting, but not so much so as to be a buy at the moment.

  13. les field
    :

    HI ROGER, GOOD TO READ HOW WELL MCE AND FGE ARE PERFORMING. AND OF CAUSE SWL. THANKS ASHLEY. THERE IS A SMALLER COMPANY THAT I BELIEVE SHOULD BE IN THE MIX. BUT ITS AS THOUGH ITS BEEN EATING GARLIC OR SUPPORTS COLLINGWOOD. THAT COMPANY IS LYL.. CAN YOU GIVE ME YOUR THOUGHTS ON IT PLEASE. CHEERS YOUNG LES.

    • Christopher
      :

      Hi Young Les,

      I’ve been following this company too. I value them in the mid $4 range, rising to close to $5 in 2012. On the face of it, they looked like they were worth closer to to $7 in 2010, but this was due to some abnormals that inflated NPAT/ROE. I think the appropriate ROE to use for them is in the mid to high 20%’s.

    • Ashley Little
      :

      Hi Fred,

      I think Roger has it as an A1 from memory.

      It is a good business but expensive I fear

    • Kade
      :

      I have been following LYL as well, it has moved around 18% in the last month and i believe is still at a discount. You might want to check the future IV’s. That’s all that’s stopped me from buying.

      I also like the look of MGX, does anyone have any thoughts on that?

    • Steve
      :

      I had a quick look at LYL (another one in the engineering space) and it looks like a quality company on the surface with low debt and steadily increasing earnings. My valuation is about 20% above the current price. However I noted that the analyst forecast EPS on Etrade show a projected decline over the next few years. This would obviously lead to declining value if correct. Perhaps someone else can shed some light on why the earnings would be expected to decline

  14. Lloyd
    :

    Roger,

    The reduced profitability reported in the article is a result of unrealized foreign exchange effects of -$1.13 million. Unfortunately, we do not have sufficient information, pending the interim accounts, to assess the basis and likelihood that these losses will be eventually be realized. The accounting for these unrealized losses and gains can be a bit arcane and I tend to ignore them until such time as the losses are realized, if ever.

    This gives rise to the question as to how the accounting effects of unrealized foreign exchange gains or losses should be treated for the determination of ROE? Do you take them as effectively realized, or back them out of the earnings result for ROE calculation?

    Regards
    Lloyd

    • Roger Montgomery
      :

      Hi Lloyd,

      WIth the first half results out and as we fast approach the full year, the 2012 expectations become more important than the 2011 result – provided you are patient of course. These unrealised FX movements are a point of contention amongst many analysts. Some back out and some ignore/leave in. Variations in exchange rates that take place after an unpaid invoice has been issued produces the unrealised gain or loss. (this is distinct from adjustments to the value of overseas operations, which affect the currency translation reserve) A business starts with an asset such as an outstanding overseas trade debtor, then the value of this asset increases or decreases due to exchange rate fluctuations, which gives rise to the unrealised gain or loss. When the account is paid, the gain or loss is realised but up until that point at regular intervals the accountants will determine the POTENTIAL impact of the change by recording an unrealised gain or loss. The reverse entries are made for creditors/liabilities. If the business, is in the business of exporting/importing its ‘widget’ then the P&L will show gains at times and losses at other times. I know lots of people back them out because its not ‘operational’ I keep it in because I reckon its part of their business. A1 and a discount to IV too.

      • Gavin
        :

        ROE when defined as NPAT/EQUITY is based on two accounting constructs.

        Interesting discussion here on how FX should be incorporated/interpreted in NPAT (the numerator). ISS is also a good case study of how Equity (the denominator) is influenced by accounting vagrancies. In 2009 ISS wrote off all intangible assets created on the initial IPO, Representing over half their equity, this non cash transaction instantly doubled ROE when measured as NPAT/Equity. (Just as it halved it when it was originally recognised)

        Roger, how do you handle this sort of accounting vagrancy in defining equity? What Equity figure have you used to calculate ROE for ISS.

      • Roger Montgomery
        :

        Great thoughts Gavin,

        And vagaries v vagrancies? The rise in ROE has a positive influence on valuation. The reduction in equity has the reverse effect. The impacts differ in their magnitude but the key is to buy businesses with economic goodwill not accounting goodwill. True economic goodwill rises in value. One of the techniques that are available to you is to reverse out ALL amortisation of (historic/legacy/old accounting technique) and impairments to goodwill. That is, carry any purchased good will at full value. That gives you a truer picture.

  15. Kumar
    :

    Hi Roger,

    Great book, has really opened by eyes to investing and I’m glad I caught onto it early in my investing career. Thanks very much for sharing your knowledge in a such an open and simple-to-understand manner. I will certainly be recommending your book to friends and family.

    I have many questions, but don’t want to take up too much of your time or space on your blog, so I’ll keep it only to two questions which I haven’t quite gotten my head around.

    As we know, the market is made up primarily of people who buy based on emotion and factors unrelated to the business. They do not calculate intrinsic value before they buy. Why then do you think market share prices tend to approximate their intrinsic value (as calculated by the formula you write about) in the long term? I think perhaps the market prices stocks based on analyst’s intrinsic value calculations. If, as a group, the analysts presented MCE’s intrinsic value as $20, I have a feeling the price would nudge up to there, even though we know the true intrinsic value is much lower. I could be wrong.

    My second question, which is probably more relevant, is what do you think of ROA as a measure of the business? ROA will directly tell us how good our assets are at producing money. As you mention in your book, ROE can be misleading in companies with high debt. Perhaps ROA is a good alternative for these companies, however, it could not be used in Value.able valuations

    Thanks.

    • Roger Montgomery
      :

      Hi Kumar,

      The market is pretty good as sifting wheat from chaff. If the intrinsic value is spurious, it will eventually be discounted. There is no hard and fast rule about how long it takes for the market to efficiently reflect the intrinsic value. MACA took a few months, Corporate Travel took no time at all and Telstra took a decade. perhaps there is an inverse function between market cap and efficiency. And also whether institutions are forced to buy or not.

      Regarding ROE/ROA. They are as good as equal for a company with no debt – the sorts of companies we are after.

  16. Lloyd
    :

    Roger,

    I think that ISS Group Limited (another micro cap) is another interesting company with some operational management software that is being taken up by by a few notable oil and gas sector and other resource players. To my eye it has all the qualities of an A1, has recently released encouraging guidance and is trading at an appreciable discount to my calculated IV. The applications it develops and markets fill a niche below that pursued by the larger developers and this affords some competitive advantage.

    Your thoughts?

    Regards
    Lloyd

    • Matt
      :

      I do find it curious when a company’s share price jumps (or declines) by a large margin 2 days before an announcement! (ISS in this case up by 12.5%)

      • Kent Bermingham
        :

        Matt I agree with you
        CPU shares were tracking down for weeks
        ASIC wrote the standard letter and got the standard reply
        Someone new something was going on?
        Out come the financials, profit down by 30%
        Not significant according to ASIC?

        A company with debt may have had to have a capital raising and our shares would be diluted again by institutional players.

        We are not playing on the same field just kicking the ball back after the big boys have a shot at the goals!

  17. Lloyd
    :

    Roger,

    I’d be interested if you have the time to spare us a few thoughts and share your MQR on CMI Limited?

    From my perspective, it appears to be an interesting micro- cap play, good cash earnings, with a growing earnings base from the manufacture and supply of automotive electrical components, electrical cabling and connectors to the mining industry amongst others. Zero net debt but the last couple of years profitability clouded by some asset impairments (non cash) that appear to be behind it. Recent profit guidance is encouraging and suggests that it may be available at around 50% of IV (calculated at 14% RR).

    Competitive advantage is not that clear to me, other than its been around as a listed entity since 1993 and met the competition from much larger competitors, so I suspect that it must have some IP and reputation, which is valued by customers. Management now appears quite focused and has a strong ownership position in the company. With its Brisbane base and a strong Queensland focus I suspect that the recent floods will have provided the basis for a further near term boost in demand for its product.

    Competitive advantage aside, the potentially big discount to its IV is an attraction.

    Regards
    Lloyd

      • Greg Mc
        :

        I’ve had my doubts about management’s intentions. I am, of course, not saying that they are dodgy, but equally, I’m not convinced that they have the shareholder’s best interests at heart.

  18. Rob Walker
    :

    Hello Roger and All,

    I would like to post my half rearly results for my first 6 Months of value-able investing, I am pleased to say I am Currently up 24.5% as at today. My Best stocks are MCE, FGE , STU and CCV. My worst performing stock is OKN. I used to watch the market every chance I had, now sometimes I forget for a number of days. Every couple of days I read this wonderfull blog, I am very happy and no stress. I was able to achieve all this by reading a book, boy Roger wish you had written your book years ago :)
    Thanks Roger

    PS:, Ashley, Ken F. & LLoyd and others love reading your comments

    Regards

    Robert W.

  19. David
    :

    Hi Roger,
    good to see you back on tv last night.

    I would be interested to know which out of FGE & MCE you believe is trading at the greatest discount to IV. I hold both so wont be influenced by what you say but would be interested all the same.

    Cheers
    David

  22. ken fraser
    :

    Nolan, I have DGX IV at $1.16 for 2010. Using 2010 ending equity of $31.1m –153.3 million shares–equity per share $.202—NP $10M–used ROE 32.5%—POR 50%—RR 10%. Waiting for half year report for 2011 forcast and then may buy more.

    • Scotty G
      :

      I’d probably use a higher RR than 10% to adequately reflect the risks in property development and the often lumpy cash flow.

      I used 14% and downgraded the ROE a few points for extra conservatism. I got $0.59 for 2011.

  23. nevada cody
    :

    Hi Roger you are Great on tv as always . the atlas iron thing surprised me , i used to own ago.
    their return on equity will be very high if analyst forecast are right .
    and your view on iron ore also surprised me i do agree on oil and
    food prices will go up massively because of all the money printing Qe 3-4-5 soon . And that will have a big effect on emerging countries were food is 50 even 70 % of wages
    i am still bullish gold silver even though i sold al my gold silver stocks ,still have the metal i also think multi nationals will do well in a inflationary scenario… safety of cash as they say might not be so safe ,, depending on which currency of course ,, but al currency looses it purchasing power over time
    cheers Cody

  24. Jason
    :

    Hi Roger,

    First time posting. Have been watching your videos and you mentioned that you got FWD when they were really low, and even though they have been trading above IV, you would not let go due to the high yield you are getting now due to low entry price.

    It just occurred to me that no one actually uses current yield and I think we should when deciding whether to hold onto a stock that has far exceeded its IV.

    For example, lets assume on entry into a stock, div was $0.06 and price was $1, giving 6% yield. Latest div is now $0.15 on price of $3.00, giving 5% yield on current price, but 15% yield on entry price. Assume we bought 1,000 shares and the div is not franked.

    One would be reluctant to let go the stock now as it is now earning 15% on entry price, but what if we sell it and get $3,000 and put this in the bank earning 6%? This would generate $180 in interest, compared to $150 of unfranked div.

    Then when the stock is no longer overvalued, we can buy the stock back, but in the meantime we are getting better yield from the bank than from div.

    Any comments?

    Thanks,
    Jason

  25. Christopher
    :

    Good show Roger,

    You two make a great double act. I also really enjoyed the discussion of Transurban over the past couple of nights on Lateline Business. The debt funded acquisition model certainly still has its believers.

    • Roger Montgomery
      :

      Hi Christopher,

      I’m meeting with an infrastructure analyst on Monday to check I haven’t missed anything and also the reasonableness of the assumptions made that support the belief that the debt can be amortised (read, paid off) by the end of the concession. There is plenty of research that says, there’s a very optimistic bias that pervades traffic growth assumptions. There’s also the small problem of the impact of rising oil prices on traffic – you saw the wiki-leaks material about Saudi oil reserves? I just can’t see how debt can be supported and paid down, while distributions continue to rise. I reckon I understand the cash flows pretty well but I don’t believe the assumptions are conservative. If the debt will be amortised more towards the end of the concessions, perhaps the salaries and ECM fees should be too. CP2 has again asked them to stop growing for growths sake. “CP2 Managing Director Peter Doherty said…””This company needs a lot of help …”Transurban should stop chasing growth through acquisitions and focus on growing its existing business.”

      • Christopher
        :

        I struggle to believe that the debt can be amortised by the end of the concession, particularly with the distributions rising as you say. I also agree that we’re running out of oil, and the traffic volumes are just never going to live up to their assumptions regardless.

        But I also don’t believe that’s their biggest problem; they’re hardly the only company who overstate the value of their assets. As you said on the program, I think the real problem is their addiction to debt and what might happen when interest rates (inevitably) rise. The debt/cash flow ratio is terrible. More and more money is leaving the company, through loan repayments and now distributions.

        Anyway, history tells us that you can’t keep taking on more debt to acquire more businesses for the sole purpose of accessing their cash flows. At best you can delay the inevitable. We might never find out if the debt could have been amortised, because they might not live long enough to succeed. I really hope that’s not what the future holds.

        I’d be interested to hear what the infrastructure analyst says!

      • Roger Montgomery
        :

        H Christopher, I did mention to the ABC that if ROE is single digits and remains so, carrying values of assets on the balance sheet are, by definition, overstated. They must have cut those out.

      • Mark
        :

        Hi Roger

        I haven’t read the reports about Saudi oil reserves but I did work for Saudi Aramco for 7 years up until the end of 2005 and it was common knowledge amongst insiders that the Saudis do not have anywhere near the reserves that they claim to have.

        I got this information from pipline guys and others working who i worked closely with and these are people who would definitely know.

  26. george
    :

    Hi Bloggers,
    Two companies I believe are trading a fair bit below IV are CDA and IDL.
    CDA manufactures and sells satellite dishes, mine detectors and radios for the military. The debt to equity ration his high though 80%
    IDL also carries debt but appears to be undervalued

    Any thoughts

    George

    • Scott T
      :

      Hi George,

      I have done a fair bit of work on IDL. Last December Roger gave IDL a quality rating of B2, which is really the lowest rating you should be repaired to put money into.

      IDL are announcing their result on 17/2/11, it will be good without being great, they do have considerable debt, but watch for further debt reduction initiatives.

      I have their IV at $1.30, but that value is raising at 10%pa for the next 3 years.

      I don’t like CDA, they have even more debt and their IV is declining over the next 3 years.

      All the best

      Scott T

    • Ash Little
      :

      Thanks for that George,

      I have looked at Codan in the past.

      Care is needed with IDL as they have a track record of destroying shareholder wealth

      Thanks for your post

  27. Nolan
    :

    Fellow Montster fans,

    I have been honing my search criteria, tweaking spreadsheets, and crunching numbers, all in an effort to practice seeking out companies trading below IV. All good fun.

    Now bare in mind, I haven’t been excluding non-A1 companies, lest I don’t get any results other than those I have found at this blog.

    Best I’ve come up with is DGX. Seems to be trading at a huge discount. My valuation is 75.2c. That is using the ending equity to calculate ROE. If I were to use the beginning equity (which is the method used by Roger?), I think that figure would be much higher.

    In any case, DGX is trading around 29c.

    I would love to hear the valuations of a few Value.able graduates.

    Thanks.

    • george
      :

      Hi Nolan,
      It appears to be very under valued but carries a lot of debt. Therefore high risk.

      Regards

      George

    • John M
      :

      Hi Nolan,
      Its a shame it isn’t halloween with an introduction like that. We could do the Montster Cash.

      It is good to see that you are having a go.

      As a little constructive feedback, I don’t believe that this company would show up on the Value.able radar. It has a very high debt/equity ration and looks to have done a capital raising during last year.

      Roger has mentioned on many occasions that there are many A-Grade companies with little to no debt. The only way that a high ROE can be a true guide to a company’s profitability is if it has no debt. Otherwise you could just get heaps of debt and make the company’s ROE look sweet.

      Hope that helps. Keep on honing, tweaking and number crunching, but always remember to keep Roger’s value.able fundamentals as part of your framework. No debt is a biggie in the scheme of things.

    • Christopher
      :

      Hi Nolan,

      DGX might be trading at a discount to intrinsic value, but they also have a mountain (or at least a decent sized hill) of debt.

    • Luke
      :

      Hi Nolan,

      Roger’s method uses the average equity. DGX does look like it is trading at a discount to IV – even with a high RR!

      The only negative I can see for DGX is the high debt and cashflow is negative. Also, does it have a competitive advantage? I don’t know much about the property situation in WA.

      Still, thanks for the post, it’s interesting looking at companies like this. Even in terms of PE and dividend yield it looks attractive (I know Roger, I’m not allowed to say things like that here!).

    • Ray
      :

      Hi Nolan

      I also get a High IV for this company in fact a little higher than you at 92 cents using a 12% IRR. Even though there was a large reduction in debt in the 2009 -10 year the company still ended with project debt of double equity. They are also very tightly held and so very thinly traded and these two points make them a little doubtful and because of the debt position I do not think Roger would include them in his investment quality shares, but I may be wrong.

      Nevertheless they are an interesting stock that looks like a good buy but with a couple of worrying issues as far as I am concerned.

    • Scotty G
      :

      I got 59c the other day using a 14% RR as this is a comparatively risky business compared to an A1. There are some relatively recent forecast figures on their website under analyst reports in the investor section of the site.

      I must disclose that I purchased DGX yesterday as I believe they have a decent future and are trading at a large margin of safety.

      Remember margin of safety and conservative valuations will guide you through.

    • Peter
      :

      Hey Nolan,

      Thanks for your post. I think everyone is interested in finding companies that trade below IV.

      At a quick glance there is one filter that does not make my grade – and that is the debt to equity.
      They have a debt to equity ratio of 97% – way too high.
      High levels of debt t will distort the return on equity –

      If we assumed the debt to be contributed equity, then the ROE on the 10mil profit for 2010 is about 16% as opposed to the 32% ROE they reported.

      They have contractual work ( which offers a steady flow of income ) however are expanding towards buying and developing sites themselves. It takes time to buy , develop and then sell property so they could experience lumpy cashflow. Then there is the risk of price deflation on property they want to sell.

      Property development has high rewards but can have high risk too.

      PS – I am no expert so dont listen to what I say. It woudl be good to hear from others as well.

      • Matt
        :

        Hi Nolan

        This business is not an A1 but it caught my interest due to the significant discount to IV. I think the next set of financial reports will be crucial. DGX makes up a small fraction of my portfolio now and is only 1 of 2 non A1’s I own. If an A1 came along with a similar discount to IV I’d switch but they are certainly harder to find now.

        The saying that you don’t have to swing at every pitch is very true. I’ve hit it.. but the ball is still in the air on this one.

        MattB

    • RobertD
      :

      This company has a huge amount of debt in comparison to equity ~97%. Best to be looking at companies with 0 debt, or minimal.

    • Andrew
      :

      Hi Nolan,

      I seem to be a bit different in approach and the valuation is the ending point rather than the beginning of my analysis. I am business first and valuation last if the business analysis warrants me putting in the effort.

      My thoughts are that it is very difficult to get any kind of competitive advantage in the construnction game. Apart from Trump which has managed to brand their buildings and his success differs greatly depending on who you talk too, the closest thing would be a workforce that is able to deliver the construction consistently on time and under budget.

      Other than that the success fo a development will depend on external elements like interest rates, property prices, location and the cost of materials to name a few. Some people think a bit differently, i commented on Finbar not long ago here and some people felt different.

      As for the financials, i agree with the rest. Far too much debt. The more debt the more risk and property is a risky game enough. It could well be a great company but lack of a competitive advantage in my view and the debt means i will pass regardless of any existign MOS.

  28. Neil
    :

    Hi Roger,

    watching you show i noticed u mentioned AGO atlas iron as being an exceptional business when it has a negative ROE , just wondering how did you get to your valuation of it having a higher intrinsic value then its current share price also MFG which has an ROE below 5%.

    any viewers of roger on tv tonight please feel free to comment

    • Pat Fitzgerald
      :

      Hi Neil

      AGO is forecast to increase earnings substantially in the next few years. I did own some but sold them because they have continually diluted shareholders by raising new capital, merging and now a takeover. Also the regulatory risk (mining tax) and the fact that when the iron ore price dropped AGO had to sell some of their iron ore at a loss. It does look like the iron ore price will stay high for a while but I am much happier not having to worry about the risks. Others may find this to be a good investment as it is now profitable, increasing its production, no debt and a very high ROE.

    • Greg W
      :

      Neil
      Atlas Iron (AGO) is a very interesting business that has exceptional growth prospects and while it has not made profits in prior years as it was not in production should report profits in excess of $160m this year and $270m the following year. Its forecast ROE is around 40% for 2011, 2012 and 2013.

      My IV calculations are:
      2011 – $4.22
      2012 – $7.34
      2013 – $11.21

      While the company does not pay a dividend at present I suspect it will in the not to distant future as this company generates substantial positive cashflow and production is set to ramp up dramatically over the coming years. The company also has no debt which is a massive positive. China still require tonnes of iron ore so AGO is in the right place.

      These IVs are based on a 14% RR so I believe they are conservative.

    • Ashley Little
      :

      Hi Room,

      Before anyone Invests in Iron or any other commoditity it may pay to look at the below video.

      http://www.youtube.com/watch?v=JO-lWNyPpec&feature=relmfu

      I am getting a fall on Investment as a % of GDP for China and a rise in consumption as a % of GDP.

      I would suggest that this would not be good for our commodities and we may have to find someone else to sell some of them to.

      We should also think about all the big increases in production that are being announced by the miners and what this may do to price in future years.

      Analysts like forecasting straingt lines which never happen.

      Iron ore is also the most abundant mineral on the planet

      Just my view

      • ron shamgar
        :

        their takeover of giralia will be highly dilutive as they are issuing 250million shares. IV will change dramatically. keep a close eye on results.

      • Peter
        :

        250 mil sounds alot – They already own 55% of garilia – they only need to buy the remainig 45% – so I dont think it will be that high – something around the 120 mil might be the number – I am getting valuations same as Greg W above, inclusive of the new issue.

      • ron shamgar
        :

        check out their presentation on the takeover, they will have 829m shares + 20m options on issue post acquisition. (assuming they get to 100% ownership and everyone elects to receive shares.

      • yavuz atasoy
        :

        But some of the best performing companies discussed in this forum at value.able last year are the ones servicing the resources industry, mainly iron ore. Take FORGE, MACA, Mineral resources, Monodelphus. If iron ore prices start decreasing then all these companies will be affected to some degree. On the other hand, a lot of the iron ore supply forecasted to come from magnetite producers, will simply not eventuate. Because some of the key magnetite projects are running either well over budget cost and/ or schedule. In addition to that my predictions are that some (if not most) of these magnetite projects will simply not be able to produce at their design capacities. Commissioning and ramp up periods will take a lot longer than usual. Who will benefit from this? Hematite producers (RIO, Atlas, etc…) and all companies servicing these producers. On the other hand service companies will benefit from up and coming magnetite producers (ironically), even if they may not be able to produce at budgetes rates. I think iron ore prices will stay high longer than most people predict.
        Regards,
        Yavuz

  29. Matt The Fat
    :

    Hi Roger,

    Saw you speak at CPA Congress last year. Read Value.able and enjoyed it. Already has given me heart with some of my “fallen stars” such as QBE and ignoring Mr Market’s infernal clattering (whom I always assumed to be akin to a child on a diet of red cordial who can’t read a financial statement). Been reading the blog for a while, but first post. Looking forward to running the green pen over your nominated A1s from tonight to try out your approach, and keenly watching for your posts over 2011.

    Cheers,
    Matt.

  30. Thomas
    :

    hi roger,

    what are your thoughts on rio tinto’s profit and do they get an MQR upgrade from B3 in november?

    I acquired this stock in may from scared investors and have a valuation of $89.28 with an RR14%, 101.43 @ rr13%, 117.51 @ 12% RR.

    since may i’ve also had an average capital gain from 8 stocks of 50% with half in A1 and half in mining. Rio Tinto is my worst stock but apparently has the biggest discount?

  31. Ashley Little
    :

    Nice show Roger,

    MCE still at a discount and they are doing all this with no Henderson as it is still being commissioned.

    I could not think of better people to run my business.

    I will just sit back and watch the ride.

  32. Chris
    :

    Hi everyone,

    Would anyone happen to know whether the analyst forecasts for EPS and DPS take into account any capital raisings or share buybacks? This could make quite a difference for some of my intrinsic values. If these analyst forecasts do not take into account the number of shares, should I guess how many shares there will be or should I just use the previous number of outstanding shares?

    Thanks,

    Chris

    • Roger Montgomery
      :

      Hi Chris,

      More often than not – as I mention in my book – analysts have a big row of zeros in their models for ‘new capital raised’. Its one of the reasons I look at NPAT for the whole company rather than EPS and DPS

  33. John M
    :

    Hi Roger,

    Half-yearly reporting is here. My question on behalf of all the value.able investors who are new to value investing is how to update IV using half-yearly figures.

    Is it best to split the NPAT for half and full year into two separate columns so that the new half year can be added to the last full year, and then summed.

    I have only ever done IV’s using full year results so this is new to me.

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