Who asked for Easter holiday homework?

403 Comments

1. 

   Tim
   May 2, 2011 at 4:55 pm:

   Hi graduates,

   some A1’s/A2’s and B1’s/B2’s that Roger has mentioned before on Switzer I think are FGE,MCE,CDA,TSM,ZGL and VOC.
   Interested in other graduates thoughts on these companies and how current IV and 2012 IV compare.
   I appreciate the knowledge shared here!

   Cheers,

   Tim.

2. 

   Andrew
   May 2, 2011 at 10:19 am:

   Sorry, just re-ran my TRS figure before Roger posts the resutls and a slight change.

   MOS calculated with the current price of $11.09, all at 10% RR

   2010 IV $18.00 (50% ROE, POR 68.96, EQPS $1.98, MOS -38.4%)
   2011 IV $11.89 (32.5% ROE, POR 60.29%, EQPS $2.25, MOS -6.71%)

   Looking forward to see how we went.

3. 

   Rainsford
   May 1, 2011 at 2:50 pm:

   Hi guys, I need some help in Debt/Equity. My understanding was that the 14 stocks selected by Roger all had debt/equity less than 50%. My calcs of straight debt/equity for TRS (61%), WAN (100% +), BKN (51%) and CPU (92%) are all greater than 50%. Obviously straight debt/equity is not the answer, Was Roger’s sort by debt/debt plus equity? What is the best ratio to use.

   thanks
   Rainsford

   • 

     Ash Little
     May 1, 2011 at 5:46 pm:

     Hi Rainsford.

     The best ratio to use is the one you are most comfortable with as long as you are consistant things will be fine.

     Roger has said in the past that real value slaps you in the face. Debt is like that as well. If you look at the balance sheet and find you need to do a debt equity calculation then you probably shouldn’t invest in the company.

     Hope this helps

     • 

       Roger Montgomery
       May 1, 2011 at 9:24 pm:

       Can I also suggest Ash, the use of the interest cover ratio?

     • 

       Andrew
       May 2, 2011 at 9:50 am:

       I concur, i have started using this ratio in my analysis and i think it has helped paint a good picture that when used in tandem with the leverage figure paints a good picture of what the business health looks like.

   • 

     Ken G
     May 4, 2011 at 9:12 am:

     Hi Rainsford

     This may or may not help. But in the book written by Mary Buffett ‘The New Buffettology’ She quotes WB as saying “he has found the traditional debt to equity ratio for ascertaining the financial strength of a company to be a poor measure of the financial power of the business. This is because a company’s assets are never a source of funds for retiring long term debt unless the company is in bankruptcy.” he goes on to say ” That most capital equiptment is so unique to the business that in truth it is worthless to anyone else, even though it is carried on the books at considerable value and that the best test ,then,of a company’s financial power is its ability to service and pay off debt out of its earnings”.
     I have a glance a its Net Profit againsts Debt if it take more than 3 to 4 years to pay it off it may not be suitable for me.
     Regards Ken G

4. 

   Peter N
   May 1, 2011 at 11:54 am:

   I can see from the other students that all of our figures differ.
   Was i correct in using the Westpac data or should i have done a more comprehensive analysis

   I have followed the instructions as best i could using the information in the Valu-able book and using Westpac as my data source as per the information on the data sources link (http://rogermontgomery.com/wp-content/uploads/2010/08/Where-to-find-the-Source-Data-for-Value.able-valuations.pdf)

   I don’t think i have properly managed to work out the method for calculating MOS, i have tried it as a percentage based on 2010 IV & 2011 IV (2011 IV used for the below MOS).

   I used the average book value (Pre calculated Equity per share from Westpac / Morningstar data source) instead of the 2010 book value as this was the method recommended in Chapter 11.

   ASX 2010 IV 2011 IV MOS
   TRS 14.486 10.295 -7.40%
   WAN
   CPU 11.536 5.883 -35.30%
   MRM 2.846 2.708 -3.60%
   FXL 5 2.572 3.30%
   CWP 3.089 6.599 20.00%
   SAI 2.27 3.723 -12%
   FMG 11.321 19.795 126.80%
   CCL 8.471 9.685 -21%
   RFG 3.327 3.168 2.40%
   TLS 3.48 2.11 -7.40%
   MMS 8.337 11.135 15.20%
   BKN 6.632 6.155 -16.80%
   ALL 1.682 1.843 -7%
   FGE 10.159 9.906 39.10%

   Westpac did not have data for WAN so i added FGE (Personal Interest).

   I can see from the other students that all of our figures differ.
   Was i correct in using the Westpac data or should i have done a more comprehensive analysis?

   If my MOS is drastically wrong as i suspect what is the correct calculation?

   • 

     Peter N
     May 1, 2011 at 11:56 am:

     I would also like to offer my thanks to Roger and his graduates for the time taken to improve our financial education.

   • 

     Andrew
     May 2, 2011 at 8:14 am:

     Without going too much into the calcualtions as i only did one which i think i posted below.

     May i suggest that the best place to find reported (i.e not forecast) details is to go straight to the financial report. I know this is longer but it is the most accurate.

5. 

   Geoff
   April 30, 2011 at 8:00 am:

   Sorry for a second Valuation (This time used Rogers future earnings guidance vice Commsec)
   TRS 16.11 –> 11.02
   WAN 5.33 –> 4.21
   CPU 10.94 –> 7.22
   MRM 3.04 –> 2.89
   FXL 5.78 –> 2.73
   CWP 3.28 –> 7.12
   SAI 2.22 –> 3.82
   FMG 9.21 –> 18.48
   CCL 8.99 –> 9.98
   RFG 3.71 –> 3.57
   TLS 3.62 –> 2.18
   MMS 18.53 –> 11.48
   BKN 6.02 –> 7.21
   ALL 3.65 –> 2.09

6. 

   Tim
   April 29, 2011 at 5:02 pm:

   I feel like I should post my homework results before Roger posts his answers….. Feel free to let me know what you think of them!
   Using 10% RR here are my 2010 and 2011 IV’s:

   TRS: $16.19 –> $11.77
   WAN: $5.92 –> $7.27
   CPU: $13.96 –> $8.12
   MRM: $3.06 –> $3.36
   FXL: $5.95 –> $3.36
   CWP: $3.26 –> $8.14
   SAI: $2.23 –> $4.56
   FMG: $15.67 –> $26.75
   CCL: $10.05 –> $10.89
   RFG: $3.60 –> $3.78
   TLS: $3.52 –> $2.15
   MMS: $9.89 –> $12.55
   BKN: $7.39 –> $7.49
   ALL: $1.82 –> $2.11

7. 

   Joab Soh
   April 29, 2011 at 12:52 am:

   Hi All,

   I have been quite disturb about the discussions in the blog lately.

   Going back to basic, our key focus is on “how to value the best stocks and buy them for less than they’re worth”. Accordingly, our contributions/questions should be around that.

   This should not be a forum to discuss recent changes in share prices, recent announcements on director of selling their holdings, or who in the community (including Roger) is buying or selling which stocks. Although these news may seem relevant today, my view is that they are ‘distractions’ from spending time to investigate and do your own homework on companies in order to differentiate the good ones from the bad ones.

   Personally, I would also like to see some boundaries around keeping comments relevant to the context post. It is getting more and more difficult to navigate through all the comments.

   I know we all have our favourite stock that we want to discuss, but may I suggest we do it in a meaningful way that will benefit this community as a whole.

8. 

   Rob
   April 28, 2011 at 3:13 pm:

   I’d better put my answers in.
   A: WAN, CWP, SAI, FMG, CCL, RFG, BKN.
   B: FMG
   Cheers
   Rob

9. 

   Anthony A
   April 28, 2011 at 8:21 am:

   Thanks for the encouragement and help guys

10. 

    Ken G
    April 27, 2011 at 4:04 pm:

    Hi All
    Would like to know what your thoughts are on Panaust (PNA)
    The following details are from Morningstar

    PNA is a copper-gold miner with operations in South East Asia. Its Phu Kham copper-gold mine in Laos started in 2008 and produces around 65,000t of copper a year. Cash costs near US$1/lb are below average for the industry, a 10 year life is respectable. Development projects include the Ban Houayxai gold project 25km west of Phu Kham and the Inca de Oro copper-gold project in Chile. Phu Kham cash flows should largely fund development and exploration aspirations. Debt was repaid in FY09 from equity issuance. Sovereign risk is average and will reduce with geographic diversification. Management’s good track record and exploration blue sky from Inca de Oro and Tharkhek appeal.

    Event

    PNA’s net profit grew nearly 600% to US$160m in FY10.
    Copper production increased 26% to 67,800 tonnes but revenue climbed 65% to US$572m thanks to much stronger copper prices.
    Operating cash flow was particularly strong, increasing from US$36m to US$265m and underpinning growth aspirations.
    The balance sheet remains in good shape with US$184m in cash and US$111m of net debt at 31 December 2010.
    Cash costs of US$0.87/lb of payable copper were 9% lower than FY09 and comfortably in the bottom half of the cost curve.
    Subsequent to the FY10 result, PNA announced a 1 for 5 share consolidation.
    Presidential approval came this month for the Inca de Oro project in Chile.

    Impact

    The Phu Kham mine in Laos continues to operate well and generates around US$300m in operating cash flows a year, comfortably funding exploration and development of other projects.
    PNA’s second mine will be the Ban Houayxai gold mine in Laos. The mine is 21% complete and will produce 100,00oz of gold and 700,000oz silver a year from late 2011.
    The Inc de Oro project will improve geographic diversification but more importantly enables access to Codelco and their asset portfolio.
    The share consolidation will increase the share price but shareholders will own fewer shares and will be no better or worse off financially.

    Some figures are
    Current Price.80
    EPS Current .047 Est EPS 2011 .078 may need revising down as usual
    Previous Book Value .19 Current .21
    Pay out Nil
    Previous Cash 98.34m Current 181.80m
    Previous Borrowings 113.56m Current 72.23m
    Previous Share Capital 603.10m Current 532.60
    With a ROE at 25 & Required RR of 12% it looks fully valued at present

    Management have a long history in this field and are respected by my broker and his company beyond that i have no knowledge
    Gary Stafford one of the directors holds a large number of shares
    the other directors hold smaller amounts The Directors have done some buying and selling but to little to note.

    • 

      Scott W
      April 28, 2011 at 4:49 pm:

      Ken I need to look further into this business as it interests me. Mostly because it reminds me of another business that in a former life was called OXIANA. This company was damaged due to taking on debt in a poor way, but in the better times I made quite a profit from the rapid climb in share price as they developed one of the first foreign owned mining businesses in Laos.

      I know that the salemanship of Owen H the former CEO aided OXIANA a lot, so with a lower profile I wonder if PNA will managed to get the attention of the market?

      Brokers like to recommend shares though, because they get paid on transaction cost. We could say the same of real estate agents and recruitment agents. I am not sure if any of them really add any value, but if they can stimulate action from us, it is usually good for them.

      • 

        Ken G
        May 3, 2011 at 7:11 pm:

        Thanks for the reply Scott sometime brokers do try to help. As mine did steer me away from DownerEDI pre Rogers book also encouraged me to purchase Corporate Travel on the float and other infomation on management which i have no access to. They sometimes have a place.
        Scott someone commented on Cash Flow and said a number of other figures needed to be added to the above info to have any meaning eg PP&E do you recall the blog and what effect it would have on my example of PNA or is it not worth the effort
        Regards Ken G

11. 

    Condog
    April 27, 2011 at 4:02 pm:

    Lloyd
    Your valuation of AUT is so wrong in so many ways it is almost impossible for me to address your inaccuraceis and errors, as the details required to do so would go many pages. So i will address some.

    Firstly the mentioning of shale gas as Ponze schemes is a complet joke. The Eagleford Shale has proven already to be an ultra reliable producer of highly pressurised gas and gas condensate. Aurora itself with the 17 wells flowing so far has a 100% success rate with commercial IP flow rates and constantly improving declines.

    In regard to the NSAI reserves statement, the reserves credited so far are extremely conservative and do not include parts of the Aurora holdings. Secondly it is more then likely AUT will end up with wells at 40 acre spacing and possibly lower, which will provide a doubling of reserves.

    In addition the reserves do not allow for the AUstin Chalks (the original target of the area) which AUT’s “Weston” well has been prolifically producing from for many many months. The use of the Austin chalks offers a realistic doubling of the already doubled reserves above.

    In regard to company information being secret, not so. Euroz has access to the data and has calculated the well repayment percentages in this reports. Many people who only go to the quarterly reports fail to note that whilst it appears revenue is small or non existant, in fact it is repaying hilcorp , and once repayed in full will suddenly appear as a large entry on the balance sheet.

    I strongly suggest using a forward cash flow projection method rather then a reserves based method, as the NSAI reserves are always going to be extremely conservative and well behind the development of the company.

    • 

      Condog
      April 28, 2011 at 7:30 am:

      Lloyd says – “Although AUT is a shale gas play the valuation principles, issues, and uncertainties are the same as for conventional oil and gas plays, although the risks are arguably higher for the reasons noted below. “
      I says – Incorrect, the Eagleford shale in its early days proved problematic as the correct techniques and equipment had not evolved. This is a vastly different story now that the technology and skills have been developed, with many companies including AUT, having a 100% success rate in targeting commercial flows from the EFS.

      Lloyd says – “For a value investor, the best, indeed likely the only time it is sensible to buy oil and gas stocks is during the cyclical “
      I say – Perhaps that’s true for a buy and hold investor. But its utter garbage for an intra cyclical investor. The best time to invest is when prices are on the rise and look like staying high.
      Lloyd says – A word on reserves:
      Valuation should be made on Proved and Probable (2P) reserve estimates……. ‘There is a 10% probability that the quantities actually recovered will equal or exceed the sum of the Proved plus Probable plus Possible reserves.’
      I say- This is all true, but it fails to show any understanding of the way NSAI conservatively and belatedly applies its techniques. We have already seen 3P reserves sured up to become 2P, and we will see it multiple times in the future.
      There are many avenues fro large scale increases in reserves that you have completely ignored. Including the reduction of well spacing which is currently 80 acre spacing, is likely to go 40 acres or less and could go down to 20 acre spacing. Also the fact there are several target layers of shale. The two most notibale are the EFS which they have 16 wells so far with 100% success. The other upper layer is the original target the Austin Chalks, which are also proving to be prolific producers. AUT has one well “Weston” producing in that layer already. This will offer significant cost reductions when they target the chalks at a later date.

      Lloyd says – Specific Issues attached to Shale Gas Reserves:
      This is quite a technical subject. However, based on the data disclosed I couldn’t get to more than 50% of the NSAI certified AUT reserves. Exponential versus hyperbolic production decline is at the core of the issue. Modest hyperbolic decline is likely, but the industry proponents are pushing aggressive extended hyperbolic decline, which (as always) will overstate reserves.
      I say – initial declines 12-24 months ago where hyperbolic. More recent wells on restricted choke settings have had minimal declines and are not looking hyperbolic, with some 60 day flows exceeding 30 day flows.

      Lloyd says- The company holds only minority joint venture, non-operated positions. Control of operations is with a third party. AUT is very much a passive investment vehicle in a shale gas play. Is this what you are looking for? The game plan may be to ‘enhance’ the value of previously purchased shale gas properties and then pass the parcel at some point; hence the composition of the Board.
      I say – we have Hilcorp as our operator, arguably the best operator in the entire US onshore oil and gas sector. Why would AUT want to be operator when they can secure Hilcorp who have uninterrupted access to some of the best frac and drill crews in the nation.
      Lloyd says – In reading the Euroz report remember AUT has near negligible production and requires another 53 well completions this year to get to its small first year production target. As a result, there is a lot of operational and project delivery risk in the business.
      I say- so far Hilcorp has had a 100% success rate for AUT. Its previous operator had an accident on one well, but Hilcorp and the EFS, have proven to be ultra reliable and
      Lloyd says – Reserves and Valuation:
      Therefore in buying AUT at the current price you are paying the equivalent of $1223/22 = $55.35/BOE.
      I say – yes that’s true. But if you fail to recognize the increases in reserves, yet to be unlocked, you don’t understand the company or the nature of the business. Without any technological or operational increase, AUT easily stands to increase its reserves by multiples.
      Lloyd says – In contrast, Roger’s IV methodology yields $0.00/share based on the most recent accounts for the period ended 31 December 2010.
      I say – anyone trying to do a valuation of its quarterlies has no idea how the company is operating. Both reserves and cash flow are delayed due to the fiscal and operational structure being used. Right now hilcorp could start drilling wells at 30 acre spacing and get NSAI to raise the reserves accordingly, but that’s not the priority. The priority is to secure the leases, by drilling one well per 80 acres, hence using all available to secure the leases. They could also choose to drop a few wells into the chalks to get NSAI to count the Chalks in the reserves report, but again, the priority is to secure the leases.
      Your valuation methods are completely flawed on this one and highlight the shortcomings of Rogers methods with rapidly growing oil and gas companies, that have higher priorities then securing large reserves reports.
      In time you will see these reserves increase significantly. Till then you are best to model your valuations on discounted forward cash flow projections. I have done so successfully with this company since it was at 25c and I have it valued at well over $6 at end of 2011.
      Lets see who’s closer to the mark.

      • 

        Rob
        April 30, 2011 at 10:05 am:

        Thanks for your posts. Differing points of view adds to our mind banks. I really enjoy the learning experience. Now if I didn’t have old timers I might retain some of it.
        Quote:
        Lloyd says – “For a value investor, the best, indeed likely the only time it is sensible to buy oil and gas stocks is during the cyclical “
        I say – Perhaps that’s true for a buy and hold investor. But its utter garbage for an intra cyclical investor.

        This is exactly right but this blog is about value investors as Lloyd says and by definition we are a buy and hold investors.

        The point of the exercise is not to provide a comprehensive analysis of all businesses. It is to, using Roger’s methodology, identify extraordinarily good businesses and a key ingredient is that we understand them.

        It’s not a shortcoming in Roger’s method that’s the problem, it’s not understanding their purpose and failing to apply all of the method. Many bloggers get hung up on IV but as Ash says in an earlier post this is probably the smallest part of the equation.

        Condg, I’d really like to hear from someone in the company. what do you think is your business’ sustainable competitive advantage over other businesses in your field? We try to identify number one and two businesses in a sector. Is AUT in that category? If so, why is it and what is its moat that makes its competitive advantage sustainable?

        BTW Roger outlines his reasons for not using “discounted forward cash flow projections” in his book. I have many, many books on the stock market and some are very good but none come close to Roger’s. Combine that with this blog and you have the best $50 I’ve ever spent. Actually $250 in my case.

        Thanks again for your contribution.
        Rob

    • 

      Roger Montgomery
      April 29, 2011 at 12:03 am:

      I have seen more and more posts on various forums disagreeing with my opinion on stocks that I have never shared an opinion about publicly. I have not discussed Aurora in any detail, so comments that propose I am right or wrong in my view/opinion/commentary appears misplaced. While images of knots and nickers float across the screen, can I just say I have the following valuations for AUT: 2011=51 cents, 2012=$2.12 and 2013=$3.91. Agree or disagree, it seems that the market (at $2.82) is beginning to price in the longer term prospects for value appreciation for AUT. The market could be be right. As Lloyd suggests however there is an element of speculation but as Mattyc suggests that element is diminishing – hence the market’s confidence.

12. 

    PETER WALLACE
    April 27, 2011 at 11:45 am:

    Hi Roger

    I’ve been ploughing my way through valueable
    quick question for Roger and others
    I have valued DWS at $4.07 (calculated at 13% return – current sp of 1.44
    and TRG at $8.46 (13% return -current sp of 4.70)
    EZL at 3.65 (13 % return, current sp of $2.15)

    This looks too good to be true as some of them are 50% or more undervalued

    what do others get? I also have COU well undervalued as well
    Am i doing something wrong?

    Peter

    • 

      Ken G
      April 28, 2011 at 9:10 am:

      Hi Peter

      I have DWS Current IV at 1.44 and next years IV 1.31 due to low earnings forcast of 0.141
      with a payout of 80%
      With TRG Current IV 5.02 next year 4.28 due to decrease of earnings from .506 down to .482 and a higher Book Value Used ROE 22.50 and then 20.00 Payout 65%
      With EZL the IV remains the same .96 as their is on earnings guidence I used 15% growth rate as the 10 year average is 19.5% with a payout of 95%
      Still does not answer your question. I tried to copy my work sheet off excel but got mixed results.

    • 

      Jonesy
      April 28, 2011 at 10:06 am:

      Peter, usually when you find something that is too good to be true, it probably is. I looked at DWS and TRG a few months back and felt that they were both just under intrinsic value, I’ve been waiting for them to drop a bit more. Might be helpful if you let us know what inputs you’ve used to get these intrinsic values/ You’ve used a 13% RR so that’s not the problem. But certainly somewhere along the line, there’s been a glitch.

      • 

        PETER WALLACE
        April 28, 2011 at 3:07 pm:

        thanks everyone for your responses -sounds like i’ve done something wrong

        I’ll copy my calculations for DWS below:

        equity: 186 million
        shares on issue: 132 million
        E÷S = 1.4 (equity per share)
        Dividends per share (2011 – 12c)
        Forecast earnings (June 2011) 14.1
        D ÷ E = .85 (85% pay out ratio)
        ROE = 32.9%
        Investor return = 13%
        Step 1. Run ROE against investor return on table 11.1 from Roger’s book (page 183)
        = 2.5
        Step 2. Run ROE against investor return on table 11.2 from Roger’s book (page 184)
        = 5.2
        Step 3. a = equity per share × step 1 answer
        a = 1.4 × 2.5 = 3.5
        b = equity per share × step 2 answer
        b = 1.4 × 5.2 = 7.28

        Step 4
        Payout ratio × a = 2.97
        b × 1 – payout ratio = 1.1

        2.97 + 1.1 = 4.07

        4.07 is intrinsic value for DWS at June 2011
        current share price is around 1.44 !!!

        Peter

      • 

        Trevor G
        April 29, 2011 at 4:42 am:

        Peter,

        Based on the information on CommSec equity should be $56m not $186m. I get 2011 IV of $1.29 using equity of $56m but $4.15 using $186m. So the math works its just the equity value thats off.

      • 

        PETER WALLACE
        April 29, 2011 at 12:01 pm:

        thanks trevor

        Iooks like I’ve been using the market cap figure for equity instead of looking for final equity on the balance sheet – don’t know why i did this

        I now come up with an IV for DWS of $1.16 at 13% return and $1.35 at 13% return

        what I’m still trying to get my head around is that some of the figures we input are changing from month to month as the company grows or struggles – for example how do you know what the current equity figure is ? or what it will be at the end of this financial year? I can find forecasts for earnings per share till june 2011 and dividends per share but what equity figure should i use?- the 2010 annual report? a half yearly ? is there a forecast equity figure to find somewhere for june 2011 ?

        thanks again everyone- I’ve got my L plates on so be kind !
        peter

      • 

        Matthew R
        April 29, 2011 at 5:30 pm:

        Peter, this blog will give you a good start:

        http://rogermontgomery.com/how-do-value-able-graduates-calculate-forecast-valuations-2/

      • 

        Ash Little
        April 29, 2011 at 5:46 pm:

        Hi Peter,

        This older post may help

        http://rogermontgomery.com/how-do-value-able-graduates-calculate-forecast-valuations-2/

      • 

        Matthew R
        April 30, 2011 at 1:01 am:

        Did I catch you snoozing Ash? ;)

      • 

        Ash Little
        April 30, 2011 at 10:39 am:

        LOL,

        Yep you beat me

      • 

        Jonesy
        April 29, 2011 at 6:28 pm:

        Here’s how it’s done. You know that current equity is $56m. How is this equity going to change? It’s the net earnings of the business minus the dividends which will be paid out. You have the forecast earnings per share and forecast dividends per share on comsec therefore, 2011 equity per share will be 2010 equity per share + earnings per share – dividends per share.

      • 

        PETER WALLACE
        May 1, 2011 at 9:09 pm:

        thanks everyone

        yes I’m now looking at equity on the 2010 annual reports and then using forecast earnings per share and dividends to get a 2011 equity figure per share.

        Must admit quite a few of my companies now look over valued!

    • 

      Andrew
      April 28, 2011 at 2:40 pm:

      Hi Peter,

      If you post your inputs you will find it easier for people here to help you. I have only looked at DWS and on a 13%RR I get the following from a really quick workout based on the 2010 annual report.

      EQPS $0.43
      ROE 34.24%
      POR 78.51%
      Intrinsic Value of $1.40

      using your figure of a $1.44 currently on the market this would mean it is currently at a roughly 3% premium to IV. Don’t take my figures as gospel but it is royugly around where Ken has it so you might be able to use some of my figures to see where any discrepency is.

13. 

    Andrew
    April 27, 2011 at 10:37 am:

    Lloyd and Ron had a good conversation about one of my fav companys at the moment in REA. I thought i would post it new as although it is in reply to what they were talking about i will also discuss something a bit more which is my theory on competition.

    The internet is a fast changing industry and barriers to entry are next to nill. Anyone can put up a new website and try to be the next internet sensation.Keeping it relevant over a long time will be the challenge for any business in this environment. REA (my top internet list website) are one of the businesses which have done that.

    My opinion is that competition is fought on three stages. For a business to succeed they need to be able to match the companies competitive advantage, brand power and than its financial resources. i usually use the metaphor of a castle.

    The competitive advantage is the size of the moat, the brand are the strength and height of the external walls of the castle and the financial resources are the cavalry inside ready to take the fight head on. The bigger the resources (cash & profitability) the larger the cavalry.

    The competitive advantage is created from the activities of the business, the better the activities the bigger and deeper the moat. For example someone like JB Hi-Fi is a lean mean machine where they operate on the lowest possible costs which are internalised through activities and processes. They are then able to dictate the price that the rest of the market who aren’t operating on the same cost structure to compete on. This causes JB’s profitabiltiy to be higher as they have added the most value through its activitys and the others have a margin squeeze.

    The brand is developed by taking advantage of its competitive advantage and getting it all wrapped into a marketable parcel which connects to the customer and they become attached to the brand on an almost emotional level. This means that they will re-use products or services by that company and in some cases defend it by refusing to engage in a competitors product regardless of whether it is better or has more value.

    So starting with competitive advantage and the battle begins:

    Onthehouse seems like it has enough of a differentiating factor that it could possibly overcome the first hurdle which is the competitive advantage element. If they can come up with a well designed website and then add free property/suburb data etc than that is a add-on which will create value for customers and as long as the cost side and business/financial performance (ie can they make it profitable) is up to scratch they can compete with REA.

    The next stage is based on brand. This includes brand awareness. The question is how will onthehouse get its message out there, how much will it cost to get the message out there and will it be effective. realestate.com.au is a well known address and people will enter it in almost out of habit without thinking. Domain have been advertising heavily but still don’t seem to make any inroads so what will onthehouse do differently. This is going to be the interesting battlefront. They have a sleeing point, it will come down to the selling.

    The final stage is the financial resources, this is the bloody man on man area of the battle coles and woolworths are currently in. This is just an all out price war. If onthehouse gets to this stage than more than likely there will be damage to everyone. REA is a cash machine and highly profitable, the start up as Lloyd mentions seems to be well capitalised. Will they fight head on and start slashing the income producing areas or will they let eachother co-exist. I have to agree with Lloyd, if they get to this stage of the battle than the only logical conclusion for me is a drop in REA’s margin.

    My gut tells me REA will eventually come out ahead as they have the better castle, but damage will be done in the short term. Also, if you are investing in internet businesses than you better get used to these battles as they will always come up.

    • 

      ron shamgar
      April 28, 2011 at 11:33 pm:

      Andrew,

      its really simple:
      go talk to 10 different realestate agents and ask them if they will stop listing on REA and move onto onthehouse?
      if most say yes, than maybe Lloyd is right. in my opinion i doubt it. if i was an agent i would stick to what works and dont forget i dont pay for the listing, the property owner does.
      i actually find onthehouse listings more of an aggregation as some of the listings are not current.
      BUT like you said this is a dynamic industry, so who knows what will be around in 5 years time.

      • 

        Andrew
        April 29, 2011 at 8:28 am:

        From my understanding the agents will not need to leave REA and go to Onthehouse. REA doesn’t from what i understand have exclusive rights to the ads and if onthehouse are offering free listings than why wouldn’t agents throw the properties onto the site.

        My opinion is that there are no bulletproof companys in the world, there are a few that come close but REA isn’t one. Onthehouse do have a differentiating factor that could help attract customers/eyeballs.

        If onthehouse gain traction, than REA will need to do something to compete and this could hit their margins/earnings. Agents don’t need to remove their listings from REA to hurt them.

        As i mentioned, the battle here will be in regards to whether onthehouse do a good job of getting their name out there and do a good job selling that differentiating factor. I know i would love to have access to free data whilst i am purchasing, perhaps other people in the property market won’t. Perhaps, the domain realestate.com.au is a hard one to beat.

        As i said, i expect REA to come out ahead but the inner cautious person in me that likes to weigh up all things that are happening in the operational landscape, is not sure yet whether this will be due to an early knockout or a points decision after a long hard fought battle. Time will tell. I am still a big fan of REA.

        I think it is prudent to take all competitors on their merits, and i hope that the management of REA do the same. This competitor or future competitor i think can be a big thorn in the side of REA so i will watch it, if you think that REA is inpenetrable and onthehouse is not worth worrying about than that is your conviction and you are more than entitled to that opionion.

14. 

    Alex
    April 26, 2011 at 8:55 pm:

    Hope everyone had a nice Easter,

    First time posting here but a huge fan of Roger’s work for some time. Thank you Roger for a great book & a great blog.

    Here is my attempt at the homework. Would be great to hear other valuable graduates thoughts.

    Most of the companies seem to show declining IV with the biggest MOS for FMG. Although ROE assumption looks high (50%) & should probably be a lot lower.

    Current FY10 FY11 MOS
    TRS 11.68 16.51 7.90 -32%
    WAN 5.02 5.80 4.50 -10%
    CPU 8.94 11.31 6.31 -29%
    MRM 3.20 3.06 2.59 -19%
    FXL 2.29 6.23 2.76 20%
    CWP 4.70 3.94 5.84 24%
    SAI 5.08 2.43 3.32 -35%
    FMG 6.49 9.74 10.47 61%
    CCL 12.16 9.51 9.07 -25%
    RFG 2.90 3.88 3.34 15%
    TLS 2.85 3.64 2.83 -1%
    MMS 9.89 25.73 11.74 19%
    BKN 7.85 6.81 6.81 -13%
    ALL 2.81 4.02 1.93 -31%

15. 

    John M
    April 26, 2011 at 3:46 pm:

    G’day one and all,

    I hope everyone has enjoyed their Easter break.

    Just some thoughts on MMS. I personally used a lower NPAT than was reported on the Income statement. I think that the sale of assets of 11.79M (cashflow statement) is abnormal (I looked at the last few annual reports) and significant. So I deducted this from the NPAT and this significantly reduced my 2010 IV and MOS. I am interested to hear from some of the accountants and Rogers take on this.

    Thought the following links would be helpful to illustrate the risks of the high gearing that MMS has taken on since the aquisition of Interleasing.

    http://rogermontgomery.com/what-do-i-think-of-mcmillan-shakespeare-now-2/

    http://www.thebull.com.au/articles/a/17619-thebull's-stock-of-the-week.html

    Remember that this is only an exercise and that 10% RR is arguably used for only a handful of the best companies. 10% has only been used for consistency as part of the exercise.

    • 

      John M
      April 26, 2011 at 4:12 pm:

      http://www.thebull.com.au/articles/a/17619-thebull's-stock-of-the-week.html

    • 

      Michael
      April 27, 2011 at 8:22 pm:

      Hi John,

      With such a big discount recorded on acquisition in the income statement, the auditor in me says the fair value accounting may be a bit out here. For example if I bought an asset for $1,000,000 and you bought it from me for $800,000, how much is your asset worth? MMS says $1,000,000 and books an immediate gain of $200,000. What they are saying in effect is the seller gave the assets away for less than the value of its identifiable assets. This does not happen often.

      In any case, you are absolutely right to back out one-off items to determine a true measure of the sustainable return on equity, and the gain in the MMS income statement should be deducted.

      Note that the amounts in the cashflow statement are unlikely to be abnormal as such, they would likely be new streams of cash inflow and outflow from the normal operations of the acquired leasing entity, and not directly related to the gain in the income statement from the acquisition.

      • 

        Greg
        April 28, 2011 at 11:59 am:

        Hi Michael,

        I like your post. It touches a subject that bothers me.
        We valueablers use the amount of equity and the return on that equity and the retained portion of earnings plus a required return figure to value an enterprise.
        Equity is a variable number with our accounting standards.
        Your example shows it could be either 1M or 800k depending on the boards preference (subject to auditors agreement, I guess).
        Earnings are generated by assets and those assets have a book value.
        My issue is: that earnings are independent of the “manipulated/manufactured/accepted” (language way too strong ?) equity number. The following examples have identical Earning and Distributed numbers but different equity and derived ROE and IV numbers. [I hope the layout looks ok]
        oe=1,e=.2,de=0 (por 0%)
        oe roe e por re de ce rr iv
        1.00 0.20 0.20 0.00 0.20 0.00 1.20 0.10 3.48
        1.20 0.20 0.24 0.00 0.24 0.00 1.44 0.10 4.18
        But if we change the equity number to 0.8 but keep the same earning and dividend then the valuation changes.
        oe=.8,e=.2,de=0 (por 0%)
        oe roe e por re de ce rr iv
        0.80 0.25 0.20 0.00 0.20 0.00 1.00 0.10 4.16
        1.00 0.24 0.24 0.00 0.24 0.00 1.24 0.10 4.83

        Similar but less dramatic for a 50% Pay out Ratio (less earnings being compounded)
        oe=1,e=.2,de=.1 (por 50%)
        oe roe e por re de ce rr iv
        1.00 0.20 0.20 0.50 0.10 0.10 1.10 0.10 2.74
        1.10 0.20 0.22 0.50 0.11 0.11 1.21 0.10 3.02
        oe=.8,e=.2,de=.1 (por 50%)
        oe roe e por re de ce rr iv
        0.80 0.25 0.20 0.50 0.10 0.10 0.90 0.10 3.08
        0.90 0.24 0.22 0.50 0.11 0.11 1.01 0.10 3.35

        No effect at all on 100% Pay out Ratio (no compounding)
        oe=1,e=.2,de=.1 (por 100%)
        oe roe e por re de ce rr iv
        1.00 0.20 0.20 1.00 0.00 0.20 1.00 0.10 2.00
        1.00 0.20 0.20 1.00 0.00 0.20 1.00 0.10 2.00
        oe=.8,e=.2,de=.1 (por 100%)
        oe roe e por re de ce rr iv
        0.80 0.25 0.20 1.00 0.00 0.20 0.80 0.10 2.00
        0.80 0.25 0.20 1.00 0.00 0.20 0.80 0.10 2.00

        The less compounding the less the effect of the book value has on IV.
        I guess this is one reason the industry likes to use PE ratios, and why Roger has advised, approx right rather than precisely wrong, AND why margin of safety gives us best coverage of most variables (risks).

        Regards Greg

      • 

        Greg
        April 28, 2011 at 1:23 pm:

        Hi Roger,

        I made two typos in my above comment, could you please let everyone know the corrections are here:
        On the third example I headers “oe=.8,e=.2,de=.1 (por 100%)”, should read “oe=.8,e=.2,de=.2 (por 100%)”. I messed up the distributed earning (de) number.

        Many thanks
        Greg

16. 

    Rob M
    April 26, 2011 at 1:25 pm:

    Hi All,

    First post from me here. Great blog and a great book thankyou Roger!

    My only disappointment was that there is no explanation for how the multiplication table for retained earnings is derived…

    My understanding is that the IV calculation assumes that ROE and RR are constant into the future. IV is defined as the NPV of all future cash flows. However, for a company that has ROE greater that RR forever, the IV is infinity. This is obviously impossible because that business would eventually out-grow the world.

    Hence, my conclusion is that the IV calculation in the book must actually be a ‘rule of thumb’ about how much to pay for a particular business.

    I am not questioning whether the method is effective for making intelligent investments, but would appreciate it if it’s derivation can be explained….

    thanks in advance,
    Rob

    • 

      Matthew R
      April 27, 2011 at 2:45 pm:

      There is a formula behind the growth table, I’m sure with a bit of digging you’ll work it out if you want to

      In terms of the growth multiplier and it’s application, you may find this post by Gavin interesting:
      http://rogermontgomery.com/valueline-fifteen-stocks-to-watch/#comment-11265
      It made me think and I used up the backs of a few envelopes after reading that one

      • 

        Andrew
        April 28, 2011 at 3:15 pm:

        Thanks for flagging that Matthew, i missed it when it came up.

        I can see that i had .04c difference when using the method in the post you linked and using the other method based on the value.able formula.

        But in regards to Rob’s post, yes the formula is used to come up with an ESTIMATE of intrinsic value. It is better to be approximatley right and then we add extra insurance by buying at a huge discount to that IV. Any errors or surprises can be absorbed in that margin of safety and as we choose. As we only choose the highest of quality of businesses than the surprises will hopefully be few and far between.

        As you mentioned,the formula is too be used as a rule of thumb and is not gospel.

        As mentioned here a few times, the calculation is probably the least important part of the whole process and of Rogers book. It gets the most attention as it is easy and will no doubt decide whether we buy or not.

        The key to all things is the rest of the book in regards to finding top quality companies.

    • 

      Ash Little
      April 27, 2011 at 5:42 pm:

      Hi Rob,

      You are correct
      we are trying to be approximately right and buy at big discounts

    • 

      Paul Rehill
      April 27, 2011 at 6:35 pm:

      “My understanding is that the IV calculation assumes that ROE and RR are constant into the future. IV is defined as the NPV of all future cash flows. However, for a company that has ROE greater that RR forever, the IV is infinity. This is obviously impossible because that business would eventually out-grow the world.”

      True so Roger’s tables have some implicit conservatism in them so it’s like an extra margin of safety. The tables are his secret recipe and as hard as we try, he won’t explicitly divulge how the factors are derived.

    • 

      Rob
      April 28, 2011 at 8:20 am:

      Hi Rob,
      The derivation of the tables is credited under the table to Richard Simmons. I believe, Roger has changed the formula slightly to make it more conservative. Roger is always conservative to ensure he selects only the best business.
      He is only interesed in the best two companies in a sector three and fours don’t cut it.
      To do this, he builds safety margins into every step to abrogate risk. His approach is uber conservative. If a business jumps all the hurdles then you can be reasonably sure it’s a good business.
      Rob, there is much to be gained by rereading the book and reading this blog. There are a lot of intelligent contributors on this blog.
      Cheers
      Rob

      • 

        Rob M
        May 2, 2011 at 2:21 pm:

        Thanks guys,

        Very helpful posts – I am fairly new to this forum, so hadn’t seen Gavin’s comment.

        Like any mathematical model, the tables provide a representation of reality, not reality. In order to apply and use a mathematical model of a real situation, the assumptions must be known for the user to understand the limitations of the model and be able to interpret and use the results.

        Thanks again – big step just there for me understanding the Value.able method.

      • 

        Roger Montgomery
        May 2, 2011 at 3:12 pm:

        Hi Rob,

        Presumptive. Better read page 193 carefully.

17. 

    Anthony A
    April 26, 2011 at 10:20 am:

    Hello Roger and Bloggers,

    Great book and blog. I have learnt a great deal on investing in companies since discovering your book and blog. I have now worked up enough courage to write my first blog ever, though there is no insight just questions. Can someone please help. Apologies for the very basic questions as I am not as smart as all you here.

    I have no real trouble working out company IV for current years using financial statements. My difficulty is working out the future IV’s. Take The Reject Shop 2011
    I can work out the EPS = $2.25, POR = 60.3%
    How do I get the ROE and NPAT for that year.
    Once I have these componants do I then use the formulae and multiplier tables as per calculating current IV’s?

    Regards
    Anthony

    • 

      Andrew
      April 27, 2011 at 10:04 am:

      Hi Anthony A,

      If you divide the EPS figure by the average of the beginning and ending equity per share figures you will get the ROE.

      Think the formula below:
      EPS/Average(EQPS1,EQPS2)

      EPS is the forecast EPS figure
      EQPS1 is the previous years equity per share figure
      EQPS2 is the forecast equity per share figure (in rogers homework this would be previoud year EQPS + EPS – DPS, however there are another two inputs which can have an affect but not on the basis of the homework)

      The EPS is the NPAT but in a per share basis. Conversley, this means if you multiply your EPS by the amount of shares you forecast than you will get your forecast NPAT.

      After that it is just the same as working out any other IV using the value.able method.

      Hope this helps.

    • 

      Matthew R
      April 27, 2011 at 11:37 am:

      Firstly Anthony – we are not all smarter, some not even smart ;) but sensible we are

      Don’t worry, some are just a little further down the path than you are. Keep going!

      To answer your question – you can work out a future year’s ROE by dividing the EPS by a forecast of equity per share (EQPS) for the year.

      A simple way to work out the future EQPS is by adding forecast EPS and subtracting forecast dividend per share (DPS).
      An advanced version is to adjust this for expected capital raisings/exercising of options but for now the above will put you “approximately right”

      Work out future POR by dividing forecast DPS by EPS

      Then you can apply the tables as per the book to the above

    • 

      Jonesy
      April 27, 2011 at 12:40 pm:

      Anthony, don’t feel you’re “not as smart” because you’re asking basic questions, we’ve all done it already when we started out.

      OK, If you’ve worked out current IV, then you should have 2010 Equity per share. The next steps will then be:
      1. Take the earnings per share guidance for 2011 Roger gave us (65 cents)
      2. Take away the dividends per share guidance (41 cents) from the EPS = 24 cents
      3. This 24 cents will be retained in the business as equity, therefore 2011 Equity per share will be 2010 Equity per share + 24 cents (this should equal $2.25)
      4. ROE will be 65 cents/(average 2010 and 2011 Equity per share)
      5. Thefore ROE = 65 cents / (average $1.98 and $2.25) which will be 32.1%
      6. Payout ratio will be 41 cents/65 cents = 60%

      You should now have all the information you need to work out 2011 Intrinsic value

      • 

        Rob
        April 30, 2011 at 9:17 am:

        Mea culpa, I haven’t been averaging equity for future IVs because I’ve either followed Roger on p196 or in the blog mentioned, by Ash, below.

        I mention it only to highlight reasons why we each can come up with slightly different answers. Some will take known share issues into account as well.

        I think Roger will say, either way it doesn’t matter as long as you Do it the same way each time.

        Cheers Rob

    • 

      Ash Little
      April 27, 2011 at 5:35 pm:

      Hi Anthony,

      Have a read of this older blog.

      If you still have questions let me know

      http://rogermontgomery.com/how-do-value-able-graduates-calculate-forecast-valuations-2/

18. 

    Gavin
    April 25, 2011 at 2:36 pm:

    In relation to the cash flow exercise homework.

    The figure tells whether the company is self funding at current dividend levels, but not much else.

    This calculation doesn’t give you just operational cash flow. It is also affected by investment in PPE and working capital etc.

    If you add back to the cash flow figure you have produced, increases in working capital and PPE investment that relates to business growth (+minority investments etc) then you would have free cash flow after allowing for maintenance of the existing business. That figure does tell you something meaningful.

    Cash flow invested into working capital and PPE to grow the business will add economic value, so long as these investments produce a return higher than the cost of capital to the company.

    A negative or decreasing cash flow as calculated by the method given is not necessarily a bad thing. You have to look at how the cash is being used and the return investment for growth generates. Some companies you want to grow and some you don’t. It all depends on their return on incremental capital.

    How a company funds growth beyond that which it can handle internally is very revealing about how management looks after minority shareholders interests. A lot of them fair very poorly on this front. Institutional placements are almost an industry endemic scandal in Australia, and because of them some existing shareholders are robbed of their moral right to have the first opportunity to proportionally provide the capital for economically positive opportunities.

19. 

    Matty
    April 24, 2011 at 9:16 pm:

    Hi Roger & Followers, Happy Easter.

    Thanks everyone for the great posts of late. Feel a little bit out of this league at the moment. How about a mere mortal blog space Roger?

    Below are my results from the Easter homework. For the 2011 forecast IV I didn’t investigate deeper into the numbers for equity issues not reflected in the latest financial report, so this is also a source of potential difference to your answers.

    I also threw GEM in there because I was intrigued how Roger upgraded this one from a C4 to an A2 rating from an earlier post. Still not sure how this one gets an A2. ROE is about 15% if you do a straight (Start/end year) average. However, the equity raising was on December 1st 2010, so if you instead average the equity, over the weighted financial year (as I assume Roger has done) then ROE would be about 18.9%. Still not scintillating stuff and this added to the fact that intangibles are 60% of net assets and debt/equity is 29% still has me scratching my head. If there is a rate of change or derivative component to these business metrics in the MQR then this would partly explain why this business has moved to an A2 because this is light years ahead of how they were looking last year. Cash flow is still bad though.

    2010 IV Market $ MOS 2011 IV
    TRS 18.01 11.68 35.1% 10.55
    WAN 3.67 5.02 -36.7% 4.31
    CPU 11.47 8.94 22.0% 8.29
    MRM 3.05 3.2 -4.9% 2.72
    FXL 6.01 2.29 61.9% 2.84
    CWP 3.16 4.7 -48.6% 6.86
    SAI 2.25 5.08 -126.0% 3.85
    FMG 9.21 6.49 29.6% 23.96
    CCL 8.96 12.16 -35.7% 9.68
    RFG 3.67 2.9 21.0% 3.81
    TLS 3.50 2.85 18.5% 2.15
    MMS 19.00 9.89 47.9% 12.55
    BKN 5.93 7.85 -32.4% 7.46
    ALL 2.53 2.81 -11.0% 2.13
    GEM 0.76 0.94 -24.2%

    Cashflow analysis ($’000)

    TRS 2009 2010 Difference
    Cash 865 4339 3474
    Borrowings 14375 31327 16952
    Share Capital 3336 3336 0
    Dividends Paid 16103 16103
    Cash flow 2625

    RFG 2009 2010 Difference
    Cash 5414 13105 7691
    Borrowings 95480 85852 -9628
    Share Capital 80959 95146 14187
    Dividends Paid 8880 8880
    Cash flow 12012

    ALL 2009 2010 Difference
    Cash 59045 19840 -39205
    Borrowings 134349 305662 171313
    Share Capital 185320 187625 2305
    Dividends Paid 17894 17894
    Cash flow -194929

    GEM 2009 2010 Difference
    Cash 173 8016 7843
    Borrowings 17453 15551 -1902
    Share Capital 30958 77985 47027
    Dividends Paid 1282 1282
    Cash flow -36000

    • 

      Rob
      April 26, 2011 at 9:08 am:

      Hi Matty,
      Given the EPS and DPS provided by Roger my 2011 IV for FMG is a lot higher.
      Cheers
      Rob

      • 

        Rob
        April 27, 2011 at 11:03 am:

        Ooops….sorry Mattie, I completely misread your figures mine is actually a little lower. Too many parties on this extra long weekend. Apologies again.

20. 

    Steve
    April 24, 2011 at 1:42 pm:

    Further to my comment earlier regarding VOC (and after just reading Ash’s comments regarding 1st prize/2nd prize situations), I note that VOC would currently be a 3rd prize situation. Certainly not ideal and I just wonder if there is some justification going on for purchases well above current IV. Or is the potential increase in IV in future years really that great? Isn’t it better to keep money in cash until that 1st prize situation comes along?

    • 

      Brad J
      April 25, 2011 at 10:15 am:

      Hi Steve,

      The problem with us humans is we want to come up with a set of rules to suit all occasions. In my opinion the normal rules don’t apply to VOC as it is just growing too quickly. Plus most on the blog are working on the latest financials for the calendar year end 2010. Is it sensible to be looking at a valuation for last year for a company that will most likely be twice the size at the end of this year?. For this year and as mentioned previously I believe it is at a large discount. I just about always buy at around a 30% discount to IV but not in the case of VOC as the opportunity cost could be too great. By the way it is not an A1 and therefore is for an investor with a higher risk appetite.

21. 

    Michael
    April 24, 2011 at 12:30 pm:

    Looking through the stocks on the market recently, there is very little to buy at discounts to intrinsic value at the present time, with many of the best companies at or above their intrinsic values.

    It seems to be a time to wait for opportunities to arise, either after a sell off in the markets, or new companies emerging that are at big discounts. Value investing calls for patience at these times. If it takes time for opportunities to arise, then I will wait.

    We have seen alot of discussion about speculative areas recently, but I hope we don’t lose the discussion around the core principles of buying top quality businesses at discounts to intrinsic value.

22. 

    Lloyd
    April 23, 2011 at 6:50 pm:

    Aurora Oil & Gas Limited (ASX code AUT & TSE code AEF)

    Ash,

    You asked for my thoughts on Aurora Oil & Gas Limited (ASX code AUT & TSE code AEF) and the Euroz report or the company. Following are some observations, which point to what you need to consider when valuing this and other small cap oil and gas businesses.

    Although AUT is a shale gas play the valuation principles, issues, and uncertainties are the same as for conventional oil and gas plays, although the risks are arguably higher for the reasons noted below.

    For ease I assume the AUD=USD in the following discussion. Before proceeding I note that all of this is personal opinion and does not constitute professional financial advice. Think about it but don’t act upon it without seeking professional advice.

    A truism:
    For a value investor, the best, indeed likely the only time it is sensible to buy oil and gas stocks is during the cyclical low in oil and/or gas prices. Invest elsewhere in the price cycle and you are either a momentum trader, or a speculator. Take a look at where we sit in the oil (NYMEX: WTI) and gas (NYMEX: Henry Hub) price cycles and make your call.

    A word on reserves:
    Valuation should be made on Proved and Probable (2P) reserve estimates with the understanding that there is only a 50% probability that such an estimate of recoverable oil and/or gas will be met, or exceeded. Basing valuations on Proved plus Probable plus Possible (3P) reserve estimates is problematic. To quote from the most recent (March 2011) AUT Investor Presentation Slide 27 footnote ‘There is a 10% probability that the quantities actually recovered will equal or exceed the sum of the Proved plus Probable plus Possible reserves.’ AUT and the analysts reporting on it then proceed to ignore this quantified probability by valuing 3P reserves in subsequent valuations (in an attempt to justify the current market valuation?). Notice the mathematical and logical inconsistency?

    Specific Issues attached to Shale Gas Reserves:
    This is quite a technical subject. However, based on the data disclosed I couldn’t get to more than 50% of the NSAI certified AUT reserves. Exponential versus hyperbolic production decline is at the core of the issue. Modest hyperbolic decline is likely, but the industry proponents are pushing aggressive extended hyperbolic decline, which (as always) will overstate reserves. The linked article gives some feel for the games that may be being played and to suggest that Shale Gas reserves my prove to be the ultimate Ponzi scheme is not out of the question:
    http://www.energybulletin.net/node/49342

    For the more technically inclined the following links provide more discussion of the problem:
    http://www.oilslick.com/Commentary/?id=746&type=1

    http://www.oilandgasevaluationreport.com/2010/03/articles/oil-patch-economics/shale-economics-watch-the-curve/

    Incidentally the late great Matt Simmons (author of Twilight in the Dessert and of Peak Oil fame) was of this view.

    The message is that you need to view unconventional shale gas reserve estimates with some caution, as typically more than 50% of the forecast gas recovery is projected to occur after 10 years, way beyond the experience of the industry to date, some even pushing this out recovery out to up to 45 years from the initial production!

    AUT Board:
    Seven highly paid (for a minnow of a company) directors with two oil and gas career professionals amongst them. The balance is from investment banking, finance and legal backgrounds. It looks a bit like a lifestyle support vehicle to me. To this add the unnecessary costs of dual listing ASX and TSE and you have to question the game plan.

    Operating Model:
    The company holds only minority joint venture, non-operated positions. Control of operations is with a third party. AUT is very much a passive investment vehicle in a shale gas play. Is this what you are looking for? The game plan may be to ‘enhance’ the value of previously purchased shale gas properties and then pass the parcel at some point; hence the composition of the Board.

    Euroz and other analysts’ Reports:
    Euroz disclosure is worth remembering when you read the report… ‘Euroz Securities declares that it has acted as underwriter to and/or arranged an equity issue in and/or provided corporate advice to Aurora Oil & Gas Ltd during the last year. Euroz Securities has received a fee for these services. This analyst also declares that he has a beneficial interest in Aurora Oil & Gas Ltd.’

    In reading the Euroz report remember AUT has near negligible production and requires another 53 well completions this year to get to its small first year production target. As a result, there is a lot of operational and project delivery risk in the business.

    Perhaps unsurprisingly I cannot replicate anything close to Euroz forecast for this and subsequent years based on what I consider realistic assumptions.

    Also remember that based on the AUT well data disclosed to date that the average production decline is 70% in the first year (in contrast to 0-10 % typical of a conventional gas well). As a result, the rolling production increase forecast by analysts requires an exponentially increasing number of wells to be drilled year on year and this does not appear to be fully accounted for based on my modelling. All told over 900 wells (by AUT’s estimate) have yet to be drilled (at gross joint venture cost of $6.8 million per well) and completed in the next 8 years to generate the forecast production. Work this through in terms of logistics and risks, plus capex and financials, and you will see the problem that this treadmill rapidly creates accompanied by the associated risks of capex escalation and schedule (value) slippage. It is easy to do on a spreadsheet, but quite difficult in the real world!

    Reserves and Valuation:
    A very basic assessment metric is how much you are paying per barrel oil equivalent (BOE) of estimated 2P reserves when you buy an oil and gas stock.

    Currently AUT has an enterprise value (market cap plus net debt) of $1223 million based on 416 million shares on issue.

    Proved and Probable (2P) Reserves at 31 December were 22 MMBOE (million barrels oil equivalent) of which only 2.54% (560,065 barrels) was condensate, which is effectively priced as oil.

    Therefore in buying AUT at the current price you are paying the equivalent of $1223/22 = $55.35/BOE.

    However, 97.5% of the BOE is gas and NGL’s which is priced at $24.84/BOE (at last Henry Hub gas price of $4.14/mmbtu). Sure there are a few adjsutments for NGL content above gas thermal spec, but lets not complicate the matter. The current market price of the stock imputes a value to the reserves of roughly twice the current undiscounted revenue of the 2P production over life (assuming no gas price rise). AUT on Investor Presentation Slide 14 footnote obliquely hint at the problem…. ‘BOEs may be misleading, particularly if used in isolation. A BOE conversion ratio of 6 Mcf:1 bbl is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.’ To this I might at that it grossly overstates the value under prevailing oil and gas price relativities in the USA ($4.14/mmbtu gas is equivalent to $24.84/BOE gas versus current oil price $112/Barrel WTI)

    Another way of looking at it is that the certifier of AUT’s reserves estimate, NSAI, valued (10% pre-tax NPV) the 2P reserves at burner tip at $414.5 million or $18.75/BOE (pre-tax). This is more realistic, but still reasonably generous as it is based on on perfect project delivery and costings. On my estimates of production, schedule and capex (without including reserves downside) it is closer to $5/BOE atax.

    As a result, we have a range of after tax valuation for the 2P reserves estimate of $110 million ($0.26/share) to $290 million ($0.70/share).

    In contrast, Roger’s IV methodology yields $0.00/share based on the most recent accounts for the period ended 31 December 2010.

    Last closing price was $2.94/share.

    Clearly Mr Market is valuing in a remarkable amount of upside to the currently certified Proved and Probable reserves of the company.

    So are you feeling lucky?

    Regards
    Lloyd

    • 

      Lloyd
      April 23, 2011 at 7:57 pm:

      P.S. for the nitpickers I note that I omitted to subtract net cash of $46 million in the Enterprise Value calculation, which should read $1177 million instead of $1223 million. This changes the market pricing to $53.27/BOE from $55.35/BOE. It doesn’t alter the magnitude of market overpricing!

    • 

      Roger Montgomery
      April 23, 2011 at 10:16 pm:

      Hi Lloyd,

      If readers don’t appreciate why they are so fortunate that they don’t have to pay $1000 per year for a subscription to the blog, this post should provide some clarity of thought. Thank you again – and also for illustrating why I don’t believe ‘hope’ is a valid investment strategy..

      • 

        Ash Little
        April 23, 2011 at 10:48 pm:

        Hi Lloyd and Roger,

        I know both your views are given away for free but I would gladly pay for them.

        I sincerley thank you both

      • 

        Chris B
        April 24, 2011 at 11:02 am:

        Ash,

        I think you speak for many of us here :)

        Thanks to all who are selflessly taking the time and effort enhancing other people’s development on their investment journeys.

        Chris B

      • 

        Gavin
        April 24, 2011 at 10:58 am:

        Lloyd

        Reading a post on AUT is something I would not normally bother with because I’m just not interested in oil companies – It’s not my thing. But I will follow some authors into subject matter where I wouldn’t normally go. So I read this post.

        Apart from obviously exceptional insights in his area of expertise the thing I really took away is just how important sticking to your own area of specialisation is. I didn’t even know that I didn’t know some of the stuff Lloyd raised.

        So thankyou Lloyd for your post – It had no value to me in relation to AUT but so much value in other ways.

        Thanks

      • 

        Lloyd
        April 25, 2011 at 8:31 am:

        Roger,

        In compiling the above post I only quoted only NSAI estimated oil reserves rather than oil plus condensate which combined accounts for 50% of the reserves to be sold at oil equivalent pricing rather than the 2.5 % I wrote in the text. The true picture is of course accounted for in the quoted economics from the NSAI certification.

        My apologies if this has caused confusion for you and readers.

        Regards
        Lloyd

    • 

      Ron shamgar
      April 23, 2011 at 10:59 pm:

      Great insights! Thanks.

    • 

      William Gill
      April 24, 2011 at 7:10 am:

      Hi Lloyd / Roger
      Fantastic post as always, I sincerely appreciate the time and effort that you have placed into your comments over the last 18 months.
      Warmest Wishes.

    • 

      Rob
      April 24, 2011 at 7:20 am:

      If Roger’s blog would let me say just one word, it would be “Wow!”

      • 

        Lloyd
        April 24, 2011 at 10:24 am:

        All,

        Oil and Gas Investment Primer Number Two:

        Amplifying on what I wrote above I have one further suggestion for those who like the idea of chasing small cap oil and gas sector stocks:

        Proved and Probable (2P) reserves are the basis of the oil and gas investment decision. Without 2P reserves a company is nothing more than a field of dreams. Invest in the field of dreams and you are likely to have nightmares.

        So the first thing you should turn to when assessing a small cap oil and gas company is the annual reserves report. If it doesn’t have or produce an annual reserves report don’t bother to look further.

        Preferably the reserves report should be independently certified, although you need to be aware that some certifiers are performing a role analogous to that of the credit ratings agencies such as Moody’s and Standard and Poors in the certification of the investment grade of CDO’s and the like during the run up to the sub-prime crisis and resulting GFC; little care and no responsibility.

        Next the reserves on the books need to be Proved and Probable (2P). No 2P oil and gas reserve and its junk. Possible reserves (3P), resources and exploration potential are the stuff that makes the field of dreams and the odds are against you in buying into this field of dreams.

        So for budding oil and gas investors, start with the Reserves Report and work out what you are paying for a barrel of oil reserves, or a barrel oil equivalent of gas reserves. Then ask yourself if this price makes sense against the prevailing crude and gas price acknowledging that the costs (capital and operating) of getting the stuff out of the ground are considerable.

        Don’t buy, or pay for the field of dreams if you are a low risk value investor.

        Regards
        Lloyd

      • 

        Jason A
        April 25, 2011 at 11:30 am:

        Hey Lloyd,

        I just thought about how to interpret the reserves report in another fashion:

        AUT’s total acreage is 73,000 acres. If we try and quantify this, a soccer pitch (100×50) is about 1.25 acres. Therefore the total field is equivalent to about 60,000 soccer pitches.

        In these 60,000 pitches, the NSAI had 15 wells to make a judgement on the whole area and given the Turnbulls are on the same pad you could argue it’s equivalent to about 12 wells. That’s an average of 1 well per 5000 soccer pitches. (Think about standing in the centre pitch and trying to tell what the ground is like on all the other pitches)

        This could go both ways during the year, the acreage could be worse or better as they start to drill more wells. This time next year I think we will have a better understanding of what kind of 2P resources they have. (And then there’s the discussion about decline curves but also the counter discussion about well spacing) I agree AUT is not a Value.able investment but I wanted to point out some other factors for people to think about which is what I enjoy about this blog.

      • 

        Lloyd
        April 26, 2011 at 10:54 am:

        Jason,

        Agree with your summary of the uncertainty to a point. However, run your decline analysis on the data published for the three longest producing wells, Kennedy 1H, Weston 1H and Turnbull 1H and you will see that the production history is quite variable, but unfortunately all are running below what one deduces in the relevant NSAI type curve. No out-performance over the NSAI assumptions is anywhere apparent in the production data released to date. As a result, I can only conclude that at this stage the production/reserve risk is weighted very much to the downside of the certified reserves.

        I’ll watch out for more production data with interest, but based on what the work that I have done with the limited public domain data, AUT will not see much if any cashflow from these three wells after the farmin earn out by the operator (capital recovery plus 12% return) is made. On one of these wells Kennedy 1H I have doubts the farminee will even make capital recovery.

        Watch this space is all I can say!

        Regards
        Lloyd

      • 

        MattR
        April 25, 2011 at 8:08 pm:

        Thanks a packet Lloyd for these insights

      • 

        Brad J
        April 25, 2011 at 10:25 am:

        Just fantastic Lloyd,

        Your insights are exceptional, thank you.

        I would love to know where you believe the biggest opportunities are at the moment.

        This blog is just fantastic. Thanks Roger for making it available to us.

      • 

        Lloyd
        April 27, 2011 at 6:10 pm:

        I suspect the biggest opportunity is in following Roger’s advice. His track record is far better than mine!

    • 

      Michael
      April 24, 2011 at 11:19 am:

      Hi Lloyd,

      Thanks for sharing your knowledge. Can you comment on using the value.able valuation methodology for commodities producers generally. My thoughts are that you may overvalue some stocks that are at cyclical highs in their performance, by projecting this performance to continue into the future.

      I think oil and gold stocks are difficult to buy using value investing principles, though I agree with you that if you are going to do it, it is after a big sell off, not when it is jumping on a momentum trade. I think we are starting to mix up the styles of Warren Buffet and Jim Rogers here and think there is a similarity. I’m sure Jim Rogers didn’t start buying oil at $110 a barrel.

      • 

        Lloyd
        April 25, 2011 at 11:02 am:

        Michael,

        I suggest that Roger’s IV methodology is applicable to the big diversified miners (BHP, RIO etc) as well as the big oil and gas companies with a large portfolio of production projects (WPL XOM, etc) provided you normalize ROE to account for the commodity price cycle. Base the IV on ROE at the top of the price cycle and you are potentially in for a nasty surprise when the cycle turns down. So yes with caution is the answer for diversified commodity players.

        For small cap commodity players with a single asset, or a few mines, etc., the IV methodology is very problematic because of the massive swings that can and do occur in operational performance at the single asset level (these tend to be averaged out in a large portfolio of producing assets). In my view the only way of valuing these companies is a conservative Discounted Cash Flow valuation (usually at 15% RR). By conservatism I mean realistic assumptions with respect to schedule, capex (always inflating) and commodity price. This is more art than science, but do it properly and buy at a discount to the calculated NPV then you are playing the traditional value investor strategy.

        Gold is one I’ve never mastered. I have been burned on several occasions with both miners and ETF’s (strengthening AUD killed the USD gold price gains in that case). I am in the Mark twain Twain camp on this .. ‘a gold miner is a liar standing beside a hole in the ground’. In each case I got burned on a miner, it was due to the hype in disclosure of grades, etc., that came in the form of ASX releases. And I am a geologist which should have enabled me to see through the spruiking BS of the media and ASX releases. Be very wary with gold. In my experience, it does things to mens’ minds and can turn the honest to dishonesty, and even the most the hardened skeptic into a naive believer.

        Regards
        Lloyd

    • 

      Peter A
      April 24, 2011 at 12:44 pm:

      Hi Lloyd,

      I think you earned an A+ for your Easter Homework!

      I had previously shied away from small resources because of the commodity nature of their game and lack of control over their pricing.

      However, your insightful post has just highlighted another reason. I don’t have the expertise to judge them accurately (whereas you clearly have it in spades) …

      Peter A

    • 

      Matthew R
      April 24, 2011 at 4:20 pm:

      Lloyd, that is an excellent post. Thank you for sharing your knowledge

      These are the kinds of posts that I, and I’m sure many others, keep coming back to this blog for

    • 

      Jason A
      April 24, 2011 at 9:20 pm:

      Hey Lloyd,

      I agree with your thoughts about management and the schedule which I also think will slip this year but I was wondering why you have priced the NGLs at the same price as a BOE of gas?
      I thought it should be like this:
      Based on the 8/3/11 ASX announcement: (Prices as mentioned in the announcement)
      NPV(0) for 2P = $839.95m
      Oil = 560605 x 93.61 = $52.48m
      Gas = 57695078 x 4.59 = $264.82m
      Therefore the difference has to be made up by the NGLs
      ie 522.65m / 11918552 = $43.85 which is the received price per barrel of NGL (about a factor of 2 higher)

      At the moment it’s roughly trading at the 3P NPV(10) for the end of the year assuming as management indicated in the presentation that they can convert most of the 3P reserves to 2P by the end of the year.

      • 

        Lloyd
        April 25, 2011 at 10:42 am:

        Jason,

        Thanks. You are correct. I made an error in writing the text while trying to explain that not all BOE’s are created equal as a general point of learning.

        In doing so, I cast my eye over the NSAI table to the Oil only column and transcribed the figure into the text. I am used to Oil plus Condensate being listed separately to NGL’s (C2-C5) and the heading of the condensate column as NGL/CND meant I overlooked it in my haste in typing the text.

        As a result, the text should read about 50% of the product stream is priced as oil rather than 2.5%. I posted an apology/correction after I recognized the error in the text. However, the condensate is fully accounted for in my suggested valuation as it is in NSAI’s.

        The problems with analyzing this shale gas play are quite complex and really beyond a few lines in a blog to portray. Unfortunately, the PR of most shale gas companies focuses on well initial rates and condensate rates but little history/data beyond the first six months production is ever presented to really enable the outsider to get a true handle on what is going on at the well specific level which is necessary to create a “type well” for the specific field and aggregation of type well performance is key to the reserve estimation.

        I am trying to to find some more data on what appears to be AUT’s longest producing well Kennedy 1H. The data in the annual report covers the first 152 days of production and gas rate decline plus decline in the critical Condensate Gas Ratio are very pronounced. Using this well as a type well would really hammer the economics compared to what is proposed. But gleaning the data from the public domain is difficult and the lack of disclosure at both industry and company specific level makes me very cautious when it comes to the assumptions an outsider has to make about longer term performance of these shale gas wells.

        My apologies for any confusion my hasty text compilation and error in transcribing the OIl plus Condensate from the NSAI summary may have caused. However, the underlying suggested valuation and NSAI valuation fully takes the condensate to account. The reasoning in respect of the need to examine the oil gas mix in BOE quoted reserves when looking at the sector still stands notwithstanding the noted error in the text.

        Regards
        Lloyd

    • 

      John M
      April 26, 2011 at 3:51 pm:

      I can’t thank you enough for this most Value.able knowledge. It has been on my TO DO list for a while now to learn about how to analyse businesses in the oil and gas sector, so thank you for this most comprehensive analysis. I value your thoughts most highly.

    • 

      My Friend Chris
      April 27, 2011 at 3:31 pm:

      Hello,

      I read with interest the piece on Aurora Oil & Gas and could not help but to make a few comments as I believe the article contains a number of errors of opinion and fact:

      As AUT is a US shale gas play the valuation issues are not the same as for conventional oil and gas plays. Conventional oil and gas plays are reliant on exploration success to create value and therefore lend themselves to probability-based valuation techniques. Shale plays are really development plays, are not reliant on exploration success (they are drilling in to source rock) so lend themselves to ROFE or NPV valuation techniques.

      The risks are LOWER for shale plays than conventional plays. US shale players drill in to source rock and applying fracking techniques to get hydrocarbons to flow to surface. This is very different from conventional drilling which is far more hit and miss. Conventional drillers need to find a reservoir, trap, seal and enough charge to bring the hydrocarbons to surface. Shale plays need to just find the reservoir. The key risk with shale plays is not geologic but economic; do the wells produce an economic return? Operating risks with shale plays are, for the oil and gas industry, relatively low.

      2P reserves are NOT the best way to measure the economic value of ANY oil and gas company and are especially irrelevant for shale plays. Like simple price to earnings ratios the 2P to Enterprise Value metric is popular but virtually useless in determining value for oil and gas plays. 2P / EV is a blunt instrument. Ultimately, the value of anything is determined by its future net cash flows discounted at an appropriate rate. 2P’s, like PE’s, don’t take in to account the capital intensity, growth or risk of future earnings streams.

      Notwithstanding the above, 3P reserves are a far more legitimate metric for the ‘in the ground’ value of shale plays. Just as Coal Seam Gas assets are valued using a 3P metric so should shale assets. This is because the resource is know and with more (economic) drilling there is a very high probability that 3P reserves are transferred to 2P. Again this is because there is little geological risk in shale plays – the hydrocarbons are there – the risk is determining the economics of the plays (i.e. does drilling an $8m well produce more than $8m in discounted cash flows.)

      Production profiles are important and AUT’s EagleFord shale has the best in the US. Shale wells production profile typically starts strongly and declines over time (unlike coal seam wells which ramp up over the first 12-18m and then decline steeply before a long low plateau). The steepness of this decline (or production profile) has a strong impact on well economics and therefore shale valuations. Production data from AUT’s wells so far indicate that their wells have relatively shallow declines. I have tracked well data for each of AUT’s wells and the trend is that production profiles are actually improving; supporting higher NPV’s and valuations. Improved production profiles are a result of better understanding of the shale geology and improved drilling techniques (more frac stages and better propellant mix). Furthermore, AUT’s operator, Hilcorp, is the 4th largest private E&P in the US and is highly regarded in the industry.

      Over 80% of the revenue AUT is generating is from liquids (gas condensate) the price which is tied to the oil price. Gas prices are immaterial in calculating the value of AUT. At current oil prices AUT is generating an average of 6 month payback on its wells. This means if they spend US$8m on a well they are getting this back in 6 months. Any production beyond this has very little associated cost. Operating costs tend to be about US$10,000 per well per month. Shale wells do have very long lives (they can produce for over 40 years) but most of the economic value is captured in the first two years.

      It is a positive that AUT do not operate their own wells. Access to rigs and frac crews in the US is tight at the moment. It is a strategic advantage to partner with a major (as SSN and SEA have done) or partner with someone such as Hilcorp who know the acreage and have access to service companies. AUT going it alone and operating their own wells would add to their risk profile, not reduce it.

      Comparisons between decline rates of conventional and shale wells are irrelevant. What matters are well economics (i.e. what returns does drilling a well generate) and risk (i.e. what is the likelihood of receiving said return).

      As we’ve discussed 2P valuation metrics are a very blunt instrument and probably serve to hid rather than illuminate AUT’s value. I propose a more relevant way of looking at value as follows:

      • AUT has ~15,000 net acres in the EagleFord shale in Texas, USA.
      • Independent Experts are assuming well spacing of 80 acres per well.
      • 187 wells (15,000 / 80 = 187) could be drilled on AUT’s acreage at 80 acre spacing.
      • Each well generates a pre tax NPV >US$15m assuming well costs of US$8m (higher than company forecasts) and ~10% mom decline rates.
      • 187 x US$15m = pre tax US$2.8bn
      • Knock 30% off this for tax still gets you to an EV of US$2bn v the A$1bn EV now

      On this basis the AUT share price does not look outrageous and it’s certainly worth more than $0.00!

      Upside to valuations for AUT will come from tighter well spacing, higher oil prices, better production profiles from further improvement in drilling techniques or another accretive acreage acquisition.

      I could go on to explain in more detail why AUT’s EagleFord shale is superior to other shale acreage in the US but suspect I’ve bored many of you enough.

      AUT is a classic, if unconventional, Montgomery stock as it generates relatively low risk ROFE of >100%. Think about it; they spend US$8m per well and get their capital back in <6m on average; what amazing paybacks!

      My Friend Chris

    • 

      Jontie
      April 27, 2011 at 5:20 pm:

      dear Lloyd

      you might want to look at your BOE breakdown. AUT’s average production is nowhere near 97.5% high BTU (ie NGL rich) gas but rather 60%+ condensate (@US$110/bbl). AUT is NOT a shale gas play on this basis.

      In the context of liquids yield, your thesis then comprehensively fails to articulate the fundamental economic proposition: high early rates of liquids rich production (based upon public data +100kbbls of oil PLUS +50kbboe of NGLs and dry gas) , more than recovering the $6.8m/well cost and delivering some US$7m of free cash at current commodity prices in the first yr alone… Even at high rates of decline you have essentially funded two wells for the price of one after 1yr of production ie 150kbboe and these wells produce circa 750kbboe according to Netherland and Sewell… neglible operating costs (say $120-$180k/well/yr) implies a fairly healthy free cash flow after initial capex is recovered on that basis even after discounting for the wells’ 10-15yr life.
      It is also evident that you do not understand fundamental oil and gas geology in your synopsis of reserves classification.

      Roger – shame on you for endorsing such misinformation.

      Jontie

23. 

    Denise
    April 23, 2011 at 5:36 pm:

    Thanks for the homework. Can anyone help me! Roger this is exactly what I wanted – these half year results put me in a pickle!!
    I’m calculating the cashflow for TRS. Do we use the consolidated statemenet of financial position as 26 Dec 2010 and compare this with the consolidated statement as at Dec 2009 figure?? Even though we have figures for FY June 2010??
    Dec 2009 and Dec 2010
    Cash = 10226 and 3033
    Borrowings= 11056 and 24497
    Share capital= 3366 and 3366
    Dividends paid = 5974 and 7289
    Answer = – $4933m

    Am I the right track on a wet Saturday afternoon. Cheers, Denise

    • 

      Roger Montgomery
      April 23, 2011 at 10:13 pm:

      Hi Denise,

      Let me now if you don’t get one of the Value.able graduates to help you out, But I suspect they’re onto it already.

    • 

      Dave P
      April 25, 2011 at 1:26 am:

      Hello Denise, I initially did it with the FY2010 data, with the following results:
      2009 2010 Difference
      Cash 0.865M 4.339M 3.474M
      Borrowings 14.375M 31.327M 16.952M Less
      Share Cap 3.366M 3.366M 0 Less
      Dividends 16.103M Add
      Operating Cashflow 2.625M Answer

      I had not thought about doing it with the HY results, so I gave it a go….

      2009 2010 Difference
      Cash 10.226M 3.033M -7.193M
      Borrowings 11.056M 27.496M 16.440M Less
      Share Cap 3.366M 3.366M 0 Less
      Dividends 17.418M Add
      Operating Cashflow -6.215M Answer

      Our figures for cash, share cap and 2009 borrowings agree. I am not sure how we arrived at different answers for 2010 borrowings. I arrived at mine by 16.899M (current) + 10.597M (non-current) = 27.496M. The difference between your 2010 figure and mine does not correlate with the differences between out answers.
      I apologise if this may be a statement of what you already understand: I am trying to express my understanding of it so that we can come to some form of agreement. What we are trying to achieve with the calculation is to find whether the business itself is self-sustaining for cash. The difference between cash at the end of the period (26DEC10) compared with cash at the start (27DEC09) could be the result of cash coming in from the business, cash coming in from borrowings, or cash coming in from new share issues. In order to remove the effect of cash from borrowings, we subtract how much borrowings rose (or dropped) over the year period. We do the same for share capital. So far, so good, but we have paid dividends during the period. Dividends are discretionary payments by the board, and are taken from the year’s profit. They also reduce the amount of cash we have in the bank. In order to remove the effect to cashflow, we add back all the dividends that have been paid over the period. Looking at the HY11 and FY10 reports, I found that a 7.289M dividend was paid 11OCT10, and a 10.129M dividend was paid 19APR10. Total dividends 17.418M, which are added back to the rise in cash over the period.

      Hope that this makes sense and is of some assistance to you. I am certainly glad I did the calculations. Going from positive 2.625M cashflow (JUL09-JUN10) to negative 6.125M (DEC09-DEC10) looks absolutely horrific. Given both are over a 12 month period I do not think that seasonal factors could be argued here. Any thoughts from the panel on this????

      • 

        Denise
        April 26, 2011 at 11:46 am:

        Hi Dave P
        Thanks so much for taking the time to continue my education – your post has helped. In relooking at my figures I can see where I made an error with the borrowings (not sure how I calculated my figure!!). Your explanation has helped and I can now see why my calculation of dividends is incorrect. Perhaps Yavuz is correct and we should only use the full year results. However by using the half year results might provide a warning sign that a particular business is not an extraordinary business and to hold your cash. Perhaps redoing the calculation again at full year may confirm this indication.

    • 

      yavuz
      April 25, 2011 at 1:55 am:

      Hi Denise,
      I am using full year results, as it should give produce more accurate results. Also, looking at your borrowings for 2010 HY, figure you are using do not match what is on the 2010HY balance sheet.
      Yavuz

24. 

    David
    April 23, 2011 at 9:28 am:

    This may be a stupid question, but I am still grappling with the concept of intrinsic value. I am interested in buying more Cedar Woods at the current market price which is above 2010 IV, but well below 2011 and 2012 IV. I know the price is only going higher and the Morningstar earnings projections the market is using are conservative, so my question is whether I should I jump on it now in anticipation of big increases in IV or should you always wait for price to be below IV? I do not understand how using old earnings is always relevant when there is a lot of certainty around future earnings. What these guys do is not rocket science as I have developed a first hand appreciation of it from brief encounters with their head office and I drive past one of their developments every day. What also buoys my confidence is that its grown 33.5% p.a. over 10 years and it seems well managed. In this case is it justified to buy above 2010 IV? Sorry to keep talking about this one specifically, but its something I have confidence in investing in unless signs emerge that we have a US-style housing bubble coming.

    • 

      ron shamgar
      April 23, 2011 at 4:30 pm:

      hi David, it seems like that in your mind you already know the answer. i personally like to buy below the current’s year IV and i like large MOS. this way you reduce the risk of being wrong.

    • 

      Simon Anthony
      April 23, 2011 at 4:57 pm:

      “a lot of certainty around future earnings” so you’ll be using a R.R of 10% then?
      Be careful when forcasting future earnings! The Morningstar earnings projections the market is using are conservative for a reason.

    • 

      Ash Little
      April 23, 2011 at 5:25 pm:

      Hi David,

      This is not a stupid question.

      First prize is A1’s at big disounts and IV rising at a good clip.
      Second prize is A1’s at big discounts but IV not rising at such a great clip.
      Third prize is A1’s at or above IV but IV rising at a nice clip.

      Only you can decided whether you want to settle for third prize.

      If you are patient and the market over reacts to declining property prices your pick may get first prize. However, this is speculating. It is just your decesion.

      • 

        Dave P
        April 25, 2011 at 1:39 am:

        Thank you Ash for your insight. The inner speculator in me was thinking along the same lines as what David asked (above). Your advice reined me in to some discipline. I’ll save the punting for ANZAC Day 2-up at the RSL club :-)

      • 

        Lloyd
        April 27, 2011 at 6:17 pm:

        The “inner speculator” is the thing that has killed my investment returns on several occasions. I learn the lesson and the inner speculator rests quietly for a period, only to emerge and burn me again a year or so later. Controlling the inner speculator and shutting out all the speculative BS that masquerades as information and investment advice is the toughest part of true value investing. Yet it is essential to success, as one speculative folly can destroy the benefit of many sound value investment decisions. At least that is my experience, but maybe I ma just plain unlucky? Roll the dice again?…. no thanks, I’m out!

      • 

        Dave P
        April 28, 2011 at 10:56 pm:

        Thank you Lloyd

25. 

    Rod
    April 23, 2011 at 2:35 am:

    Oil, anyone?

    http://english.aljazeera.net/indepth/opinion/2011/04/2011415143212280315.html

    • 

      Roger Montgomery
      April 23, 2011 at 2:47 pm:

      Hi Rod,

      I have been listening to these complaints for a couple of decades. Even before I started my career when I was studying investing, economics and markets it was the subject of discussion and I have seen the price of oil rise from $10 to $147 and back down to $30. Its the weight-of-money argument turned on its head. The weight of money argument is simply nonsense. The idea that stocks will always go up because 9% of everyone’s superannuation or reinvested dividends force them to is silly. The evidence is sharply falling prices even in the face of the inflows.

      Speculators are on both the buy and the sell side and that is why comments like this one from your link: ” “Approximately 60 to 70 percent of the oil contracts in the futures markets are now held by speculative entities,” he argues. “Not by companies that need oil, not by the airlines, not by the oil companies. But by investors who profit money from their speculative positions.” fails to take into account the reality. This one; “The TV news magazine 60 minutes spoke with Dan Gilligan who noted that investors don’t actually take delivery of the oil. “All they do is buy the paper, and hope that they can sell it for more than they paid for it. Before they have to take delivery.” Fails to take note that 1) prices go up and down and must settle at the physical price at expiry of the contract and 2)when prices fall, bullish speculators lose money.

      • 

        Robert
        April 23, 2011 at 4:44 pm:

        Hi Roger,

        Speaking of oil and energy. I read a story in New Scientist magazine recently titled: ‘Wind and wave farms could affect Earth’s energy balance’ New research is being done by physicists (one in particular it seems) on what energy can actually be safely extracted from the atmosphere without causing effects as bad or worse than Co2 induced climate change. It turns out that renewable energy (wind, solar, wave) is not so renewable. http://www.newscientist.com/article/mg21028063.300-wind-and-wave-farms-could-affect-earths-energy-balance.html?page=2 This research will no doubt become more mainstream.. and if true (I believe it is), means we have far fewer options for energy (cheap or otherwise) than is currently generally believed.

        Here is another story about the limited supply of the materials that solar cells and electronic components are manufactured from: http://www.newscientist.com/article/dn16550-why-sustainable-power-is-unsustainable.html

        I believe these stories have quite allot for investors to think about… like the relative scarcity of the elements such as ‘Indium’ for the manufacture of electronics and solar cells, and the future drivers for coal and oil.

        Hope this is helpful.

        Rob F

      • 

        Robert
        April 23, 2011 at 4:54 pm:

        Roger,

        My apologies, the link above was to page 2. Page 1 link: http://www.newscientist.com/article/mg21028063.300-wind-and-wave-farms-could-affect-earths-energy-balance.html?page=1

        Rob F

      • 

        Simon Anthony
        April 23, 2011 at 5:37 pm:

        Hi Rod,
        For a Value investor I would recommend ASX STX as a company that will take advantage of surging interest (& prices) in oil. One of the few oil producers that is cash flow + and has $$$ in the bank to fund its next several wildcat exploration wells, so no capital raising for the short term at least.

      • 

        Rod
        April 24, 2011 at 4:14 am:

        Much appreciated, Roger. I posted the link simply because I’m in no position to comment on it myself, and I know that you and others on this blog are. Your perspective is invaluable. I would never try to big-moat myself around here!

26. 

    Rod
    April 22, 2011 at 7:28 pm:

    Thanks for everyone’s really useful insights! One point of confusion, at least for me – could people please distinguish between mote (a particle, speck, or grain of something such as dust) and moat (a water-filled circular ditch intended as fortification)? I hope I’m not too fussy, but this really threw me for a while!

    • 

      Brad J
      April 23, 2011 at 9:01 am:

      Hi Rod,

      We are not all good spellers here but a lot of us are WB followers. If you haven’t been following WB this would have created confusion and I am sure you are not alone.

    • 

      Lloyd
      April 23, 2011 at 9:57 am:

      “In business, I look for economic castles protected by unbreachable ‘moats’.”
      -Warren Buffett

      So its about a competitively defensive fortification, rather than a speck of competitive dust.

      Hope this helps.

      • 

        Lloyd
        April 23, 2011 at 9:58 am:

        P.S. Unfortunately many an analyst confuses the speck of competitive dust (mote) with a truly defensive competitive fortification (moat).

      • 

        Andrew
        April 27, 2011 at 8:17 am:

        Hi Lloyd, damn me having a break from the blog over easter. You beat me too it.

      • 

        Lloyd
        April 27, 2011 at 6:20 pm:

        Probably we should summarize this in an investment aphorism: “Avoid the folly of the competitive mote.”

    • 

      JustinP
      April 23, 2011 at 11:27 am:

      If you can barely float a boat in your moat then a mote is what you will have left… end quote.

27. 

    Simon Anthony
    April 21, 2011 at 5:45 pm:

    Just got back from the Royal Easter Show and I made sure I got my $$$ worth. I picked up a Montgomery A1 show bag! Inside it contains all sorts of goodies including a share in these extraordinary business ACR, ARP, FGE and FWD. There’s also JBH, ORL TRS and my favourite MCE. But that’s not all it also has a signed 2nd Ed. of Value.able!

28. 

    Josh E
    April 21, 2011 at 3:47 pm:

    Hi All,

    I’m extremely interested in the views of others on Medusa Mining (ASX:MML). Very low cost, low debt gold miner (costs are less than $200 per ounce) operating in the phillipines looking to increase production around 2013/14 and have some exploration upside in the region as well.

    I understand resource stocks don’t typcailly have a competitive advantage however I feel the cost per ounce of production at less than $200 is a major advantage for MML as they are achieving great margins to the current gold price. Even if there were a pullback, while some mines may struggle MML will continual to operate and still be making reasonable margins.

    I have a personal valuation currently of $9.10 and a future valuation of $13.02. I’m interested in the opinions of others, with not only their valuations but also any potential and/or headwinds they can see for Medusa.

    Note: I do hold and was lucky enough to get in at $6.90 in february which even though I thought i’d missed the run due to only finalising my value investing strategy early this year, turns out to still have been an ok entry. Current Price – $8.27.

    Look forward to any replies.

    Regards

    Josh

    • 

      Ken
      April 22, 2011 at 7:40 pm:

      It’s not a low debt miner, it’s a no debt miner ! Assets $241M (incl $87M cash) Liabilities $8M. Excellent financial position with a low cost, productive mine and it has started to pay shareholder dividends. In my opinion, one of the three best in the small to medium gold producers. (RMS & NST are the other two) My valuations are slightly higher than yours.

      • 

        David
        April 23, 2011 at 10:01 am:

        Hi guys, I guess the one assumption that would make a big difference in your valuations could be the short and long term price of gold. I can see the economic risk is low in this case because there is little debt and costs are super low, but is there a high degree of certainty that you are buying at a discount at present? I got out of some good gold stocks a few months ago because the uncertainty was killing me and I like things I can measure with confidence (I would be risking my house trading commodity warrants if I had the perfect crystal ball!). I would love to know what commodity price you are using for the valuations because Medusa sounds very appealing. I noticed that the 2 year earnings estimates provided by Morningstar do not seem so bullish though – i.e. based on your valuation and their earnings it would be trading at a PE of 22 in 2012. Perhaps they plan to increase production in future years?

    • 

      John
      April 26, 2011 at 8:30 pm:

      Hi Josh,

      I agree with yourself and Ken. MML looks good value my valuation is also slightly higher that yours. You should also have a look at PNA & RSG

      Regards
      John

29. 

    Lloyd
    April 21, 2011 at 2:49 pm:

    Roger et al,

    REA Group Limited (REA) – Competitive Advantage Shrinking Rapidly?

    A few blogs back, the buzz was about the rumor of competitive threats to Carsales.com Limited (CRZ) . I didn’t buy into the rumors based on the lack of facts and evidence to substantiate the rumors.

    However, there are some facts and evidence of the emerging competitive threat to REA.

    Go to http://www.onthehouse.com.au/home/ and test the functionality of this real estate site (its all free) and compare to http://www.realestate.com.au

    Now read this http://www.smh.com.au/business/the-betting-starts-early-and-its-on-the-house-20110419-1dndf.html

    Free listings for real estate agents, accompanied by the ability of potential home buyers to access free sales history records for a specific property, a specific street, or a suburb, all on the one site with an intuitive interface. Looks to me like REA is in for some real competition.

    To my mind this development highlights the vulnerability of internet based business model to improved delivery by competitors. REA’s incumbency will count for little under these circumstances.

    Tell me what you think?

    Regards
    Lloyd

    • 

      Ron shamgar
      April 21, 2011 at 7:37 pm:

      It won’t work. The only company it can hurt is rp data and they have been taken over recently. In my opinion the only way u can hurt market leaders on the Internet who enjoy from the networking effect, is if majority of Realestate agents pull their ads off REA and use onthehouse or majority of car dealers do the same. What r the chances of that? If u think it’s high don’t invest in these businesses.

      • 

        Lloyd
        April 22, 2011 at 9:59 am:

        Ron,

        You seem as certain of the sanctity of REA’s competitive moat as you are that NWT is the next big thing. Good on you! Conviction is what its all about.

        However, thirty years in business has taught me that when it comes to competition, conviction regarding one’s position and competitive prowess can be a very dangerous thing, particularly when it results in complacency.

        The ‘network effect’ argument run by analysts in respect of REA is very similar to the ‘rivers of gold’ argument that we heard so much from Fairfax (FXJ) leadership at the turn of the century. We know what happened there. A disruptive business model threw it to the refuse pile of smart ideas.

        The fact is that shortly REA will face a well capitalized new start with a disruptive business model that combines the functionality of REA and RP Data in one site that is free for vendor and potential purchaser. The long term consequence is a distinctive new risk to REA’s business. The likely near term effect is a diminution of REA’s margin, ROE and thus IV. Therefore, I don’t share your conviction.

        I don’t own REA and don’t intend to, as it has always traded well above IV since it listed. Now that IV could be entering a period of decline rather than growth as a result of business competition from a competitor whose stated goal it is to disrupt the REA incumbency. They may or may not be successful, but in the short term headwinds will arise for REA as surely as they did for FXJ with terminal consequences for the ‘rivers of gold’ business model. Good luck with your conviction.

        Regards
        Lloyd

      • 

        Ash Little
        April 22, 2011 at 5:55 pm:

        Hi Lloyd,

        I am doing some research on something I probably shouldn’t but I know you have vast experience in the Oil and Gas sector so I was wondering in you could comment on shale gas generally and also The quality of management for ASX list AUT. Their is an analyst report from Eurox on the company website that I would also like you to have a look at and give me your thoughts.

        BTW I wont be offended if you don’t reply but it would be great if you do.

      • 

        Jason A
        April 23, 2011 at 9:16 am:

        Hey Ash,

        I think I can help you out here a bit.

        Firstly Management:

        The Sugarloaf field in the Eagle Ford Shale (EFS) originally had 4 companies involved in it – AUT, EKA, ADI and TCEI (American). ADI was taken over last year by AWE which is why it isn’t there anymore. It was AUT who had the relationship with TCEI in the first place which is how AUT got into the EFS play. This has also been part of the reason why AUT have been able to expanded their acreage more than both EKA and AWE because they have been buying parts of TCEI’s acreage and also buying into the Excelisor field.

        Another thing that doesn’t come up in any of the broker reports (I don’t think) is the Austin Chalk Layer. The EFS has two oil horizons, the first is the shale layer, which they’re drilling now, is deeper and then on top there is the Austin Chalk which may be just as productive. The reason they’re drilling the shale first is because the way the leases work is that you own everything above the well. Therefore, Hilcorp, the operator are drilling deeper now to secure all the territory and then in the next 3/5 years when they come back to in-fill the other wells they will be able to start drilling into both horizons (This could mean up to a doubling in reserves)

        The last thing I can think of is the well pressures. Last year when they fracced the Morgan well it had the highest 30 day flow rates recorded in the EFS. Now they have started to try and slow down the well declines so they’re choking the wells so I don’t think we will see the record challenged but it’s a good indication of the quality Sugarloaf field in the EFS.

        If you have any other questions I’d be happy to try and answer them

      • 

        Ash Little
        April 23, 2011 at 3:42 pm:

        Hi Jason

        Thanks for the info

      • 

        Lloyd
        April 23, 2011 at 9:41 am:

        Ash,

        I’d rather looker at AUT than do the Easter Holiday Homework that Roger has set. There goes the homework! The teacher may be displeased, but I’ll be have some fun doing an initial dissection of an interesting little beast. I’ll get back in a day or so and post it at the top of the blog so you can easily find it. It will be my alternative homework submission.

        My initial five minute look at AUT based on the latest releases is that it is interesting but overpriced. However, don’t take that as the final answer as some deeper digging (or is that drilling?) is warranted.

        Regards
        Lloyd

      • 

        Roger Montgomery
        April 23, 2011 at 2:31 pm:

        Will be interested to see whether we have reached the same conclusion. Homework is for new grads and for those who have asked for more. Not at all displeased.

      • 

        Ash Little
        April 23, 2011 at 3:34 pm:

        It certainly looks expensive at the moment but I was just think about putting it on watch.

        Seems to be in a good space but you would know more about this than me.

      • 

        Ash Little
        April 23, 2011 at 9:54 pm:

        BTW thanks for your time Lloyd but I am guessing this is tap dancing to work stuff

      • 

        ron shamgar
        April 22, 2011 at 6:23 pm:

        hi Lloyd,

        in investing u need some conviction. but to clarify i don’t own REA and will need a very large MOS to buy this one. and don’t underestimate the power of the networking effect. fairfax didnt lose theirs, what happened to their classified business was that a new way to deliver it emerged (the internet) and they weren’t quick enough to adapt. don’t forget they milked their classifieds for many years before REA came along. now, when the next new medium will arrive, (i don’t know what) and nobody will use the internet to advertise their property anymore, than REA will be in strife. then again u can say that about any business.

        and in regards to NWT i don’t think its the next big thing but i will be watching their story closely.

        hope that helps Lloyd, but then again different opinions is what makes a market!

        take care.

      • 

        Lloyd
        April 23, 2011 at 9:47 am:

        Ron,

        It’ll be interesting to watch how this plays out over the next 12-24 months. I think it will prove to be a good test of the ‘network effect’ competitive moat hypothesis, as it is applied by analysts to internet based business models.

        The closest parallel I can come up with is Murdoch’s ill fated play on My Space, just after which up popped Face Book. And look what happened there!

        The ‘network effect’ is baloney in my opinion. It is used by stock analysts to justify otherwise unjustifiable premiums to valuation.

        Have fun watching this one.

        Regards
        Lloyd

      • 

        Roger Montgomery
        April 23, 2011 at 2:30 pm:

        The network effect IS a form of competitive advantage, but as I have suggested previously, not one that is ‘unbreachable’. Indeed deep pockets is sometimes all that is needed to undermine it. And the jury is still out as to whether the network effect itself is subject to the vagaries of fashion. In Sydney, night clubs lose their lustre over time just as AAA office buildings do. The crowd simply moves on to the new new thing. One does wonder whether the the network effect is equally impermanent. It is when the network effect a company or technology platform enjoys evolves into high switching costs for customers that the moat is fortified.

      • 

        Ron shamgar
        April 23, 2011 at 11:07 pm:

        One more thing I forgot to mention is that REAs clients who provide the content ( the Realestate agents) don’t actually pay for their listings as their customers (property owners) are the ones who pay the listing fees.

        Now if ur selling a million dollar property and ur agent recommends u use REA would u care about spending couple of hundred dollars? I know I wouldn’t.

        I think this aspect is what differentiates REA from CRZ for example.

      • 

        ron shamgar
        April 23, 2011 at 5:52 pm:

        one more thing Lloyd, i’m not sure if REA will be around in 10 years from now but u can still make money by buying it at a big discount to IV and holding it for a while.

      • 

        Andrew
        April 27, 2011 at 8:20 am:

        I think MySpace is a textbook example that “the network effect” is not an unbreachable or even sustainable sometimes competititve advantage. Facebook was the big network now it is a relic. It had the network effect but something shinier and new come in and the network went elsewhere.

        I am very wary about competitive advantages that aren’t formed out of the activities of the company. Not to say that i don’t find it attractive but as it is not born out of the activities than it is not as controllable by the company who has it.

        Like Roger says, fashion is fickle and people can change their minds quite suddenly.

      • 

        ron shamgar
        April 27, 2011 at 9:24 am:

        hi Andrew,

        my space and facebook are not a classified/list business!
        please look at how these different businesses operate and make money and then compare them to REA/CRZ.
        its like comparing apples with oranges!

        cheers.

    • 

      Gavin
      April 23, 2011 at 10:44 am:

      I like the internet list companies; they have many of the qualities I look for. There is no doubt that they have a current competitive advantage which delivers them great return on equity.

      I brought into WTF a couple of months ago which had the effect of really concentrating the mind. I have subsequently sold back out of that position.

      My problem in holding the position resolved around how sustainable the competitive advantage was, and given that the price I paid required that their competitive advantage needs to be sustainable for quite some time, I judged that the business had more chance of underperforming the assumptions I had imposed upon it than outperforming them.

      Benjamin Graham wrote a paragraph that summarises what I think is the real risk to buying list companies at current prices. “Thus it follows that most of the fair-weather investments, acquired at fair weather prices, are destined to suffer disturbing price declines when the horizon clouds over” (actually I think this paragraph summarises the risk of a lot of the current activity in the market)

      Specifically back to REA. The speed of their site really gives me the …… It’s almost as slow as the I-tunes website. Onthehouse looks almost the same but it’s a lot quicker and it’s got the additional sales data for free. If they get all the real estate agents on board then I know which one I would use.

      On the networking competitive advantage, I have always thought that those networks that have many buyers and sellers are stronger than those that have many buyers but fewer sellers. The few sellers could more easily band together, boycott the old site and start another – the buyers would soon enough migrate. On this basis I thought Ebay had a stronger network effect than our Australian lists, but even here I see competition chipping away.

      I have a bit of a bike fetish and getting rid of the old ones has always been a bit of a drama. Over the years the story has always been – We don’t want trades and won’t offer you a reasonable price, you would be far better off selling it yourself in the:

      Used to be, in the paper.

      Then it was on Ebay.

      Now on buying my new 29er I was surprised to be told that I could de-clutter the shed by selling on “Bike Zone” or “Gumtree- its free”

      Never heard of Gumtree before, but on checking it out I was surprised at just how it had taken off in my geographical area. So even the mighty Ebay network is being eroded through geographical (gumtree) and product (Bikezone) specialisations.

      Lasoo is buried within SLM and it is one list that appears to have a great competitive advantage in holding its sellers. It’s not that prominent with buyers yet and the friendliness of the site still needs work. But the sellers remain committed. My wife is one of the target buyer market and since she found it she loves it (she wouldn’t dream of buying on ebay) she prepares for her social shopping trips here and has also bought online direct from the site when she can’t be bothered going out to the shops.

      The bricks & Mortar shops are never going to have the low cost model of a pure online store but they provide a social experience and they can certainly put together ‘specials’ to attract clients. This site caters directly to the sellers needs and I think there is a pretty big demographic that would use this site that would not generally be a devout online shopper. Perhaps the best thing about Lasoo at the moment from an investors point of view is that you don’t have to buy the potential up front. If it happens than it will be a bonus and if it doesn’t than you won’t lose your shirt.

      Sorry for the length. The dribble just sort of kept coming.

      • 

        Lloyd
        April 23, 2011 at 7:51 pm:

        Gavin,

        Great post with plenty of food for thought on the potential transience of the network effect as a competitive advantage in internet based business models.

        I see the internet as nothing more than a catalyst for the rapid evolution of new business delivery models. The latter is a threat to the incumbents in the same market space that the rapidly evolving new entrant tackles. Moreover, the pace of evolution of business has stepped up a couple of orders of magnitude thanks to the catalyst. Hence my belief that the network effect is likely to be transient for most incumbents.

        Regards
        Lloyd

      • 

        Ron shamgar
        April 23, 2011 at 11:09 pm:

        Hi Lloyd,

        Would u say that the yellow pages enjoyed the networking effect for the last 20+ years?

      • 

        Lloyd
        April 24, 2011 at 9:31 am:

        Yes, but this one made the transition from print to web very effectively. The exception that proves the rule?

30. 

    Peter A
    April 21, 2011 at 2:27 pm:

    Hi All,

    A couple of quick question for Rodger or any other experienced graduates around Margin of Safety.

    How much Margin of Safety do you typically look for?

    And when is it appropriate to start doing valuations based on 2012 forecasts (as opposed to 2011 forecasts)?

    These two questions lead up to the real underlying question – if you have a small margin of safety on 2011 forecast (less than desired), but a larger one in 2012 (more than desired) is that a buy signal?

    Any comments appreciated.

    Peter A

    • 

      Simon Anthony
      April 21, 2011 at 3:38 pm:

      I look for a min. MOS of 25% in all cases. In the past I have purchased shares with a MOS 40%. However these days I don’t need to be so impatient. If you wait long enough there are a handful of companies (A1/A2) each year that the market will allow you to buy them @ >25% cheaper than they are worth! You just have to look.

    • 

      Craig B
      April 21, 2011 at 4:38 pm:

      Peter,

      Interesting question. I think it depends on what’s on offer elsewhere. I can imagine a time in the future when there will seem to be nothing around worth buying. That is, all the good quality firms are at or near intrinsic value. In that situation, if you’ve got money to invest, what do you do?

      Sit it out in cash I suspect is the answer.

      But what if something pops up that’s a clear A1, and is trading at say, 20-25% below IV. If it was at 50% below IV then you’re probably going to pull the trigger, but in that 20-25% range it becomes less alluring.

      But if there’s nothing else about and all you can get in cash is 6-8%, what do you do? You would seriously think about it probably.

      But the other scenario is where there are plenty of companies that are quality trading at 40-60% below IV (yes please). In that case the one at a 20-25% discount doesn’t look so enticing.

      There is no escaping the need for judgement.

    • 

      Craig B
      April 21, 2011 at 4:44 pm:

      And that’s without considering future prospects, and the whole ROE/Retained Earnings impact on future valuations.

      What are those sayings about not having to ask a young child if he’s old enough to drive…..or an obese person their weight?

      It’s a whole lot easier when its blatantly obvious.

    • 

      Jonesy
      April 21, 2011 at 5:02 pm:

      Pretty sure Rogers number 1 pick is at a big margin of safety currently as well as significant increase of IV over coming years (think Matrix around 6 months ago) Number 2 is a company that isn’t available at a big margin of safety currently but one which has future IV rising at a good clip (think Vocus currently)

      • 

        Brad J
        April 21, 2011 at 7:09 pm:

        In my humble opinion it entirely depends on the following –
        – the type of business, resource based, financial, retail etc
        – it’s moat
        – it’s rate of growth
        – your personal risk profile

      • 

        Ron shamgar
        April 21, 2011 at 7:43 pm:

        Hi Peter,

        I would add to the above comments that u might not want to commit all ur allocation to a certain stock at low MOS but u may decide to accumulate and as price drops u can buy more. Think VOC & MCE in the past….

      • 

        Ron shamgar
        April 22, 2011 at 10:34 pm:

        Sorry Ken. Bad habit from using iPhone/iPad keypads too much!

      • 

        Jeff Burnett
        April 22, 2011 at 11:15 pm:

        Ron

        Your abbreviations may not be the proper use of the language, but your contributions here are insightful and informative.

        You are a mensch!

        Good luck!

        Jeff

    • 

      Peter A
      April 22, 2011 at 10:56 am:

      Hi Folks,

      Thanks very much for your well-considered comments. They give me some useful food for thought.

      Cheers,

      Peter A

31. 

    Andrew
    April 21, 2011 at 11:59 am:

    Just came back from lunch and got the chance to see the new Zara store in pitt street. You know a company has a great competitive advantage when a store (albeit only open for 2 days so still new) that is three stories high, still needs security to prevent too many people from going in at once. The store was apcked, Zara bags everywhere and a healthy line waiting to get in.

    I wish i could get a slice of this company, probably the best fashion retailer in the world at the moment.

    On another note, looking forward to seeing how everyone else went with the home work over the easter break so we can discuss that.

    • 

      Ron shamgar
      April 21, 2011 at 8:05 pm:

      U can! Owned by imdex and listed in europe.

      • 

        Jason A
        April 23, 2011 at 9:26 am:

        Andrew,

        I would tend to think the opposite and would consider selling ZARA if I owned it now. The way I think about it is this: ZARA’s advantage is constantly stocking their stores every 1 or 2 weeks with new merchandise and they do this from one distribution centre in Spain.
        Now in Europe this is relatively easy to achieve logistically. However, as they look to expanded their business into Asia/Australia this is going to get more difficult and expensive. In 2015 (for example) when the jet fuel price is high $1XX or even $2XX, the cost of sending a separate plane to Australia, Japan, China, Thailand, India, Indonesia, Malaysia, etc etc 26 times a year is going to add up.
        They can either increase their prices in line with the increasing shipping costs and risk losing customers or they can accept smaller margins.
        The other thing I think of is that the Australian and SE Asian market will constantly require a different set of clothes to the European and American markets. This means they need to employ more staff and have more materials constantly in stock. While I don’t think this means the end of ZARA, I just think you will start to see its ROIC and ROE decrease as these costs increase.

      • 

        Roger Montgomery
        April 23, 2011 at 2:34 pm:

        Arguably Jason, its the lowest cost operator that is the last man standing in the scenario you describe. Their competitors may suffer even more. Granted they have higher nominal costs due to their volume, but their margins offer the most room. Low cost is a competitive advantage that can last but you really do need to be the low cost operator.

32. 

    Ash Little
    April 21, 2011 at 11:09 am:

    For those that are interested. If you applied for $15K in VOC SPP you got 2015 Shares and $10970 cash returned.

    • 

      Brad J
      April 21, 2011 at 7:12 pm:

      Thank you Ash, much appreciated.

33. 

    Jonesy
    April 21, 2011 at 9:22 am:

    I have another question from chapter 11regarding buybacks (page 211). When discussing factors that increase IV, one of the factors is “share buy backs below equity per share” – now, I’m sure the first time I read chapter 11 many months ago, I read it as “share buy backs below intrinsic value”. Using JB HiFi as a current example, the buy back price will be much more than current EqPS but less than intrinsic value.

    • 

      Paul Rehill
      April 21, 2011 at 10:09 am:

      “share buy backs below intrinsic value” will increase IV. That’s fine. I won’t comment on chapter 11.

      • 

        Jonesy
        April 21, 2011 at 5:22 pm:

        Thanks Paul – that was my understanding too

    • 

      Josh
      April 21, 2011 at 1:57 pm:

      I wouldn’t mind some clarification on this too!! Here is my (probably too simplistic) understanding currently:

      Rogers valuation method in its most simple form (ie before any tweaking for specific companies considerations) values a company on the basis that they will continue to earn the same return on existing equity in the future as they have in their recent history, as well as continue to earn that same return on new equity. (This is why it is best used for simple, understandable, consistent businesses with the potential to grow by doing more of what they already do).

      For a company to acheive this (earn a return on new equity equivalent to their historical return on existing equity) when buying their own shares, I would have thought this means they need to buy back their shares at their equity per share value.

      Looking at it the other way around, I wonder how it could be good for a company like JBH (earning 40%+ on their existing equity) to accept the same lowly 10-12% return that we seek in our valuation formula, unless they cannot continue to invest in their business like they have done previously. If 10-12% is as good as they are going to get going forward, I would think one needs to use 10% ROE on the retained earnings portion of the valuation formula… obviously this would significantly drop the valuation.. which is why Roger puts a lot of emphasis on companies like JBH reaching this saturation level where they can’t continue to grow as effectively by doing what they have done in the past.

      Unless I’m mistaken though, JBH’s buyback was well received on this blog and I don’t understand this. (Except for appreciating its still a somewhat positive situation if it was funded through debt rather than equity and that debt was otherwise not going to be utilized to grow the business and that debt cost less than the 10-12% RR in interest.. although I fail to see how this is any better than me getting my own margin loan other than that JBH’s rate is probably a bit lower than I could get myself).

      • 

        Jonesy
        April 21, 2011 at 6:51 pm:

        Ok, I’ve had more time to think about it – I had the same issue with this a few months back but finally got my head around it. Do you remember Rogers example of his bank account earning 20%? This is a similar situation. JB HiFi (the company) may make a 40% ROE but the owners of the company, the shareholders do not make 40%. Like the auction for Rogers $10m bank account – most people are happy to accept a lower return (say 10-11%) for a piece of this business. So noone is going to get share of JB HiFi for a 40% return. However, there may be times (eg after bad news concerning retail sector) that people will become pessimistic about the future earnings of JB HiFi and offer you a piece of the company at an attractive rate of return. It is at these times that management can buy back those shares at a discount to what their true value is and this will have the effect of increasing the value of shares in the company for those people who continue to own them. This is why it is good to have managers as shareholders because it is in their interest to increase shareholder wealth. Hope this explains it well enough.

34. 

    Jonesy
    April 21, 2011 at 9:16 am:

    Almost finished the holiday homework (and before Easter like the nerd I am!) but my one observation is regarding equity per share on which we base our intrinsic value calculations on. I was going through the intrinsic valuation chapter for the first time in a long time and realised that Roger used ending equity for his example in the JB HiFi calculations (page 188). I came up with my excel spreadsheet after reading the book but it has gone through multiple revisions since then, but when did we decide on using average equity? (I usually use ending equity for companies that have increased their equity base significantly during the year but otherwise tend to use average equity)

    • 

      Andrew
      April 21, 2011 at 10:22 am:

      We didn’t. Average Equity is used in the calculation for return on equity but equity per share is the ending equity.

      Hope this has cleared things up

      • 

        Jonesy
        April 21, 2011 at 5:15 pm:

        Thanks Andrew. Knew I’d read it somewhere. Just wanted some validation that I had actually been using the right figures after all these months!

    • 

      David Edmondson
      April 21, 2011 at 12:14 pm:

      Average equity was suggested in Value.Able. Roger wrote about using beginning equity and average equity. The ending equity figure is a ‘result’ of the return on equity, so a better understanding occurs when the calculation is based on beginning or average equity. I think Ash Little uses beginning equity (Ash?) but Value.Able suggests use of average equity.

      Someone on the blog wrote that using average equity reflects that the ROE for a year is a part result of starting equity AND the deployment of equity generated throughout the year, hence adopting average equity as the input for calculating ROE. I don’t remember Value.Able’s explanation for using avg equity. Perhaps someone can illuminate us? I’m going to stick my nose is the book again.

      In any case, the calculating ROE on avg equity reduces the percentage (so, a higher ROE would be achieved on starting equity than on average equity, assuming the business is actually generating earnings, and probably assuming a couple of other things) which results in a more conservative valuation, and ROE figures that are ‘more’ sustainable, though you should still ask yourself whether the figures you’ve generated are sustainable.

      • 

        Jonesy
        April 21, 2011 at 5:21 pm:

        I actually try to be even more of a nerd by weighting when the additional equity came into the business. For example, I will use beginning equity when the extra equity is the result of a capital raising after 11 months of the reporting period (as it hasn’t had an opportunity to have an impact on the businesses earnings). Equally if they raise funds on 1st July then I’ll use ending equity.

      • 

        Roger Montgomery
        April 21, 2011 at 10:10 pm:

        Thanks Jonesy, you can also weight by the number of months the funds have been available. For example a company with $100 million of equity at June 30, 2010 that raises $12 million in July 2010 will have a weighted average of $100 + ($12/12 x 11) = $110. If the $12 million was raised in June 2011; $100 + ($12/12 x 1) = $101.

      • 

        Jonesy
        April 22, 2011 at 9:23 am:

        Even better. Little bit of extra work but I’m sure it would be worthwhile seeing as trying to get an accurate ROE is what we’re ultimately aiming for.

    • 

      ken fraser
      April 21, 2011 at 1:56 pm:

      Jonesy, I think Roger says to use ending equity when calculating equity per share and it`s preferable to use average equity rather than beginning equity when calculating return on equity.

      • 

        Jonesy
        April 21, 2011 at 5:12 pm:

        Exactly what I thought. Was tired reading the book late last night and then couldn’t sleep, maybe I should stick with novels at bedtime!

35. 

    Simon Anthony
    April 20, 2011 at 9:03 pm:

    Many people have adopted Warren Buffet’s use of a quote by Mae West: “Too much of a good thing can be wonderful!”-Mae West
    but sometimes sub. the word ‘is’ instead of the words “can be”. Now that that is cleared up another quote, also from Ms West is: “Too much of a good thing can be taxing”- Mae West, and another
    that I think fits in with investing: “Virtue has its own reward, but no sale at the box office.”-Mae West. My favorite quote of Ms West (and I always remind myself of when viewing an IPO) is the following : An ounce of performance is worth pounds of promises.
    Mae West.

    Finally a quote to sum up Roger’s book (and this blog) comes from Mr Twain: “The man who does not read good books has no advantage over the man who cannot read them.”
    Mark Twain

    “

36. 

    Brad J
    April 20, 2011 at 11:50 am:

    RE: VOCUS COMMUNICATION (VOC)

    I phoned VOC directly yesterday and Mark was extremely knowledgeable and helpful. These were my questions and answers –

    QUESTION 1.
    What stops your customers buying IRU capacity directly?

    ANSWER – Economies of scale. We had to commit to $50 million during the height of the GFC in order to set up an agreement with Southern Cross, which we financed at very low rates. These rates wouldn’t be available today. Further to this you need extremely high levels of Technical expertise at the main data points which very few companies have. We are one of the few companies Southern Cross are prepared to deal with due to these points.

    QUESTION 2
    How long are your contracts with your customers?

    ANSWER – There is 21.4 months left on contracts currently if you were to average them out. They are of course staggered and will all end at different times.

    QUESTION 3
    How hard would it be for a data centre customer to move their business away and would it be as hard as me moving my loans away from a bank?

    ANSWER – It would be extremely hard, much harder than for you to move your loans away from a bank. You would need to replicate very high tech equipment in another secure location. This is a very secure source of income for the company.

    I have significant exposure to VOC and this has clarified the areas I was uncertain about. I am now very comfortable that it ticks all the boxes. The current IV in my opinion is meaningless with the company likely to double in size within a year. When you take into account current contracts and the enormous growth in mobile and internet usage it is as certain as it gets. Tie this together with a management team that would be almost impossible to replicate and it looks to be a very valuable investment. Nothing is certain and this is not a recommendation, just my opinion.

    The only risk that I can see, is the possibility of natural disasters affecting the cable or technical disruptions to the networks. There is no business however without risk.

    Also I have used a RR of 12% due to the current contracts they have in place over the next two years.

    Hope you all find the above questions and answers helpful.

    • 

      Michael S
      April 20, 2011 at 1:22 pm:

      Hi Brad J,

      Thanks for sharing this. I really appreciate it.

      Regards,
      Michael S

      • 

        Ash Little
        April 20, 2011 at 4:10 pm:

        I Agree Michael,

        Just fantastic Brad

      • 

        Jim
        April 25, 2011 at 5:29 pm:

        Hi Bloggers

        Great work Brad.Thanks heaps

        Cheers
        Jim

    • 

      darrin
      April 20, 2011 at 4:01 pm:

      HI Brad

      What was your valuation for VOC

      darrin

      • 

        Brad J
        April 20, 2011 at 10:16 pm:

        Hi Darrin,

        My valuation comes to $3.44. This is based on my own modelling based on what I think they will achieve in 2011 hard to value going forward as there are really no estimates. Mark from Vocus did however say that if you want an indication of their growth going forward look at –
        http://www.vocus.com.au/investor/20100914-InvestorPresentation.pdf
        Look at their quarterly revenue on page 5 and extrapolate the graph into the future to get some indication. My 2010 valuation was $2.59. As Roger has said the current numbers are probably meaningless and insignificant longer term and I totally agree.

        Its the business though and its unbelievable growth prospects that really excites me though, backed up with the contracts they have for the next two years with their customers.

    • 

      Scott T
      April 20, 2011 at 6:09 pm:

      Great work Brad J.

      I have always found the best source is the horses mouth, and the less interested they are in giving you 10 minutes, the less interested they are in all shareholders.

      You have proven Vocus to be one of the interested ones.

      All the best

      Scott T

    • 

      Michael
      April 20, 2011 at 7:41 pm:

      Thanks Brad, good work.

      I still have a few unanswered questions, so maybe you can help:

      1. The capacity has a useful life of 14 years – what happens then?
      2. How will increased data usage translate into increased profits – while data use is increasing, the average price paid by consumers is falling.
      3. Why isn’t the debt to equity ratio of 92% a risk? The return on equity is artifically high due to the high portion of debt funding.
      4. How much revenue and profit will be generated from the current contracts in place?
      5. How much capacity is left to sign up new customers – the cable wouldn’t enable them to take on an unlimited number of customers.

      I still may invest, however not until I am able to find answers to these, which I will revisit when they release their 2011 financial report.

      • 

        Brad J
        April 21, 2011 at 7:05 pm:

        Hi Mike,

        I am not telling you to buy VOC and in fact I can tell you are not totally comfortable with it yet, so I don’t think you should. In saying that here are my views on your questions –

        1. I am not worried about 14 years just looking forward 2 years as of today and this is based on current contracts.
        2. They clip the ticket as usage increases. Read Rogers article in the Eureka report or ring the company. I don’t believe they will have to reduce prices significantly when you look at their market position.
        3. As mentioned this dept was secured as extremely low rates at the height of the GFC. It is easily serviceable.
        4. Hard to tell exactly what future revenue will be, but look at the increase in internet usage which is an absolute certain especially in the mobile phone area. Then there is the added upside of cloud computing, NBN and the likelihood of them securing more customers which also needs to factored in. The potential is enormous.
        5. Read up on Southern Cross and the improvement to their network and your question will be answered.

        Do your own research and only invest in your area of competence as WB would say.

    • 

      darrin wong
      April 20, 2011 at 7:53 pm:

      Hi Brad

      Did some more research this afternoon on VOC closed at 2.80.
      IV according to one of Roger’s articles was at 2.45.
      My dilemma is VOC is 14% above IV.
      Do we ever buy stock which is above IV.

      cheers

      darrin

      • 

        ron shamgar
        April 21, 2011 at 9:39 am:

        Darrin, the bigger the MOS the more room for error..

      • 

        Brad J
        April 21, 2011 at 6:48 pm:

        Hi Darrin,

        I think that Roger’s valuation was done using year end 2010 numbers. My valuation of $3.44 uses numbers which I think they will do in 2011. Please do your own homework.

        If the company is growing very quickly I feel it is makes sense to use next years valuation. Very few companies fall into this category but VOC for me is definitely one. When I invest in commodity businesses I require a huge margin of safety so it also depends on the company.

        Also WB has said the best purchases he has made are when the numbers almost told him not to, which is food for thought.

      • 

        Nick Mason
        April 22, 2011 at 12:03 am:

        The value investor purists are going to shoot me down for this although I believe very strongly that if you get a great company with outstanding growth prospects, to hell with the margin of safety, ‘pay up,’ as Phil Fisher put it.

        If fair value is rising at a considerable rate you could get badly burnt constantly waiting for a margin of safety to appear. Not to say it wont although it is not uncommon for the really great growth stocks to constantly trade at a premium to their intrinsic values.

        Why shouldn’t they??

        These are the companies you want to own and which will contribute most significantly to your increasing wealth.

    • 

      Steve
      April 22, 2011 at 11:19 pm:

      Interesting topic. In regards to the question about the difficulty for a company to move their business away from a data centre, the response was that it would be hard because you would need to “replicate very high tech equipment in another secure location”. But what about just moving to another data centre? There seem to be a few companies now entering the data centre area. Next DC is a recently listed company that springs to mind.

      Also, while the prospects do seem bright for this company, the truth is that this is a ‘2nd prize’ situation. It is not ideal because it is not trading at a discount to IV. That is the reality which we must face up to and not try and convince ourselves otherwise to justify the purchase. We might think that the valuation will rise significantly but it is no bargain based on current numbers. It is certainly not a Matrix a few months back (A1 and significant discount to IV at the time).

      I’m not saying that you wouldn’t buy it, but it would be far better if it was cheaper!

    • 

      Greg
      April 28, 2011 at 4:46 pm:

      As I read the Vocus website, they mention 26 buildings powered by Vocus, these look like somebody else’s Data Centres/Exchanges to me, plus two DC of their own one in Sydney & one in Melbourne. They have just purchased a DC operator in Perth (Perth iX) for $6.3M (with paying customers). They have also just purchased 59Km of layed fibre (Digital River) in Sydney & Melbourne (with paying customers) for $3.95M or $67K per Km, seems cheap but I’m no expert. I bet it is waaay cheaper that NBN will pay per Km!
      Maybe domestic Vocus is moving from low capital intensive to a higher capital intensive organisation. The bane of this sector – some new technology is always being invented, that requires constant capex.
      The more POPs (point of presence) they open/acquire the more fibre/traffic they will need to build/buy/lease to service customers at these POPs. The margins on future deals may not be as high as those negotiated at the heights of the GFC.
      Regards Greg

37. 

    ken fraser
    April 20, 2011 at 11:41 am:

    I use 12% RR on FGE, MCE, MLD,TSM, AIR, MTU, DTL, VOC, DCG. It makes it easier to compare the discount to IV. I like RRA for safety so 10% for them. I think if you have to use any higher than 12% maybe you are not confident in the company and should not buy it at all. Would anyone like to say what they do and what they think. Thanks a lot.

    • 

      Andrew
      April 20, 2011 at 1:17 pm:

      I have/had a similar general rule that if the RR for me is above 12% it indicates that i am no longer in control of the investment due to too many external elements and there for i should just let it the company be. However i breifly diverted away from this.

      The 3 USA companies on my watchlist have 13% as a minimum as there is currency risk and time zone factors involved plus the usual factors. It makes me feel a bit more comfortable if i was to buy a US stock by being even more conservative than usual.

      The majority of my companys however are on 12%. I only have 4 on 10%. These are live ratings however and can change, in fact i moved ORL from 11% to 12% due to the Asian expansion as i could see potential headwinds based on the results of that.

      I actually don’t have any of those companys on my watchlist at the moment but i am investigating vocus and currently think 13% for myself. However this company is still on the edge of falling into the “outside my circle of competence” category where all good companys that are too complex for my simple mind go. We will see how that goes, i am starting to get a good picture about it but could not compfortably invest in it at this stage. This might be another case where if i decide to go ahead with it i will accept 13%.

    • 

      Brad J
      April 20, 2011 at 5:02 pm:

      Hi Ken,

      I think it is a very personal thing and entirely dependant on your risk profile as an investor.

      I personally think that if you are valuing a company that is growing very quickly it sometimes also makes sense to use next years valuation rather than this years. Provided you are getting into the right business with a big moat. But it needs to be a business that is growing VERY quickly. Imagine last year you valued MCE at $4.50 with a 10% MOS for that year using a 12% RR but a big MOS for the year after, would it have been sensible to miss out on buying into it? I put VOC into this category.

      • 

        Peter P
        April 20, 2011 at 11:31 pm:

        My thoughts regarding to selecting an appropriate RR are as follows –

        Market forces price risk and return for stocks as participants trade in the market. The market has no regard as to how we price risk on an individual basis based on our own personal circumstances.
        To illustrate what I am trying to say I will use a simplified example on a commercial property.
        Valuers may value a commercial property by using a “capitalisation rate” approach. They look at the income (rental) and the yield ( return), that similar properties are achieving in the area at a given sale price. Market value is then estimated simply by, the income ( rental) divided by the yield (return).
        Our individual thoughts and preferences on risk and return are not going to change the estimated value of this property. This is already priced in by what the lessee’s are prepared to pay, what the vendors are prepared to sell and the investors are prepared to buy.

        I think the stock market has similar principals. Risk and return is priced in. If we can work out what the market is pricing in as risk / return on a given stock, then we can apply an appropriate RR, come up with an estimated IV and look for an opportunity to buy it at a discount. If we are using our own personal RR (which has nothing to do with how the market is pricing RR), then we could be missing out on opportunities or even paying too much in some cases.

      • 

        Paul Rehill
        April 21, 2011 at 10:01 am:

        Hi Peter

        Sounds like you, like me, studied Efficient Market Hypothesis, the Capital Asset Pricing Model and Beta as a measure of risk at University. I’ve managed to reverse the brainwashing spread by my finance professors that is adopted by a lot of institutional investors for myself at least and I had to study this stuff over and over again in different courses.

        Value investors should be thinking about their own individual required rate of return rather than a cost of capital that is taught in modern finance theory in universities. Quoting page 107 from “Poor Charlie’s Almanack” on Cost of Capital and Opportunity Costs:

        Warren Buffett: Charlie and I don’t know our cost of capital. It’s taught at business schools, but we’re sceptical. We just look to do the most intelligent thing we can with the capital that we have. We measure everything against our alternatives. I’ve never seen a cost-of-capital calculation that made sense to me. Have you, Charlie?

        Charlie Munger: Never. If you take the best text in economics by Mankiw, he says intelligent people make decisions based on opportunity costs – in other words, it’s your alternatives that matter. That’s how we make all of our decisions. The rest of the world has gone off on some kick – there’s even a cost of equity capital. A perfectly amazing mental malfunction. Obviously, consideration of costs is key, including opportunity costs. Of course, capital isn’t free. It’s easy to figure out your cost of borrowing, but theorists went bonkers on the cost of equity capital. They say that if you’re generating a one hundred percent return on capital, then you shouldn’t invest in something that generates an eighty percent return on capital. It’s crazy.

      • 

        Gavin
        April 21, 2011 at 7:14 pm:

        Hi Paul

        Classic Charlie Munger – and I for one totally agree.

      • 

        Nick Mason
        April 22, 2011 at 11:40 am:

        Hey Paul,

        Thanks for posting that.

        I’ve never read “Poor Charlie’s Almanack” although will when I get the chance. Charlie also wrote ‘The Art of Stock Picking’ which is a great read and which others on this forum may be interested in, it’s available on the internet.

        A Happy easter to you, Roger, and the rest of the people here on the forum.

      • 

        Paul Rehill
        April 25, 2011 at 5:37 pm:

        Happy Easter Nick

        I googled The Art of Stock Picking and it matches up with Talk Two: A Lesson on Elementary, Worldly Wisdom as It Relates to Investment Management and Business in Poor Charlie’s Almanack which is a must buy for all value investors. The expanded 3rd edition is just $49 USD or $99 if you want a copy signed by Charlie Munger which I’m lucky enough to have. All I have to do now is carry a copy of Value.Able around until I bump into Roger so he can sign it. ;)

    • 

      ken fraser
      April 20, 2011 at 10:21 pm:

      Sorry not RRA it is now TGA. Thorn Group.

    • 

      Paul Rehill
      April 21, 2011 at 9:48 am:

      Hi Ken

      If you use a 12% RR, this means you are happy to earn AT LEAST 12% p.a. after tax year after year. That is your goal, to earn 12% compounded returns.

      Warren Buffett and Charlie Munger have the COMPOUND INTEREST model compounded into their investment process. To determine your required rate of return which is your discount rate, think about the opposite of discounting, compounding your capital. Think about:
      1. Taking some sum of money. E.g. $10,000.
      2. Your investment time horizon. E.g. 30 years.
      3. Your minimum required rate of return. E.g. 15%.

      Compounded capital in 30 years time = $10,000 x (1+RR)^(Time horizon)
      = $10,000 x (1 + 15%)^30 = $662,000.

      If you are still undecided about your RR, follow steps 1 to 3 but for step 3 repeat the calculation for 10%, 11%, 12% etc to 20% and determine which compounded capital target best suits your goal.

      Buffett and Munger use 15% but achieve more (20%+) by using Mr. Market as their servant who lets them receive more for their security sales and pay less for their security purchases (the MARGIN OF SAFETY) plus they earn a little bit extra through their derivatives float.

      A quick mental note for sizing up a common stock to see if it will meet your required rate of return = Stock’s future/incremental return on equity x (1 – dividend payout ratio) + dividend yield.

      If you want a 12% RR, it is going to be a lot easier if you select securities that have a low dividend payout ratio, high return on equity (say >15%, the higher the better) and are purchased at a discount to your IV and have little or no debt to minimise insolvency risk.

      Once you settle on your RR, the OPPORTUNITY COST model comes next. You evaluate your investment opportunities using your IV calculations on a CONSISTENT BASIS and decide how to allocate your limited capital to these opportunities to try to achieve your investing goals.

      Good luck, Paul.

      • 

        ken fraser
        April 21, 2011 at 4:21 pm:

        Paul, I think of the RR as a rating of risk and thats about it.

      • 

        Paul Rehill
        April 22, 2011 at 10:05 am:

        Hi Ken

        RR (investor’s required rate of return) of 12%. What risks did you rate to arrive at 12%? E.g. risk free rate of return, inflation, equity risk premium etc. Will you adjust the RR up and down in the future as your rated risk factors change? If so, how easy will this be to evaluate? Is there a simpler way?

        My minimum required rate of return is 15% p.a. after tax on the underlying economic value of the company (i.e. increasing book value per share + dividend return). This is sufficiently higher than the RBA’s average inflation target of 2.5% and the long-term government bond rate such that movements in these factors are unlikely to require an adjustment to my RR. In addition, I sell long-term put options (generally with deep-out-of the money strike prices) to generate premium income that is invested into high quality common stocks. With this and Mr. Market’s help, my goal is to compound at 20% p.a.

        It’s fine to have a different approach. But at the basic level, the required rate of return for Roger’s two tables is the discount rate applied to the future investment prospects for one company that pays out 100% of earnings as dividends, and another that retains and reinvests (or compounds) 100% of earnings back into the business.

        The opposite of discounting is compounding but they are really two sides belonging to the same coin. One represents the value of an investment today and the other the value of that investment tomorrow. If value investors think about the compounding part which was a big theme in Buffett’s biography The Snowball and one of Charlie Munger’s big mental models that he draws upon, it greatly simplifies the thought process that goes into determining their required rate of return.

        All the best, Paul.

38. 

    Andrew
    April 20, 2011 at 11:07 am:

    Just remembered throughout my day today a WB Quote.

    “There seems to be a perverse human characteristic that likes to make easy things difficult”.

    After thinking about it some more i realised out of all his pearls of wisdom, this one sticks with me and in my view encompasses everything else and is probably the best definition of my investing style.

    I like simple companys, the business ideas I generate and one day put into practice are simple companys.

    I think, in a way echoing robs post, we can sometimes on this blog be guilty of trying to make it difficult and go searching more than we need to for the next great investment.

    Remember, value investing is a game of patience, you may have learnt a new investing method and want to put it into practice straight away however, you may need to wait for the next big opportunity. Don’t get carried away, sit back and relax, spend some time with loved ones, the market will open again tomorrow and then the next day, year, decade. At some point you will find a great opportunity, there is no need to force it.

39. 

    Roger Murdoch
    April 20, 2011 at 8:11 am:

    Hi Everyone
    My first blog after reading Roger’s book, a book i wish i read five years ago ,but thats a long story.
    I think the Easter home work is a great idea and am looking forward to getting in to it upon finishing work on Thursday.
    I would also appreciate the blog communities opinion on a small company which i do currently own. LGD . I have used this company as my first application of Roger’s valueing methodology. I have come up with an IV of $ .41 cents using the companies latest report. A second opinion would be helpful in establishing if i am on the right track.

    • 

      Josh
      April 20, 2011 at 12:12 pm:

      Gday mate.. jeez you wouldn’t want to abbreviate your name around here.

      What RR are you using for a $0.41 valuation on LGD? I think you need to use a bit higher RR.

      They seem to be in reasonably healthy condition and ticking along OK at the moment but they are not anywhere near the type of high quality company we search for here nor are they trading at a very tempting discount. Their ROE is less than impressive and I think this is to be expected and not something that is likely to vastly improve going forward because they are dealing in what are commodity type products in a very competitive market (for which they are a minor player) with low barriers to entry, and which is a mature and fairly niche market.

      Of course I could be wrong and also their share price could do well irrespective of that but the risk/return isn’t attractive in my opinion.

      • 

        Roger Murdoch
        April 27, 2011 at 8:20 pm:

        Thank you Josh, Brad and Rob for your advice, very helpful.

    • 

      Brad Voigt
      April 20, 2011 at 12:14 pm:

      Hi Roger, Just worked through LGD i get IV 0.29 for 2010 and 0.31 for 2011. So know margin of safety for me at the moment. I used a 13%RR and 15% ROE for calculations. The ROE is quite low indicating it doesnt have a major competitive advantage all the other financials look ok to me it has low debt/equity and is paying down its debt. Only a beginner like yourself but think there is better opportunities out there.

    • 

      Rob
      April 20, 2011 at 2:12 pm:

      Hi Roger,

      Firstly welcome to the blog, you have lots of friends here.

      As everyone else has suggested you probably used an RR of 10% ‘cos that’s the IV I get when I do that.

      There are two things (OK three) you need to be aware of.

      First don’t get hung up on IV. Check out this comment by Ash for more info. http://rogermontgomery.com/who-asked-for-easter-holiday-homework/#comment-12046

      Second, use 10% for only the very best companies, actually best of the best. Roger uses it in his examples only to make the homework easy and the results comparable. OK companies get a 14% and the better the company the lower the RR. If the company is only average then apart from doing Roger’s homework you shouldn’t be wasting your time on them.

      And thirdly, IV calculations will vary. It’s very hard for two people to come up with the exact same IV. So except for checking you are in the right ballpark, Don’t get hung up on the accuracy. As has been said many times on the blog, it’s better to be approximately right than exactly wrong.

      Lastly, all the other stuff that Ashley talks about can seem a bit daunting but after you do it awhile and spend plenty oif time on the blog reading what others have to say, it gets a lot easier. Your knowledge will grow and it will be time well spent.
      Cheers
      Rob

40. 

    Jason
    April 19, 2011 at 10:10 pm:

    Good to see a very active blog post. Market dropped today so a good day for most people here I am guessing.

    Just want to know if you guys are ignoring companies that have high retained losses but have posted a net profit in their latest result. I find companies with high ROE but upon closer inspection of the annual report, they have very high contributed equity, high retained losses which reduce their net equity, thus giving them a high ROE. Should we calculate ROE based on net equity, or contributed equity? I prefer the latter as it is what owners put into the company in the first place.

    Your thoughts?

    • 

      Gavin
      April 20, 2011 at 10:13 am:

      From an owners perspective rather than an accounting perspective. I think it’s logical that you look at what the owners have put in + what they have left in (profits not distributed)

      Accounting ROE is distorted as an economic measure because losses are charged back to retained earnings.

      Look at ORL as an example. They had major problem s in 2005 & 2006 which resulted in goodwill being written off and losses of 26 Million charged back to retained earnings. Without this negative event their accounting ROE would be much lower. (accounting ROE is not always logical as a valuation input)

      • 

        Paul Rehill
        April 20, 2011 at 10:45 am:

        I prefer to use contributed equity. This means some extra work in reversing accounting write-offs and lowering ROE by going through past financial statements. The adjustment is worthwhile if it is material. A recent immaterial adjustment I looked at was Austin Engineering’s minor and unnecessary write-down of intangibles as the company’s economic earning power is substantial. The adjustment had only a minor effect of 0.3% (I think from memory) on ROE and the valuation assumptions I used were biased enough on the conservative side to ignore the adjustment.

        An example of making a substantial adjustment would be Transurban (I think their accumulated losses exceed $3bn last time I looked).

      • 

        David C
        April 21, 2011 at 9:52 am:

        Gavin I agree with you but wonder if there is a compensating offset via a reduction in the equity per share. Roger’s IV tables are a function of equity per share and ROE.

        Like ORL Wesfarmers could increase its ROE by writing down the Coles purchase, but methinks this would reduce equity per share and not help improve the IV much.

        I have wondered but not investigated which factor has the greatest impact on IV.

      • 

        Paul Rehill
        April 21, 2011 at 10:16 am:

        Hi David

        The problem is with future retained earnings. Applying an inflated ROE to future retained earnings will lead to overestimating IV.

        I use a different valuation model that allows a lower ROE to be applied to future retained earnings post the valuation date.

41. 

    yavuz
    April 19, 2011 at 6:43 pm:

    There was a discussion on GR Engineering IPO a couple of weeks ago. GR has debuted 90% premium @ $ 1.90 today. Interesting.
    Yavuz

    • 

      Ash Little
      April 19, 2011 at 7:02 pm:

      Hi Yavuz

      Tell us if it drop to $1.30. We might get excited then

      • 

        Leon
        April 19, 2011 at 7:23 pm:

        I have been looking at GR since it launched its public offering.

        Recently I have been taking a notice at the new IPO coming into the market that have been screaming buys for me. I have taken notice of three IPO’s they are Maca Limited (up 253% in five months), Corporate Travel Management (up 190% in < four moths) and a new unlisted company GR Engineering.

        Currently I have an intrinsic value 24% above its issued price of $1. GNG was established in 2006 and net profit has been rising ever since (forecast 18.8 million next year). The offer proceeds will be primarily used to fund the growth of GR Engineering possibly hinting at takeovers. In my opinion this company is slightly under priced and could be a great and rare opportunity to purchase a company substantially below intrinsic value. I have an IV of $1.24 2011 and $1.38 in 2012.

        So right now in my opinion its overpriced.

      • 

        yavuz
        April 20, 2011 at 9:49 am:

        I do not own GNG shares. I thought it was expensive. However, I will be watching with interest how they go mainly because I know quite a bit of people working there (I work in the same industry, mining engineering services).
        Yavuz

      • 

        Graeme
        April 20, 2011 at 10:46 pm:

        Yeah, I did expect it to start higher than $1, but $1.90 way over priced IMO.

42. 

    Rob
    April 19, 2011 at 5:23 pm:

    I’d love to be able to write creatively like Craig B and Scott T and use some good analogies to illustrate my points but unfortunately I think I’d come off rather corny, so I’ll leave that to the experts.

    So I may have to just bore you with my real life observations.

    When I first got into the share market I was told to “Do your own research and learn to control fear and greed”

    Gordon Gecko says “Greed is good”. Well perhaps it is, it got you here didn’t it? But it can also be a bit of a problem.

    Greed is what makes you borrow to invest. It’s what says “In this market I can’t go wrong” and you know what, you do. It’s what makes you throw caution to wind and play derivatives or buy stocks you normally steer clear of like gold or IT or anything you don’t really understand. It makes you hold on to stocks you should have got out of a long time ago. It what makes you watch them go up and then fail to sell and watch them go down.

    It’s what makes you forget your formula for picking stocks and relax your rules and buy with no or little MOS, or but a stock that is rising but has no real fundamental reason to.

    Fortunately, this blog is a great source of education. Remember, Warren Buffet won’t buy any business he doesn’t understand. With contributions, such as Mal’s on gold, it helps us all to understand them a bit more. But unless you really do understand the business you should steer clear.

    Another quote from Gordon “The most valuable commodity I know of is information”. This blogs got it in spades.
    Cheers
    Rob

    • 

      Ash Little
      April 19, 2011 at 6:54 pm:

      Nice Post Rob

      Thanks for that

    • 

      Scott T
      April 20, 2011 at 6:18 am:

      I think you write very well Rob, well done.

      All the best

      Scott T

    • 

      Andrew
      April 20, 2011 at 8:12 am:

      Nice post Rob, I have been guilty of committing some of the sins you have mentioned. There is an idea Roger (no offence meant to anyone of a religious persuasion and if i cause it i am sorry), the deadly sins of Value investing, already thought of some.

      1-Speculation
      2-Buying bad businesses
      3-Buying without a margin of safety
      4-Buying above intrinsic value
      5-Making decisions based on market movements and not rational analysis

      As per the Gekko mantra, “Greed is good”. My observations have been that greed is good, but just usually not for the greedy one.

      However as always, these mistakes can teach us a lot more. If i hadn’t made some investing errors i wouldn’t be here now as i would still be “investing” blindly in businesses i thought were good but weren’t or were good but were too expensive and i still lost money.

      And never fear Rob, creatvity is something we all have i believe, and we all have it in our own sort of way. It can also be harnessed and taught and nurtured through various techniques in my experience. I am sure you are creative in your own way, perhaps you just don’t realise that you are.

    • 

      Sean
      April 20, 2011 at 9:13 am:

      Rob and blog

      Words of wisdom indeed. Sometimes we identify great businesses at a discount to their value and make some coin on them and then sometimes we just get lucky; the important thing is to know the difference between the two. This blog helps set our compass towards the first; however human nature being what it is; greed sometimes sways us towards the luck.

      That’s what people are doing racing to get into anything Roger mentions or delving into ‘penny stocks’ or speculative minor miners employing hobbits hoping for a ten bagger!

      The dangerous thing is to think how easy it is and how clever we are when we are just dumb lucky sometimes. My fear is that by Roger introducing us to the ilk of MCE, FGE and DCG etc which have been very profitable; that some people may get the impression that this investing gig is easy.

      I like this Buffet quote when I’m getting impatient or thinking about higher risk investments. I find it helps reset my compass when I mistake getting lucky for being clever: “I don’t look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.”

43. 

    Adam
    April 19, 2011 at 4:02 pm:

    Hi Roger,

    Looking at your recent post giving Apple an A1 Montgomery quality rating got me thinking, and I was wondering if you could tell me what MQR rating Coca Cola gets? (I.e. the American company not Coca Cola Amatil)

    It appears to generate consistent 30% plus ROE, which is pretty amazing given the size it already is. (Although the debt may be slightly high..) Plus I don’t beleive it would have the same technology risk as a business such as Apple.

    Plus I think may have one of, if not the strongest competetive advatages in the entire world.

    Would it be an A1? (Not asking for your valuation, I’ll have a go at that myself!)

    Thanks Roger

    • 

      Roger Montgomery
      April 19, 2011 at 7:01 pm:

      Hi Adam,

      Great suggestion Adam. I just ran the numbers for KO The Coca Cola Company and it has held an A1 MQR since 2001 with the exception of 2010. You are right ROE has been 29% and 37% every one of the last ten years but is currently expected to fall to 25% by 2013 – a case of unjustified pessimism?

      I can also tell you that my estimate of its Intrinsic value has risen from $25.86 in 2002 (when the shares price was $47) to $49.17 in 2009 (when the share price was still $40). So for nearly ten years the stock traded sideways while intrinsic value oscillated but generally rose. In 2010 intrinsic value rose to $60.94 (share price $52.72) and in 2011 $62.12 (share price $63.92). My 2012 and 213 forecast IVs currently are $64.57 and $68.93 respectively.

      I hope that helps. Not a recommendation of course.

      • 

        Leon
        April 19, 2011 at 7:25 pm:

        Of course Coke would have been an A1. We should all know who has a large stake in the company. Warrent Buffet the value investor king.

44. 

    ron shamgar
    April 19, 2011 at 2:31 pm:

    VOC SPP was oversubscribed 3.4 times. we will get about $3k :-(

    • 

      Nick Mason
      April 20, 2011 at 9:42 am:

      Hello Ron,

      great posting by you the last few months, you’ve contributed a great amount of knowledge to the forum and a great amount of wealth to people’s wallets. Keep it up.

      Vocus were seeking $1.9 million and they got over $6.5 million so I worked it out like this.

      1.9/6.5 = 29%

      29% of $15000 = $4384 = 2192 shares at $2. This is assuming you applied for the full amount. If you didn’t you’ll get less.

      The money returned to me I’ll be putting back into MCE,

      Best Wishes and a Happy Easter to all.

      • 

        ron shamgar
        April 20, 2011 at 10:28 am:

        hi nick,
        thanks.
        ill take whatever they give me.
        cheers.

      • 

        Joab Soh
        April 20, 2011 at 10:56 am:

        Hi Nick,

        I am afraid we are not getting as much as you would like. The announcement states that applicant who applied for 1,000 or fewer shares will be fully allocated. The rest are pro-rata. So, your calculation works on the assumption that every shareholders wanted to maximum amount shares.

        I hope you are right, but I am not going to put my hopes too high.

      • 

        JustinP
        April 21, 2011 at 6:08 pm:

        I received 2015 VOC shares (applied for the full $15k.)
        Thanks to Stephen Mayne, I’m in around 950 coy’s, so I don’t
        miss too many capital raisings :)

      • 

        James
        April 22, 2011 at 12:06 pm:

        Hi JustinP,

        If I could ask; how did you accumulate small parcels in 950 companies? I thought you needed to buy $500 worth of shares in each company as a minimum?

        I have been wanting to use this strategy for a while but am not sure how to do this in an economical way (saving on brokerage, bypass the minimum amount etc…?) Any help would be appreciated.

45. 

    Robert
    April 19, 2011 at 12:13 pm:

    Hi All,

    Someone was asking about screening stocks in the US a few posts ago… This morning I discovered that Google finance does it, Free! : http://www.google.com/finance/stockscreener Go to ‘add criteria’ and select whatever you like.

    Rob F

46. 

    Darryl
    April 19, 2011 at 9:41 am:

    It seems all the above calculations are done using ROE calculated as recommended by Roger in the book. I have seen valuation calculations performed using a figure called “normalised return on equity” instead of ROE calculated as suggested. NROE figures seem to be considerably different to straight ROE figures and therefore lead to a significant variation in valuation figures. Could you please comment on NROE vs ROE. Many thanks.

47. 

    John Edwards
    April 18, 2011 at 8:43 pm:

    Hi All,

    I am reasonably new to the valueable theory, would like an opinion on the following:
    I recently purchased CSV at $1.19 as I had an IV of $1.69. Today they dropped 23 cents to $1.07 after having a seeming confusing capital raising of $40 million. Are they still value?

    I had a couple of other IV are they in the ballpark
    RIO $116.90
    ORI $42.84
    KAM $2.51
    MOC $2.98

    Thanks
    John

    • 

      Ash Little
      April 19, 2011 at 1:38 am:

      Hi John,

      This is just my view but the valuation chapter of valuable is the least most important part of Rogers book.

      In this case the section on cashflow may have saved you some pain.

      We are looking for good businesses with little or no debt and a good competitive advantage.

      I am not sure CSV fits the bill.

      I would recomend you reread all the other section of Rogers book and forget the valuation bit until you can find the ones that is worthy of valuation.

      Just my view and hope it helps.

      • 

        Brad J
        April 20, 2011 at 11:03 am:

        I agree with you Ash the valuation chapter is least important and this analysis should be done once all other boxes are ticked. Its the quality of the business that is most important once you are happy with the business then you figure out what you are prepared to pay for it.

    • 

      Michael P
      April 19, 2011 at 11:20 pm:

      CSV: I had IV of $1.08 based on my stricter RR of 12% and FY09-10 figures. Looking at the history since FY08, I see declining ROE, and the Equity increased from $65m to $217m and debt from $38m to $165m, while the NPAT increased only from $18mil to $31mil. So that is where my analysis ends I’m afraid with this one.
      In the IT sector, there are a couple to look at (not currently trading below IV) and exercise patience.
      Michael.

    • 

      darrin
      April 20, 2011 at 9:53 am:

      HI John

      Check out the etrade site for CSV under balance sheet.
      Long term debt is 43% of capital and shareholders equity makes up 57% of capital.

      cheers

      darrin

      • 

        John Edwards
        April 20, 2011 at 10:32 pm:

        Thanks everyone for your advice. Looks like I have a lot more homework to do.

        John

48. 

    Ash Little
    April 18, 2011 at 8:33 pm:

    Hi Guys,

    I know a few people are interested in buying stocks so I thought I would post this here.

    http://www.commsec.info/etis/about.aspx

    Exchange traded individual stocks have now been developed to trade on the ASX. At the moment it is limited to the top 30 US stocks and you must have a comsec account. to trade them.

    It is envisaged that you the number will increase over time.

    Your should also note the following warning about ETF’s generally.

    http://www.businessspectator.com.au/bs.nsf/Article/ETFs-pd20110418-G29GX?opendocument&src=rss

    • 

      Ash Little
      April 18, 2011 at 8:57 pm:

      BTW this is not a recommendation

      Given the exchange risk I would not buy US stocks with stolen money.

      • 

        Ken
        April 19, 2011 at 3:47 pm:

        Ash,

        The commsec link is to ETIS and the article is about ETF – two entirely different animals. What is the exchange risk ? Do you see the AUD going higher ?

      • 

        Ash Little
        April 19, 2011 at 5:37 pm:

        Hi Ken sorry I thought ETIS and ETF were similiar as they both use derivativies to achieve their goal.

        It is not so much that I think the Australian dollar will be strong but the US dollar being weak.

        With the money they are printing in the US I personally believe that we will be suprised how high the $A goes and how high it stays

      • 

        Lloyd
        April 19, 2011 at 5:00 pm:

        Ash and others,

        WARNING: The ETIS instrument carries considerable counter party risk. It is ‘money for jam’ for RBS, given the all time high AUD/USD and the all time high share price in USD of most of the 35 stocks on offer. This before consideration of the 50% fee on income (notional dividends) and nominal ownership of withholding tax offsets by RBS. In truth, the ETIS instrument is nothing more than a fancy and expensive option, which is not underpinned by the ownership of the stocks involved, nor does any direct beneficial interest attach to the referenced stocks. The risk is very much to the downside for the retail investor buying into an ETIS given current pricing, exchange rates and the likely limited liquidity in the essentially unregulated ETIS secondary secondary market when it opens. The latter represents another grab for new commission income by the ASX, with no care and no responsibility attached.

        This is not financial advice, but rather a financial health warning that should be attached to the ETIS package (disclosure document) if the regulator was doing his job properly.

        Regards
        Lloyd

      • 

        Chris Brincat
        April 20, 2011 at 7:34 am:

        I concur with your sentiments Lloyd,

        I will also add that in my opinion if I were inclined to buy stock listed on an American exchange I would rather simply open an American brokerage account and buy the shares directly.

        Personally, i use Interactive Brokers (IB). I don’t buy/sell US shares through IB. Rather I use them to trade futures. Also, just to let people know, using IB the minimum comission to trade US stock and ETFs is $1 (USD), compared to Comsec’s minimum of $19.95!

        Food for thought,

        Chris B

      • 

        Scott T
        April 20, 2011 at 6:21 am:

        I would not buy US stocks with stolen money

        LOL

        Love that one Ash.

        All the best

        Scott T

      • 

        Ken
        April 20, 2011 at 10:45 am:

        And yet the US market has outperformed the Australian market by a considerable margin. Where is the logic ?

      • 

        Ash Little
        April 20, 2011 at 1:04 pm:

        In $A term Ken?

        I don’t think so

      • 

        Ken
        April 20, 2011 at 6:33 pm:

        Ash,

        I was referring to the % increase in the S&P 500 (US) since the GFC, versus the increase in the S&P 300 (AU) in the same timeframe. If you make the same comparison of Australia to the European markets, you get the same results. The ASX has lagged in % increase terms. That has nothing whatsoever to do with currency exchange rates.
        I acknowledge your point about exchange rate risks associated with overseas investing however.

        (As for Ilya’s comments, I really don’t understand his point at all.)

      • 

        Ash Little
        April 21, 2011 at 8:45 am:

        Hi Ken,

        Illya Point is that the the markets you point out are in the countries that have printed the most money so their currencies are worth less.

        If you had of put $A in those markets your % gain would have been very different

      • 

        Ilya
        April 20, 2011 at 1:30 pm:

        The price of everyting goes up when it’s measured in a currency of diminishing value. Stocks are no different.

        If I recalibrated your ruler and made the inch marks at every half inch, would you become twice taller?

        Measured against the price of hard assets, for example commodities, the stock market is way down.

      • 

        Ash Little
        April 20, 2011 at 6:56 pm:

        Good one IIya.

        I like your height reference.

49. 

    Craig B
    April 18, 2011 at 7:20 pm:

    A: CWP, SAI, FMG, CCL, MMS, ALL

    B: FMG

50. 

    Luke
    April 18, 2011 at 3:05 pm:

    Hi All,

    Have Coca-cola Amatil been paying down debt because the last annual report shows debt/equity ratio much higher than 50%.
    If they brought there debt down I would be more interested in this company.

    Interestlingly I performed steps 1 and 2 and filters the list 115 companies. Much less than 255 so not sure what is going on there.

    Regards
    Luke

    ASX Code Company Name Return on Equity Debt/equity ratio MNF My Net Fone Limited 14,541.4% 0.0%
    AAE Agri Energy Limited 833.4% 0.0%
    MOO Monto Minerals Ltd 188.5% 0.0%
    AJJ Asian Centre for Liver Diseases and Transplantation Limited 129.0% 0.0%
    EIO Energio Limited 92.9% 0.0%
    EHR Earth Heat Resources Ltd 81.4% 0.0%
    TEG Triangle Energy (Global) Limited 74.1% 0.0%
    MZM Montezuma Mining Company Limited 63.6% 0.0%
    PTM Platinum Asset Management Limited 60.7% 0.0%
    ACR Acrux Limited 57.8% 0.0%
    LRL Leyshon Resources Limited 56.4% 0.0%
    NCK Nick Scali Limited 52.5% 0.0%
    CRZ Carsales.com Limited 48.6% 0.0%
    THX Thundelarra Exploration Limited 46.5% 0.0%
    IRE Iress Market Technology Limited 42.4% 0.0%
    SOO Solco Ltd 39.4% 0.0%
    LER Leaf Energy Limited 38.0% 0.0%
    IDG Indago Resources Ltd 37.8% 0.0%
    REA REA Group Ltd 37.6% 0.0%
    MML Medusa Mining Ltd 37.5% 0.0%
    IFM Infomedia Limited 33.6% 0.0%
    RKN Reckon Limited 33.5% 0.0%
    CNH China Steel Australia Limited 33.0% 0.0%
    DWS DWS Advanced Business Solutions Limited 32.9% 0.0%
    DRA Dragon Mining Limited 31.6% 0.0%
    SRX Sirtex Medical Limited 31.2% 0.0%
    TWD Tamawood Limited 30.5% 0.0%
    MOC Mortgage Choice Limited 30.4% 0.0%
    CST Cellestis Limited 30.2% 0.0%
    SMX SMS Management & Technology Limited 30.2% 0.0%
    ARP ARB Corporation Limited 29.3% 0.0%
    MOD Medical Corporation Australasia Limited 27.9% 0.0%
    PVA pSivida Corp 26.5% 0.0%
    WEB Webjet Limited 26.4% 0.0%
    HIG Highlands Pacific Limited 25.0% 0.0%
    FWD Fleetwood Corporation Limited 24.6% 0.0%
    FPS Fiducian Portfolio Services Limited 24.5% 0.0%
    CPZ Car Parking Technologies Limited 24.2% 0.0%
    CGS Cogstate Limited 23.3% 0.0%
    PME Pro Medicus Limited 23.3% 0.0%
    APP APA Financial Services Ltd 22.6% 0.0%
    HSN Hansen Technologies Limited 22.3% 0.0%
    IRI Integrated Research Limited 22.0% 0.0%
    STU Stuart Petroleum Limited 22.0% 0.0%
    ASW Advanced Share Registry Ltd 21.9% 0.0%
    SND Saunders International Limited 21.8% 0.0%
    AOP Apollo Consolidated Limited 21.4% 0.0%
    RCO Royalco Resources Limited 21.4% 0.0%
    BGL Bigair Group Limited 21.0% 0.0%
    TRG Treasury Group Limited 20.8% 0.0%
    CMJ Consolidated Media Holdings Limited 20.7% 0.0%
    WTF Wotif.com Holdings Limited 61.6% 0.2%
    DTL Data3 Limited 41.8% 0.4%
    MAQ Macquarie Telecom Group Limited 25.9% 0.5%
    ISS ISS Group Limited 30.7% 0.5%
    IDE IDEAS International Limited 27.4% 0.6%
    AFT AFT Corporation Limited 31.9% 0.6%
    NSP Nusep Holdings Ltd 25.6% 0.8%
    CNA Coal & Allied Industries Limited 24.2% 0.9%
    HGO Hillgrove Resources Limited 34.1% 1.5%
    KKT Konekt Limited 51.9% 2.0%
    REZ Resources & Energy Group Limited 21.5% 2.1%
    GBA Grandbridge Limited 49.5% 2.2%
    NVT Navitas Limited 61.0% 3.4%
    KCN Kingsgate Consolidated Limited 23.9% 3.5%
    TNE Technology One Limited 28.1% 4.6%
    SWL Seymour Whyte Limited 41.8% 4.6%
    JML Jabiru Metals Limited 20.3% 4.7%
    LYL Lycopodium Limited 36.9% 5.0%
    DDT DataDot Technology Limited 35.8% 5.1%
    FGE Forge Group Limited 33.3% 6.8%
    RZR Razor Risk Technologies Limited 29.8% 6.9%
    TGA Thorn Group Limited 23.8% 7.3%
    GLE GLG Corp Limited 22.6% 8.8%
    AIR Astivita Renewables Limited 36.2% 8.9%
    KNH Koon Holdings Limited 23.8% 9.9%
    SXE Southern Cross Electrical Engineering Ltd 22.2% 10.4%
    CSL CSL Limited 22.1% 11.0%
    HHL Hunter Hall International Limited 30.3% 11.0%
    SKS Stokes (Australasia) Limited 21.4% 11.6%
    PNA PanAust Limited 22.6% 11.7%
    SFH Specialty Fashion Group Limited 50.2% 13.2%
    MCE Matrix Composites & Engineering Limited 30.3% 13.5%
    DJS David Jones Limited 23.0% 14.0%
    CUE Cue Energy Resources Limited 27.7% 14.2%
    OKN Oakton Limited 20.9% 14.5%
    AZZ Antares Energy Limited 73.4% 14.5%
    MIN Mineral Resources Limited 21.2% 18.8%
    GUD GUD Holdings Limited 21.3% 19.1%
    COU Count Financial Limited 41.5% 20.5%
    MTU M2 Telecommunications Group Limited 21.0% 21.5%
    MND Monadelphous Group Limited 57.7% 22.6%
    QTG Q Technology Group Limited 37.9% 23.6%
    VSC Vita Life Sciences Limited 58.3% 23.7%
    JBH JB Hi-Fi Limited 40.4% 23.7%
    ZIM Zimplats Holdings Limited 22.7% 24.6%
    RIO Rio Tinto Limited 24.0% 24.6%
    ANG Austin Engineering Limited 22.2% 26.9%
    CIL Centrebet International Limited 26.0% 27.7%
    SEK Seek Limited 25.4% 28.2%
    FPH Fisher & Paykel Healthcare Corporation Limited 24.4% 28.7%
    FAN Fantastic Holdings Limited 20.5% 29.4%
    BHP BHP Billiton Limited 25.7% 32.5%
    ORL OrotonGroup Limited 80.0% 33.5%
    COH Cochlear Limited 35.4% 35.8%
    NWH NRW Holdings Limited 22.4% 36.0%
    NFK Norfolk Group Limited 24.0% 38.4%
    REF Reverse Corp Limited 85.3% 38.7%
    PCC Probiomics Limited 65.0% 40.6%
    AGX Agenix Limited 87.1% 41.3%
    EOS Electro Optic Systems Holdings Limited 25.2% 44.0%
    ORI Orica Limited 47.9% 46.1%
    OEC Orbital Corporation Limited 21.7% 46.4%
    WOW Woolworths Limited 26.7% 46.8%
    LWB Little World Beverages Limited 20.3% 47.8%

    • 

      Roger Montgomery
      April 18, 2011 at 11:03 pm:

      Nice work Luke. Thanks. SOme of our numbers differ. But a few got me thinking. Well done.

    • 

      darrin
      April 20, 2011 at 9:55 am:

      HI Luke

      Great Job, How long did it take you?

      cheers

      darrin

    • 

      Ken
      April 20, 2011 at 10:47 am:

      Checked a few of your debt/equity figures and I can’t find one I agree with. You are not calculating NET debt to equity it seems.

    • 

      Rob
      April 20, 2011 at 1:47 pm:

      Hi all,
      Luke did a good job of filtering and I think you’ll find the results are directly from eTrade. It’s really interesting what it throws up.
      Thanks again, Luke.
      Cheers
      Rob

      • 

        Luke
        April 21, 2011 at 3:19 pm:

        Results courtesy of westpac broking website filter tool.

        Luke

      • 

        Rob
        April 21, 2011 at 10:47 pm:

        Hey Luke,
        that’s interesting. ETrade throws up the same list. Obviously Westpac and ANZ use the same data.

      • 

        Lloyd
        April 24, 2011 at 6:53 am:

        All sourced from the same AspectHuntley database.

51. 

    Grant Duggan
    April 18, 2011 at 9:43 am:

    Please Help TRS
    Regarding homework those that are using E-Trade come up with 51%roe 2010.Can someone please spell it out for me as i am a little lost how to get to this figure?
    Sorry for the simple question but if use the 45% figure showing 2010 i am to far off the mark.Thanks in advance

    • 

      Andrew
      April 18, 2011 at 3:55 pm:

      Can’t comment on E-trade but tend to shy away from the brokers and go direct to the balance sheet as that is the most accurate.

      2010 NPAT was 23,351
      Beginning equity was 40,428 and Ending equity was 51,543.

      My bet is that if you are getting a 45% ROE figure than this is because E-trade are using ending equity which is different to how people use it here. This is why it is good to actually measure it yourself instead of relying on the broker info as the way they calculate things might be different to how you want to calculate it.

      I got ROE of 50.78% and would use the 50% ROE input. This is based on the Return on average equity method described in value able where you average out the beginning and ending equity figures and divide the NPAT by that.

      • 

        Rob
        April 18, 2011 at 5:04 pm:

        Grant,
        I get exactly the same as Andrew using average equity.
        Cheers
        Rob

      • 

        Ash Little
        April 18, 2011 at 5:44 pm:

        Hi Everyone,

        I would just like to reiterate Andrews remarks regarding ROE on comsec and etrade. DO NOT USE THEM.

        They are wrong as Andrew points out they use ending equity to calc ROE

      • 

        Matt
        April 19, 2011 at 12:11 pm:

        Not just ROE either! That fantastic cash flow / ROE may be due to a once-off that isn’t correctly reflected in the summary data.

        You can’t beat looking at the report, it’s about the company first anyway, not the numbers.

      • 

        Brad J
        April 19, 2011 at 1:26 pm:

        Hi Ash,

        What has your general experience been with the accuracy of EPS, DPS and shares on issue with comsec and Etrade?

        Interesting that when I had a look at shares on issue on comsec, Tradingroom and NAB online trading, I got three enormously different numbers. Obviously they have raised capital but it is quite confusing.

        Thx in advance

      • 

        Ash Little
        April 19, 2011 at 5:26 pm:

        Mostly OK Brad but I would not make or miss an Investment decision on based them

      • 

        ron shamgar
        April 19, 2011 at 5:40 pm:

        imagine a student getting paid $18/hr entering all day these meaningless data to them. how accurate do you think it can be???

      • 

        Ash Little
        April 19, 2011 at 6:59 pm:

        Hi Ron,

        It is more likely worse.

        Imagine someone in India being paid $18 per day( or less) doing the same thing

        How accurate can they be???

      • 

        Lloyd
        April 20, 2011 at 1:46 pm:

        More likely about 0.2 cents per data entry is the going rate in India…the more entries the more pay… go figure the likely accuracy based on this equation!

      • 

        Michael P
        April 19, 2011 at 11:00 pm:

        Hi Brad,

        I use Comsec and the shares on issue is as at the last annual report entered, this makes sense, you have to be aware of what shares have been issued since then when forecasting future and current IV. eg. KCN , the Annual report ending 30 June has 99.995 million shares on issue and the 6 monthly report ending 31 Dec 2010 has 101.7 million shares on issue. However, there was a raising since then to buy Dominion mining. Now there are 135.22 million shares – this can be seen on google finance – search ASX:KCN. Also check the ASX company announcements information for the current year (look for Appendix 3B – New Issue Announcement), as this should be the primary source.

        Michael

      • 

        Brad J
        April 20, 2011 at 11:20 am:

        Thanks Micheal, Ash and Ron,

        Most helpful and much appreciated.

52. 

    garry
    April 18, 2011 at 8:05 am:

    to ron,
    i think you were the first to mention VOC and ZGL , i think your mystery stock is BGL.

    • 

      Leon
      April 18, 2011 at 6:57 pm:

      I was thinking BGL too or AMM

    • 

      ron shamgar
      April 18, 2011 at 7:54 pm:

      hi garry, its not BGL. i wouldn’t be interested in this company.

      i think its hard to nominate anyone who mentioned anything first on this blog, as we discuss almost every company! :-)

      but i basically get every single announcement by every company on the asx so im able to pickup on news very quickly as they come up with updates etc.

53. 

    Geoff
    April 17, 2011 at 7:13 pm:

    Company 2010 2011 2012
    TRS.AX $16.11 $11.69 $10.75
    WAN.AX $5.33 $3.98 $1.70
    CPU.AX $10.94 $6.32 $9.71
    MRM.AX $3.04 $2.59 $3.20
    FXL.AX $5.78 $2.80 $3.03
    CWP.AX $3.28 $6.82 $7.24
    SAI.AX $2.22 $3.67 $4.40
    FMG.AX $9.21 $18.12 $21.78
    CCL.AX $8.99 $10.59 $9.38
    RFG.AX $3.71 $3.13 $4.29
    TLS.AX $3.62 $2.12 $3.50
    MMS.AX $18.53 $9.92 $9.41
    BKN.AX $6.02 $7.35 $12.78
    ALL.AX $3.65 $1.68 $4.16

    Thoughts?

    • 

      Andrew
      April 18, 2011 at 12:57 pm:

      I have only done a calc on the reject shop as i just wanted to focus on the cashflow part (quite comfortable in my ability to do the calculations) but wanted to have a go at forecast valuation using figures given by Roger.

      For TRS i got the following
      2010 IV $17.95
      2011 IV $11.59 which is a drop in IV of about 35%

      Using a price of $11.42 which i just got from the ASX site, this means it is currently trading at a 1.5% discount to the 2011 IV

54. 

    MarkH
    April 17, 2011 at 2:02 pm:

    Hey Andrew,

    Thanks for your cashflow figures – the way you lay them out’s very easy to interpret.

    For the dividend figures, is there a reason you use 2010 only and not the difference? e.g. TRS paid 16,103 in 2010 and 13,166 in ’09, so a difference around 3,000. This would make a big difference in the final cashflow position (i.e. make it -ve not +ve).

    Similar for RFG, they paid 10,206 last year and 8,911 in ’09.

    ALL cashflow… what a shocker…

    Not my strength and i’m probably barking up the wrong tree..

    Cashflow, good management & strong competitive advantages are the main chapters in valueable I like to review the most, so will refresh these over Easter!

    Thanks Again,

    Mark H

    • 

      Andrew
      April 18, 2011 at 8:14 am:

      No worries Mark, although don’t use my word as gospel, i encourage and want everyone to do that exercise for themselves and see what they find, i am no guru and could be wrong. in fact, cashflow analysis is my weakest element i feel and thank roge for this exercise and posting his MQR’s as i used that as a guide for further digging.

      In fact the first draft of my post looked completley different to the final post, i went and had a deeper look as i was sure i was missing something.

      So i want everyone to post what they think and to tell me i am wrong if they think so as that is how we can all learn and get better at this thing.

      With regards to your question though, and i may not be the best person to explain it. When it comes to the balance sheet don’t look at it as 2009 and 2010 details. The cash flow method uses shows the change in the cash position of the business over the financial year.
      Replace 2009 with the word beginning and 2010 with ending. So the 2009 figures are what the business looked like at the start of the 2010 financial year and the 2010 figures is what the company looked like at the end. If you look at the statement to changes in equity you will see it is set out the same way with biginning and ending figures. As there is only one reported line for dividends per financial year there is nothing to compare against and there for no difference in the dividend figures.

      For thos who want to see a finished example (and for those who want a shortcut with the Reject Shop cashflow) search homework in the search box and you will see the christmas homework. Also, just re-read chapter 9 of Value.Able.

      • 

        Rob
        April 19, 2011 at 5:44 am:

        Hi Mark,
        Perhaps if you think of it in these terms. The others are the actual balances of the items so the cash flow is the change in the balance. On the other hand the dividend paid is the cash that flowed e.g. Debt went up or down by a certain amount, whereas so much was paid in dividends.
        Cheers
        Rob

55. 

    Rainsford
    April 17, 2011 at 1:24 pm:

    Hi Roger
    Thanks for the homework. I’m really looking forward to it. I’ve asked you to comment a couple of times on BKN and now it’s on the table!

    Reading the blog and doing my own analysis reinforces that this is not an exact science but that hard work and rigor in searching for quality pays off.

    I have been a bit distracted as I live in Christchurch but good investment opportunities wait for no one!

    Rainsford

    • 

      Roger Montgomery
      April 18, 2011 at 6:56 am:

      I trust you and your family are safe Rainsford.

56. 

    fred
    April 17, 2011 at 1:18 pm:

    Hi Roger,

    I know you have had an exiting couple of weeks with Mr Rogers and all your other commitments but could you please post your last 15 picks when you get a chance please. Would your Gold pick be Kingsgate consolidated limited ( kcn ) and of course I do not expect you to tell me yet .

    Thanks for all your help always Roger

    Roger I am now going thru every company in the Aust stock market in more detail, I will post anything I thing is worth while posting!

    • 

      Roger Montgomery
      April 18, 2011 at 6:55 am:

      Indeed Fred, on all points. JB Hi-Fi (A1), Flight Centre (A2), Westpac (A1), Woolworths (B1), Platinum Asset Mgt (A1), Mineral Resources (A1), CSL (A2), Computershare (A2), Monadelphous (A1), REA Group (A1), Wotif.com (A1), Reece Aust.v (A2), Cochlear (A1), Seek (A2), News Corp (A2).

    • 

      Simon Anthony
      April 18, 2011 at 4:03 pm:

      Mr Montgomery was on your money your call last week and said he has been investing in a gold stock and would not elaborate which one- I’ ll take a guess and say it is this one RMS

57. 

    Chris B
    April 16, 2011 at 6:44 pm:

    Hi everyone,

    Roger, thanks for the homework. Looing forward to tackling it.

    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. This is because even a small adjustment to the Required return (in the Montgomery estimated value formula) has a significant impact on the resulting IV. And, it is only after you understand the risks, growth potential and competitive advantage(s) that one can determine what the required return should be.

    sorry if that didn’t make much sense, but I have had a few wines with dinner.

    Oh, on a separate issue, would anyone like to share how they go about choosing stock analysts. Here’s a few questions I’ll put out there for anyone to consider…

    Do they cost much?

    Are there regular free reports?

    Why are some reports listed for free (like the recent Matrix one) while others are not?

    Are Analyst reports worth it?

    Where does one find them (is there a useful internet site)?

    Are they bias?

    Cheers everyone :)

58. 

    David
    April 16, 2011 at 3:22 pm:

    Hi guys, I think I’m comfortable calculating the 2010 intrinsic value, but I’m having a little bit of trouble with the concept for 2011 and 2012. Firstly, doesn’t the equity/share change in 2011/12 or do we just hold it constant for our model from 2010 as E*Trade etc do not provide estimates for this measure in the future?

    My one concern is that if we do this, it will distort our estimates for ROE in 2011 and 2012, since ROE = earnings/ equity per share.

    My 2010 calculation for CWP is below:
    2010 EPS: 29c
    Payout Ratio: 45%
    RRR: 10%
    Equity/Share: 1.8

    ROE = 29/1.8 = 16.1% (so I used 15% in the tables).
    All Dividend Multiplier @ 15% ROE = 1.5
    No Dividend Multiplier @15% ROE = 2.075

    IV = (45% x 1.8 x 1.5) + (55% x 1.8 x 2.075)
    = $3.27 (hope this is correct!)

    • 

      Ash Little
      April 17, 2011 at 8:01 am:

      Hi David

      Have a read of this older post

      http://rogermontgomery.com/how-do-value-able-graduates-calculate-forecast-valuations-2/

      Hope this helps

      • 

        Richie
        April 17, 2011 at 1:05 pm:

        Hi Ash or anyone else

        Just a question on calculating future IVs: where there is a significant movement in shares outstanding from year to year, is it accurate to use the previous year’s EqPS as a starting point in calculating the future EOY Equity or would last year’s EOY Equity be better? That is, to calculate 2011 EOY Equity, instead of starting from 2010 EqPS (then add NPAT, subtract dividends, add capital raised and subtract equity returned), can we start from the 2010 EOY Equity? Surely the 2010 Equity ‘per share’ figure is misleading if the number of shares moves significantly from year to year?

        Cheers

      • 

        Ash Little
        April 18, 2011 at 9:17 pm:

        Hi Richie,

        I assume this is in reference to calculating ROE.

        Personally when a company raises equity I weight the equity depending on when it is raised to calculate ROE.

        I hope this helps.

      • 

        Richie
        April 19, 2011 at 10:13 am:

        Hi Ash

        Sorry not really, I was asking more about calculating the future EOY equity but I think I’ve found the answer now. This is extracted from Roger’s blog from the link you provided above:

        “How can you estimate future equity if you don’t have a forecast number such as those readily available in analyst research notes? It’s easy. Take the last known equity per share figure, add the estimated profits, subtract the estimated dividends, add any capital raised through new shares issued and subtract any equity paid back to shareholders through buybacks and you have it.”

        Where Roger has “Take the last known equity per share figure”, this should be “Take the last known equity figure” (ie. take out the ‘per share’ because all the other components in that sum are not in ‘per share’ terms). This confused me because I was thinking in cases where the number of shares outstanding figure moves significantly from one year to the next, the ‘per share’ figure would be misleading as it is based on the previous year’s number of shares figure whereas the forecast EPS and DPS figures may be based on the following year’s number of shares figure.

        Does this make sense? I hope I’ve now got it. Thanks for your help.

      • 

        Ash Little
        April 19, 2011 at 5:18 pm:

        Sounds like you have nailed it Ritchie.

      • 

        Richie
        April 20, 2011 at 9:33 am:

        Cheers Ash. I really do appreciate your contributions to these blogs. I have learned so much from you and others who have been generous to share their knowledge.

      • 

        David
        April 18, 2011 at 12:40 am:

        I take it my calculation was incorrect?

    • 

      Jonesy
      April 17, 2011 at 9:18 am:

      David – you can work out 2011 Equity per share if you have the forecast EPS and DPS. The formula will be 2010 Equity per share + 2011 Forecast EPS – 2011 Forecast DPS.

      • 

        yavuz
        April 17, 2011 at 2:31 pm:

        This, of course, is correct provided that forecast EPS & DPS take into account possible future capital raisings by the company in question. I recall, Roger mentioned in of the blogs that some analysts ignore capital raisings because they cannot be reliably estimated. Unde these circumstance we can only assume that this consensus EPS & DPS figures obtained form common data sources (Comsec, ETrade, etc..) take into account any future capital raisings. Any comments?
        Regards,
        Yavuz

      • 

        Jonesy
        April 18, 2011 at 9:40 am:

        Good point Yavuz, simple answer is I don’t really know. Always dangerous to make any assumptions when it comes to analyst forecasts. I always assume that it doesn’t take into account new share issues, use their figures to calculate an estimate of NPAT and then recalculate EPS using my forecast change in the number of shares. I’m much more comfortable underestimating IV rather than overestimating. Hope I’ve explained that well enough (difficult typing long messages on the iPhone keyboard!)

      • 

        Jonesy
        April 18, 2011 at 9:44 am:

        And I realise the irony stating assumptions I make after stating it’s dangerous to make assumptions!

      • 

        David
        April 18, 2011 at 12:52 am:

        Cheers Guys, this should make my life a whole lot easier now. I think I was reading a lot more into the equity per share aspect given that it can also be affected by the shares issued to Directors and staff, options in the market that are executed as well as capital raisings etc. Perhaps the former events do not have such an effect on equity and it would be hard to bet on a capital raising occurring. There have been that many companies raising capital though at dilutive prices and we only get the crummy oversubscribed SPP piece of the pie. I completely disagree with the institutional raisings that occur these days without consultation of the owners of the business – they used to be illegal for a reason.

59. 

    Ron F
    April 16, 2011 at 12:45 pm:

    Hi Roger,
    Heaps of thanks for the homework, I am sure the homework will help me to enhance my knowledge and skills further.

    After buying your book (first addition) last year, I haven’t contributed hardly anything to this site you setup, but I have been an avid reader of your posts and blogs posted by many others.

    I greatly appreciate the amount of time and effort you put into setting up this site and your continuing posts and answers to the blogs.

    I have mentioned this once before and it is thoroughly worth mentioning again, how your site serves as a Value.able backup to your book. Your book and this site could both be aptly renamed ‘Invaluable’

    Repeating what I thought was a wonderful deserving summary and tribute Graeme posted recently regarding your site. “You could have sent us all out into the wilderness with you book to fend for ourselves, but instead you set up this great community and resource center to aid us in our travels”…..well said Graeme.

    Thanks again for everything Roger.

    Regards
    Ron F

60. 

    JustinP
    April 15, 2011 at 11:57 pm:

    As a matter of interest, can you get Share Capital from Etrade or only from the balance sheet?

    • 

      Ash Little
      April 17, 2011 at 8:03 am:

      Hi Justin.

      The Balance sheet tab has lots of useful information but it is not allways accurate

      • 

        JustinP
        April 17, 2011 at 1:58 pm:

        Thanks Ash, but I don’t see Share Capital in the balance sheet tab in Etrade, or is some other name used?

      • 

        Ash Little
        April 18, 2011 at 7:13 am:

        Think what your after is under S/holders Equity ($ million)

      • 

        JustinP
        April 19, 2011 at 12:18 pm:

        Ah I see S/holders Equity = Share Capital.
        Thanks Ash!

61. 

    Leon
    April 15, 2011 at 11:11 pm:

    My Valuations

    Current 2011 2012
    TRS 17.29 11.59 15.52

    WAN 5.92 5.62 6.28

    CPU 11.59 7.84 11.53

    MRM 2.66 3.20 3.75

    FXL 6.93 2.93 3.49

    CWP 3.95 7.63 8.96

    SAI 2.46 4.13 4.65

    CCL 10.16 10.43 11.20

    RFG 4.24 3.80 4.03

    TLS 3.65 2.15 2.71

    MMS 10.14 12.41 12.61

    BKN 8.91 7.18 7.51

    ALL 2.06 2.26 5.48

62. 

    Geoff
    April 15, 2011 at 10:03 pm:

    Is it just me or when using the advanced search tool in Commsec, each one of the companies Roger has listed appear to have a Debt/Equity ratio of greater than 50%?

    • 

      Jeff Burnett
      April 16, 2011 at 9:28 pm:

      Hi Geoff

      I have not looked at all the companies on the list as yet, but I suspect you are right,but I still think that MMS is just such an attractive longer term business that I cannot bring myself to sell it, even with such a high debt ratio. Need to watch closely though.

      Good luck!

      Jeff

    • 

      Bernie
      April 17, 2011 at 10:15 am:

      I need further guidance here too. Using ETrade all have D/E ratio > 60% and some well over 100%. Also, for example, various Business Channel analysts sa FMG is in way too much debt, Etrade shows it as 201.5%.
      Can someone/Roger help here?

      • 

        Nic Arena
        April 17, 2011 at 4:54 pm:

        I know in Commsec you need to enter “.2” to equal 20% for ROE and “.5” for 50%. if you enter 20 this means 2000%. Hope this helps.

      • 

        Pat Fitzgerald
        April 17, 2011 at 6:05 pm:

        Hi Bernie

        Etrade does not deduct cash from debt before they calculate the ratio. But they may still have too much debt and maybe part of the homework might be to do our own research and not rely on Roger.

63. 

    Phil C
    April 15, 2011 at 5:52 pm:

    Hi Bloggers,

    Looks like I will have to buy the book and learn the secrets.

    In the interim could the team help with some comment on one of Roger’s recent stocks (ie) Zicom Grp (ZGL).

    I’ve been watching and trying to learn through your collect comments, however this one has me a little stumped.

    The share price has risen recently so went to look for the reason – the most recent announcement 15/4/11 at 2:41pm outlines the Companies structure etc. It looks like a small stock with too many fingers in too may pies. At first glance it seems that the management are trying to achieve too much in a very short time, which to me, puts up the warning signs.

    What are your comments / thoughts

    Cheers

    Phil

    • 

      Rob Walker
      April 16, 2011 at 10:11 pm:

      Looks like you will have to Phil

    • 

      Pat Fitzgerald
      April 17, 2011 at 12:08 pm:

      Hi Phil C

      When I looked at Zicom last year I decided that it was too hard (or too much work) for me to understand the prospects of all of its businesses and I would leave it to the professionals. Even after reading Rogers article in The Eureka Report and the comments from other bloggers I have not changed my mind. Others obviously understand its prospects better than me and have chosen to invest in Zicom. They are doing well but I have also done well investing elsewhere. We can all be winners just with different businesses.

64. 

    ron shamgar
    April 15, 2011 at 3:52 pm:

    hi everyone,

    i found a small cap (market cap under $300m) (A1 or A2 MQR) currently trading at a 20% discount to my FY11 IV and IV rising at 10% clip. ROE is about 27.5% has lots of cash and in a similar space as Vocus.

    I’m currently looking at buying so cant mention what it is, but i thought that once you finish roger’s homework u can maybe look for what it is.

    • 

      Josh E
      April 15, 2011 at 4:35 pm:

      Hi Ron,

      This is my second time posting here, have been reading for quite a while though. While I don’t exactly undetake Roger’s way of valuation and investing, it interests me greatly and definitely adds to my views and thoughts. I use my own valuation technique and with the brief information you supplied I did a quick screen of companies and applied a shorthand version of my valuation method and my two guesses are that your talking about MAQ (Macquarie Telecom Group Limited) or HSN (Hansen Technologies Limited).

      From my very quick look at both, they seem to meet the criteria you suggested. I could be way off base and I only quickly did this at work by they are my two guestimates.

      Interested to see what company it is, I tend to only look at companies with greater than 20% ROE and less than 30% D/E which both of these fit that criteria. Look forward to your reply.

      Josh

    • 

      Ash Little
      April 15, 2011 at 5:36 pm:

      Hi Ron,

      I look forward to your comments.

      If Roger permits do you mind letting us know what broking house you work for.

      I tried googling ron shamgar and got nothing.

      • 

        Ron shamgar
        April 16, 2011 at 9:55 am:

        Hi ash,

        I work for Shamgar broking pty ltd. Our office is in Dover heights overlooking the ocean, and my team consists of the big boss (wife), little Lior (10months old) and Heffe (4 year old dog). Our research is done on an iPad and our reference material is a Valueable book with baby food stains all over it. :-)

        Hope that helps.

      • 

        Ash Little
        April 16, 2011 at 3:05 pm:

        LOL,

        Sounds a very nice life

    • 

      Simon Anthony
      April 15, 2011 at 6:08 pm:

      Found it! ASX: MAQ

      Macquarie Telecom Group Limited (Macquarie) is an Australia-based company. The Company, along with its subsidiaries, is principally engaged in the provision of telecommunication and hosting services to corporate and government customers within Australia and Singapore. The Company operates in four segments: voice, data, hosting and mobiles. The voice segment is engaged in the provision voice telecommunications services. Its data segment relates to the provision of services utilising the Macquarie data network.

      • 

        Kevin
        April 16, 2011 at 10:05 am:

        MAQ – I get an IV of $10.53 , its defiantly is one ill keep on the watch list though.

      • 

        Kim jordan
        April 16, 2011 at 5:25 pm:

        I’ve had a look at them too but can’t see any competitive moat.

    • 

      Kevin
      April 15, 2011 at 8:34 pm:

      Hi Ron,

      another one to keep an eye on is Decmil (DCG) i got IV raising a great clip.

      Cheers

      • 

        Ron shamgar
        April 16, 2011 at 10:07 am:

        Decmil was a great buy for me at 1.70 ( thanks to Roger) but I recently sold out at 3.75 as it looked fairly expensive to me. I’m also a bit worried about commodity markets in the short term… But I would love to buy back in under 2.50 maybe….. Let’s see what’s mr markets thoughts.

      • 

        Graeme
        April 16, 2011 at 6:35 pm:

        Decmil is very nice, I have it sitting around it forecast 2011 IV right now. So I do agree with Ron that it would have drop back a bit before I buy, and I hope it does :)

      • 

        Kevin
        April 16, 2011 at 6:46 pm:

        My 2011 IV is $3.43

      • 

        Leon
        April 18, 2011 at 11:00 am:

        Currently I think DCG is too expensive. I have a IV of $2.60. It is rising but right now I am looking for something more “Valueable”.

      • 

        JustinP
        April 19, 2011 at 6:18 pm:

        I get the following for DCG with Etrade data (RR of 12):

        Code: DCG
        Price: 3.24

        INPUT:
        ……….. EqPS .. Shares … DPS … EPS … RR
        2012 … 1.06 .. 123.60 … 7.1 .. 24.5 .. 12
        2011 … 0.88 .. 123.60 … 6.0 .. 21.3 .. 12
        2010 … 0.73 .. 123.60 … 0.0 .. 6.3 .. 12
        2009 … 0.66 .. 117.40

        OUTPUT:
        ………….. IV .. .. ROE . NPAT .. POR .. MOS
        2012 … 3.45 … 25 .. 30.28 .. 29% .. 6%
        2011 … 3.09 … 26 .. 26.33 .. 28% .. -5%
        2010 … 0.39 …. 9 .. 7.80 .. 0% .. -736%

    • 

      Brad J
      April 15, 2011 at 11:21 pm:

      Hi Ron,

      It will be interesting to find the company you are referring to.

      The good thing about Vocus is their unique position in the market, being the only wholesaler and as a result they don’t compete with their customers. This to me gives them a distinct competitive advantage and increases their mote. Their other point of difference is the calibre of their management team which would be very hard to replicate. If the company you are referring to has an equivalent mote it would be worth a look.

      • 

        Roger Montgomery
        April 15, 2011 at 11:55 pm:

        Great insights Brad. This is the combination I like too.

      • 

        Brad J
        April 16, 2011 at 7:24 pm:

        Hi Roger,

        I have mentioned before on this blog that I am particularly enthused about VOC, it seems to be an exceptional opportunity.

        Ron you mention that it is worth buying a company if it is cheap enough, without a clear mote and this is heading towards the cigerette butt approach. I could argue that the likes of FGE and ZGL do have weak motes and bright prospects so they don’t quite fall into this category. It works so there is nothing wrong with this approach and I do use it from time to time.

        I prefer to find a company which has a clear defined mote and due to this am prepared to pay more for it and stay in for a long time. As WB says if you buy into a great business and stay in it for a long time you are going to make a lot of money, but with a lousy business the opposite is true even if you buy it cheap.

        With this in mind I feel that I need to know more about the type of pricing arrangement that VOC has for their IRU with Southern Cross Cable and whether they have an exclusive agreement with regards to pricing that is not available to a new company. There must be or they wouldn’t have been able to sign up Vodaphone in NZ, I just want to get clarification on it. We want to be sure that there is no risk of a cheaper competitor coming in and taking their market share. We also want to be sure that Southern Cross don’t offer the same deal to someone else. If this all stacks up (which I have a feeling it would) it puts VOC in a very strong market position. It would also mean that Southern Cross would need to maintain competitive pricing to VOC so that they can combat competition from other cable companies, in particular Pipe Networks.

        Does anyone know where I can find out more about the VOC/Southern Cross agreement as I am having trouble finding out about it?

      • 

        Ron shamgar
        April 16, 2011 at 10:19 am:

        Hi brad, Vocus is not the only wholesaler but the only wholesaler that does not compete in ISP market. Don’t forget pipe networks had many different customers and still do before and after TPG bought them. I think it comes down to the quality of the service they provide to what gives them a competitive advantage. Also their recent dark fibre business acquisition, does give them a retail presence which they will need to offload in order to keep their so called independence. The other part of Vocus which is growing is the data center business, and I don’t see any moat there, as others are all getting on to this lucrative space.

        I agree with management calibre, the more I read and listen to James spenceley the CEO, the more I like this company. Let’s hope share price halves so we can buy more.

        The company I’m referring to looks great on paper but the question is always what’s the moat??? Sometimes u don’t need one if u can buy cheap enough…. (DCG,FGE,DTL,ZGL etc…)

      • 

        Brad J
        April 16, 2011 at 8:37 pm:

        Hi Ron,

        I would imagine that a data centre’s moat would be the difficulty in switching, similar to moving away from a bank. Also if VOC are then building on the relationship by selling them other products this would make switching even harder especially if they are bundling deals.

        It would be extremely hard for me to move away from the national bank as I get a reduced rate through their professional choice package and have about 10 different accounts with them. This gives them a significant moat.

      • 

        Ron shamgar
        April 17, 2011 at 6:49 am:

        I have multiple accounts with all the major banks….what does that say about their moat??

      • 

        Brad J
        April 17, 2011 at 7:12 pm:

        Sorry Ron, my mistake I mean’t loans. Yes I agree not too hard to set up accounts with the banks.

      • 

        Brad J
        April 16, 2011 at 9:31 pm:

        Just another thing Ron, I think the chance of VOC halving is just about zero. If they have the competitive advantage I think they have (to be confirmed) they are probably already half next years to be updated IV. Look at the pace these guys are moving at. Think MCE six months ago. Just my opinion as I own VOC and am looking to increase my exposure.

      • 

        Ron shamgar
        April 17, 2011 at 6:45 am:

        In simple words u mean … Wishful thinking :-)

      • 

        Brad J
        April 17, 2011 at 7:14 pm:

        Hi Ron, yes wishful thinking LOL.

      • 

        Paul Rehill
        April 18, 2011 at 1:35 pm:

        I’ll try to provide a counterweight to all of this dangerous Vocus group think. Although a friend pointed me in the Vocus direction at 70c and after admiring their high profit margin and ROE, I pointed him in another direction which is (I must admit) unfortunate he listened to me but I’m dispassionate about “missing such opportunities”.

        Buffett follows Graham in investing mainly in companies that have a listed track record of more than 10 years. This is a good idea for controlling risk (at least 5 in my book) as the historical track record allows you to observe if the company is displaying some sort of sustainable competitive advantage that shines through in ROE, profit margins, capital structure, management’s propensity NOT to destroy shareholder value etc. One year’s data is insufficient especially in the telco space to judge this.

        Roger has mentioned that Internet data traffic has been rising rapidly. OK. But what about the cost of data traffic that has been falling at a dramatic rate. You don’t have to look to far to see the examples. Telstra was charging approx. $90 for 25GB of data transfer (upload and download) for cable connections and currently charge $90 for 200GB (if you have a home line with them) or $70 for 50GB.

        Digital Pacific recently announced that they would move their ISP hosting service to Vocus but take a look at the pricing of their plans. For < $200 pa, you can host a website with them and have unlimited traffic downloads. Lots of data transfer at an extremely low cost! This is happening across the board in this industry. IINet are offering virtual private server plans for $30 per month running Windows Server 2003 in Australia. It would be very dangerous to assume this will not filter down to wholesalers like Vocus so the prudent position would be to assume Vocus is a price taker, not a price maker and costs of data traffic will continue to fall rapidly.

        All this talk about cloud computing and how to benefit from it would at least in my opinion, intuitively lead to looking at Microsoft as they provide Windows Server software that is often used (at least by customers with the money) to run application services through VPS or dedicated servers. $5.5bn of Microsoft's $24bn operating income comes from its Servers and Tools division which includes its Windows Server operating system, Windows Azure, Microsoft SQL Server, SQL Azure and Visual Studio.

        MSFT has a ROE of around 45%, payout ratio of <30%, still has more than $23bn of its current $40bn share buyback program left, trades at a historical PE of around 12. Cloud computing? Vocus vs MSFT. Bill Gates who has learned plenty about investing and profitability from Buffett is on the board of MSFT and Berkshire Hathaway and MSFT is in its second $40bn buyback program. Vocus with a 1 year track record and higher historical PE and lower ROE? Maybe its time to de-risk and rebalance your portfolio.

    • 

      Manny_Sorbello
      April 15, 2011 at 11:54 pm:

      Ron, is your mystery company DWS?

      • 

        Manny_Sorbello
        April 16, 2011 at 12:53 am:

        Hi Ron, Or TNE technology one.

    • 

      Leon
      April 16, 2011 at 12:13 am:

      Ron,

      My search for your ‘mystery stock’ has been narrowed down to one company.

      MTU- I like this stock. I Have an IV of $3.90. It has High and increasing ROE and was a beneficiary of an ACCC ruling.

      • 

        Ash Little
        April 17, 2011 at 8:22 am:

        Hi Leon,

        MTU’s market cap is above $300M so it can’t be that one

        That said my view of MTU looks alot like your

        It is staring to look interesting to me I hope is drops below $3 to give a big MOS

        Forecasts keep getting upgraded as well.

        Have you listened to this one.

        http://www.brr.com.au/event/78916

      • 

        Kevin
        April 17, 2011 at 3:07 pm:

        Hi Ash,

        what do you think the competitive advantages for MTU are ?

      • 

        Ash Little
        April 18, 2011 at 7:16 am:

        The Guys running it,

        Very impressive in my view

      • 

        John Watson
        April 18, 2011 at 9:50 am:

        While I haven’t met the management of MTU their bios are impressive. As an insto portfolio manager I first met the Tudehopes of MAQ back in the 1990’s and I was impressed with their professionalism then and even more so when they survived the tech wreck of 2000. In terms of 2013 IV’s I have MAQ on $16.15 and MTU on $5.10. At current prices I’d prefer MAQ, though I currently see more upside in VOC, TSM, AGO and MCE. In terms of quality of management and competitive advantages VOC and MCE are the standouts.

      • 

        Gavin
        April 18, 2011 at 10:22 am:

        Not Ash, but I do have a view on MTU’s competative advantages

        Low cost model. They have no infrastructure which means they already have the low margin model that all other will need to adopt as resellers of NBN.

        Small Business Customers are generally sticky because of switching costs. Even retail customers only have moderate churn rates.

        They were the earliest consolidators and have (still are) purchasing customers profitably at less than the cost of converting them from other providers. (similar to how QBE buys businesses to obtain policy holders.) Last couple of deals have raised some question marks for me though.

        As their size increases they get scale advantages and now have a dominant position in the small business niche.

        Threat will be when the majors go Infrastructure light and have to adopt the MTU model to compete. But MTU have the head start, already now the nuances of the model and have the workforce base already appropriately sized and skilled. It may actually turn out that the majors won’t be able to match MTU once they don’t have an infrastructure advantage. That’s the light in which MTU is looking forward to NBN and I tend to agree. If they can be the lowest cost provider then nothing really stops them from growing profitably under NBN.

      • 

        Gavin
        April 18, 2011 at 10:41 am:

        Again not ash (but I do spell like him)

        Edit “now” to “Know” in the above post.

        Also forgot to mention that they are generally regionally focused, which has allowed them to develop scale within local markets and provide decent customer service to those areas.
        .

      • 

        Ash Little
        April 18, 2011 at 6:00 pm:

        I once deluded myself that I could spell but could not type.

        I have now recognise that I can’t do either.

      • 

        Leon
        April 17, 2011 at 10:44 pm:

        Hi Ash,

        Its also worth noting that some directors sold some of their shares on the 7th and 14th of April. Maybe they just needed the extra cash but since then then stock has fallen.

      • 

        Ash Little
        April 18, 2011 at 8:12 am:

        He has been selling since they went over a dollar so that is fine by me

    • 

      Matt
      April 19, 2011 at 12:18 pm:

      In doing a quick scan I found IRI which I’ll continue to research, thanks Ron

      • 

        Leon
        April 19, 2011 at 5:37 pm:

        Hi Matt,

        Just did a quick valuation on IRI. Using a 14 RR I have a an IV of around .23c and not really moving up in the next two years.

        For now, I say stay away.

      • 

        Matt
        April 20, 2011 at 9:49 pm:

        Cheers Leon, I agree. I’m not buying for now either.

65. 

    ron shamgar
    April 15, 2011 at 3:32 pm:

    hi everyone,

    just a heads up:

    matrix at $8.47 on friday 3.21pm.

    could be the only chance to buy shares at a cheaper price than roger has recently :-)

    no advice to buy BTW.

    good luck!

    • 

      Chris Brincat
      April 20, 2011 at 7:59 am:

      Haha,

      Nice one Ron.

      Maybe Roger is selling so maybe if your buying you’ll be buying from him!

      I have an order in to buy some more.

      Cheers,

      Chris B

      • 

        ron shamgar
        April 20, 2011 at 10:31 am:

        hi Chris,

        just my gut feeling and is pure speculation, but i think matrix might go lower unless new update comes through…

        cheers.

66. 

    Martin
    April 15, 2011 at 12:46 pm:

    Roger, how does TLS get a look-in?
    Interest bearing debt at 31/12/10 is $14,742m
    Equity is $$12,208M.
    Gearing (conservative method D/E) is 121%
    Gearing (TLS method D/(D+E) is 55%.
    Are you counting NBN chicken (proceeds from sale of network) as having come home to roost?

    • 

      Rob
      April 15, 2011 at 7:26 pm:

      Hi Martin,
      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.
      Cheers
      Rob
      I’m working on Ron’s discovery and would love to know if there’s a link to Major League Baseball. Maybe not ‘cos I can’t find where it gets an A1 or A2.

67. 

    JustinP
    April 14, 2011 at 8:34 pm:

    Using Etrade data for TRS I get different figures for the DPS and EPS, but plugging in your figures Roger my worksheet spits out the following – does that look about right? (No idea how reliable Etrade data is) :

    Code: TRS
    Price: 11.53

    INPUT:
    ……….. EqPS .. Shares … DPS … EPS … RR
    2012 … 2.51 .. 26.00 … 69.3 .. 94.9 .. 10
    2011 … 2.25 .. 26.00 … 41.0 .. 68.0 .. 10
    2010 … 1.98 .. 26.00 … 67.0 .. 89.1 .. 10
    2009 … 1.53 .. 25.80

    OUTPUT:
    ………….. IV .. .. ROE . NPAT .. POR .. MOS
    2012 … 15.52 … 40 .. 24.67 .. 73% .. 26%
    2011 … 11.59 … 32 .. 17.68 .. 60% .. 1%
    2010 … 16.81 …. 51 .. 23.40 .. 75% .. 31%

    • 

      David
      April 15, 2011 at 11:37 am:

      Etrade data is from Morningstar. I’m guessing its a reasonable guide, but I have noticed lately that they have not been updating their earnings projections consistently based upon company announcements and they often apply conservatism. It took them months to update CWP to respectable figures. They also had declining earnings for LYL, a company that has a solid earnings growth profile and pretty good fundamentals, which I think is now being proved incorrect. It seems if they don’t follow or care about a company that much because its “small”, their estimates can be a bit off if they provide them at all. I used to subscribe to Morningstar(ex-Huntleys), but decided to give it up after some screaming buy recommendations on Babcock & Brown as it kept falling to a few dollars, ILF and a few others. They also make some good recommendations too – but beware there seem to be a few flaws in the methodology. Is there any other place to get a different or generally more accurate consensus on projected earnings? I know its only an estimate.

      • 

        Ash Little
        April 17, 2011 at 5:52 pm:

        Hi David,

        As I understand it the Morningstar forecasts are not done by morningstar but from the analysts themselves who cover the stock and subscribe to the morningstar feed. Morningstar average the forecasts and send them to subscribing brokers.

        For example CWP are only covered on Morningstar by one analyst and that is some guy from Pattersons Securities. If It took Morningstar a long time to update earnings it would have been because it took the guy from patterson a long time to get around to looking at it.

        Not all brokers give the data to morningstar and i think a few years ago a few high profile ones pulled out. Roger is probably using another non morningstar analysts figures who he knows covers this company better than most are is averaging many guesses.

        Hope this helps

68. 

    Ann
    April 14, 2011 at 6:19 pm:

    Thanks for the homework!!

69. 

    David
    April 14, 2011 at 4:57 pm:

    I audited Cedar Woods in WA a few years ago and I’ve been impressed by the story so far. I was fascinated by how such a big operation had such a small head office, but obviously there are some more out in the field. It may be part of the reason why they generate much higher ROE than others like Stockland etc. I also live in the suburb adjacent to their flagship development in Victoria and am amazed at the reduced block sizes and higher prices from the initial projections that they are getting, as well as the recurring income they are going to receive from a lot of these long-life projects. I don’t want to sound too much like a fanboy, but the company continually states in its presentations that the shares are worth at least $6 today and its steadily grown around 34%p.a. over 10 years (despite the crazy stock sell-downs of the GFC), so I must say that the mention of this on Roger’s blog (along with Cash Converters – finally!) is pretty exciting. Would be interested to know what others are thinking about this company, good or bad.

    • 

      Blake
      April 16, 2011 at 12:52 pm:

      Hi David,

      I must say i really like the look of this company. They seem to be really well run and have a good reputation for quality developments. I like that they seem to be passionate about including sustainable living technology as well.

      Consistent good returns on Equity and seem to be very aware of maintaining a minimum of 10% earnings growth every year for shareholders. (as mentioned in all annual reports that Ive read).

      Management seem to really have the shareholders best interests in mind, recently announcing a Bonus Share Plan. They also just recently knocked back a takeover offer at $5 stating that they think the company is worth significantly more.

      They went through the GFC with goodresults and even increased their earnings during that time and have since payed off most of the debt accumulated then back down to safe levels.

      They just recently upgraded their 2011 estimates saying this years profit will easily exceed what they previously thought.

      I have CWP currently valued for 2011 at $6.03 and predicted to increase at a steady rate in 2012 onwards.

      Disclaimer: I don’t own……… yet

      • 

        Jeff Burnett
        April 16, 2011 at 9:14 pm:

        Hi Blake and Others

        They do look to be a good investment grade company but my opinion of them as a client, as I live in an ocean front apartment developed by them is rather different.

        Better to be a shareholder than a client perhaps.

        No recommendation by the way.

        Jeff

    • 

      Bernie
      April 17, 2011 at 10:44 am:

      I cannot comment on CWP overall as I haven’t researched but with a large development in Pt Mandurah, I’m wondering as to their short term revenue prospects. Mandurah has gone from being the fastest growth area in Australia to now being one of the slowest. It has an over-supply of apartments especially. I live there and have had little/no price growth in my area over last 2 years for my somewhat humble 4×2 abode.

      • 

        Mike
        April 20, 2011 at 12:04 pm:

        All it would take is for China’s growth to slow and demand for our resources to fall, and Cedar Woods would be in trouble, given its entirely dependent on Western Australia’s economy.
        Looking at their latest half year report, they have $41.9m in debt (including $21m that’s due to to a Camberwell vendor for property)
        They also announced a new $110m debt facility with ANZ. How quickly do you think they can utilise that, and how wisely?
        Another issue to consider is that they have $127m of inventory – which I assume consists of land & houses. If the property market falls, then that inventory may be worth much less than $127m.
        That of course would affect their Book Value Per Share and your calculations of Intrinsic value.

        For mine, I’ve seen what property developers can do with other people’s money, and I want no part of it.

70. 

    Lei Lei
    April 14, 2011 at 2:21 pm:

    What does the blog think of AJJ?
    This is my first post so Ill avoid ramping the stock.
    If you review this stock use its annual reports as commsec provides the data of the business that it used to list on the ASX (thru a reverse takeover) which ended up a bankrupt business.

    This is a bit of a left-field investment, and I think it does have a high degree of risk, but it does tick certain boxes in my value investing approach. Profits and postitive cash flow (usually bigger than than accounting profit) every year.
    from my analysis its in an industry with high barriers to entry. A problem exists in the fact that the company is exposed to the need for specialist doctors and if it loses them, they will suffer – however this could be a competitive advantage if management is successful at attracting and retaining talented staff.

    The growth potential is outstanding, rising populations combined with increasing affluence in asia will contribute to more liver problems (bad western diet etc..). It is estimated around 2% of a population will require liver treatment…

    Another issue with this stock is the horrible liquidity (partly due to management retaining 80 odd percent ownership) but also due to most people having never heard of the company.
    It seems management is intent on overcoming this issue by declaring investor roadshows in the near future.

    Latest HY report showed a reduction in profit on PCP due to increased expenses primarily relating to purchasing and establishing new clinics (new income streams). Cash flow was still solid.

    From what I can see, management appears to be investor orientated with a long term approach…for many this one will be too small/risky to enter…but its definitely one worth keeping an eye on!

    • 

      Bernie
      April 17, 2011 at 11:18 am:

      Although they are in right market as populations grow old and need more health support. My somewhat sceptical view on AJJ is that they don’t have a long track record, the sudden dramatic increase in ROE seems strange and that a company tightly held by one group doesn’t leave much room for share price growth. Also being somewhat illiquid makes it very hard to get out of, without scuttling the sell-price, if that becomes necessary. As a result, my somewhat ‘conservatised’ i/v has them current about equal at 11c, leaving no margin-of-safety.
      I’d rather wait and see how they go over next 2 years before considering an investment.

      • 

        Lei Lei
        April 17, 2011 at 12:49 pm:

        ROE hasnt suddenly jumped, its been high since at least 2005…the oldest report iv read thus far.
        I agree on your other points about illiquidity tho.

      • 

        Bernie
        April 20, 2011 at 9:33 pm:

        Lei Lei…are you sure you’re looking at AJJ? Commsec, ETrade and Lincoln Indicators all show company data only from 2006/7 with negative ROE until Dec 2010 where its suddenly grows to 129-133%.

      • 

        Grant Rogers
        April 21, 2011 at 8:14 am:

        Bernie, in his post he clearly states not to use the brokers if you are checking the results. They are the results for the bankrupt company which AJJ took over in order to list.
        Read the annual reports.

      • 

        Peter S
        April 23, 2011 at 3:31 pm:

        Interesting to read about AJJ – I didn’t know it had listed…

        Whilst the business model would never work in Australia, it may work in South East Asia where the approach to health care is very different.

        Liver disease is very common in SE Asia, but as one of the other readers said – many centres can provide these services. What tends to happen in SE Asia is that the Pareto Principle can work (also known as the 80-20 rule). Money is allowed to buy health care and at the top end there are no limits in what can be charged, so the company bottom line is greatly favoured.

        They will make their money from the special care provided to sick patients and vertical integration doing tests and even selling them medications. Liver transplants are what they are spruiking as their specialty but that gets very delicate when it comes to a limited supply and patients in need in the private sector as ethics would suggest that supply is based upon medical need rather than other factors.

        I suspect they will get in to living related donors as that would solve the supply of organ issue – and generate more income as you get to do 2 operations ! For example this Perth woman went to Mr Elizabeth in Singapore for her second transplant (living related) as a private paying patient. This company now supplies Mt Elizabeth’s liver surgeons.

        http://www.perthnow.com.au/news/liver-mum-claire-murray-in-surgery-in-singapore/story-e6frg12c-1225841881346

        Obviously other issues with the main liver surgeon who started it and the CEO holding > 60% of shares between them, and Tan himself drawing 2.4m salary presumably for his management skills as well as his surgical skill as senior transplant surgeon (there is a second Dr Tan who is a surgeon). Add to that – he is an executive chairman of the board….Also note the credit risk under 10b… that’s what happens when dealing in Medicine.

        It was fun reading about it – but you have to feel comfortable about both the business model and the management.

      • 

        Ron shamgar
        April 17, 2011 at 5:05 pm:

        I haven’t done any research on this business but what will happen if tomorrow:

        Another company comes up with a better liver treatment technique?
        Specialists doctors decide to go it alone or ask for a better pay?

        Don’t c anything special here.

      • 

        Lei Lei
        April 18, 2011 at 9:45 am:

        You can ask those questions with any company:
        What will happen if someone invents a better buoyancy device?

        As stated in the post the problem of specialists can either be a problem, or a competitive advantage – something that is worthy of further research and debate.

      • 

        ron shamgar
        April 18, 2011 at 8:08 pm:

        have a look at vision group VGH. it generally doesnt work this model. only one to do well is ONT but too expensive.

71. 

    Andrew
    April 14, 2011 at 12:43 pm:

    Done with the cashflow analysis. Will get started on the intrinsic value one.

    (All figures are 2009, 2010, diff)

    TRS
    Cash 865 4,339 =6,474
    Borrowings 14,375 31,327=16,952
    Share Capital 3,366 3,366=0
    Dividends Paid 16103
    Total $2625

    RFG
    Cash 5,414 13,105=7,691
    Borrowings 95480 85852=-9628
    Share Capital = 80,959 95,146=14,187
    Dividends Paid 10,206
    Total 13,338

    ALL
    Cash 59,045 19,840=-39205
    Borrowings 134,349 305,662=171,313
    Share Capital 185,320 187,625=2305
    Dividends Paid 18,609
    Total -194,214

    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 there for 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 there fore pobably 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.

    There for 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 adequatley meet its future needs.

    • 

      Ash Little
      April 14, 2011 at 9:43 pm:

      Hi Andrew,

      Well done.

      Aristocrat has a special place in my heart and not for any reason you would think.

      I have always looked at ROE and thought that companies with consistent earnings from gambling could handle any recession.

      In 2007 they undertook debt fuelled share buyback that took the debt to equity to a sky high 170%.

      With 20 20 hindsight the GFC proved me very wrong and I lost $10K on this bulletproof stock.

      The reason it has a special place in my heart is that it was about this time I noticed someone one the business channel taking about buying great businesses with little or no debt and high ROE. The forerunner to what would become A1’s.

      So aristocrat is the worst investment I have ever made but that debt fuelled share buyback is possible the best thing that has ever happened to me

    • 

      jc
      April 15, 2011 at 8:38 am:

      Not being able to pay current debt does not neccessarily mean that they will raise capital. Its far more likely in this case that the debt is rolled over (i.e. “renewed”, for lack of a better word).

      • 

        Joab Soh
        April 15, 2011 at 2:41 pm:

        Hi JC,

        Debt refinancing is precisely the issue that gets companies into trouble. If you could recall, during the GFC where access to credit is (Very) limited, companies who cannot refinance their debt are the ones that went under.

        There’s a reason why we pay very close attention to debt level here.

      • 

        jc
        April 15, 2011 at 4:40 pm:

        While cognisant of the fact that excessive debt levels are sometimes difficult to rollover, I would argue that with a trailing EBIT interest cover of 8-10x that this is precisely the type of company that banks are looking to make loans to. With reasonable cash flow and a shown ability to pay down principal in the past I would be comfortable stating that while terms may change, the actual rolling of the debt is a matter of when, not if.

        Not all debt is bad, and debt refinancing is business as usual for banks. Without extending loans, banks don’t make money.

      • 

        Ash Little
        April 16, 2011 at 12:39 am:

        Hey jc

        I am very biased here but I would recommend you have a look at their cash flow statement.

        Just of the top of my head and this may be a bit out but cashflow from operating activities was about minus 160M. So cashflow was not very flash really

    • 

      Kent Bermingham
      April 15, 2011 at 8:44 am:

      Andrew, Thankyou for your post you have assisted my understanding greatly.

72. 

    chris
    April 14, 2011 at 10:49 am:

    Has anyone considered FSA? i would like to hear peoples thoughts!
    they hold a 51% of their market.
    15-33% growth in NPAT
    NTA has grown nicely
    Trading at around 5x earnings for 2012
    don’t pay a dividend at this stage

    • 

      ron shamgar
      April 14, 2011 at 3:20 pm:

      roger rates it B5 – not investment grade – and claims directors might have stretched themselves thin with other business interests.

      does look cheap but seems to be going nowhere at the moment….

    • 

      Craig B
      April 14, 2011 at 5:04 pm:

      Chris,

      Bought them in Sept/Oct last year, mostly because they were what I considered to be cheap. In the hole a bit at present. Pretty sure I passed on better opportunities at the time, but live and learn.

      I attributed the relatively poor result in 2010 to the GFC (low interest rates and higher unemployment), but there have been a few reporting seasons since then, and they don’t seem to have been able to re-invest their retained earnings (they don’t pay dividends) at a high rate of return.

      There’s some hope that their foray into the mortgage market works out so I’ll hang in there.

      One thing I’m learning is that a cheap price isn’t enough. You need to be able evaluate the firm’s prospects well too.

      Suitable bit of homework from the Maestro.

      cheers

      • 

        Jarrad Stuart
        April 14, 2011 at 10:22 pm:

        Hi Chris, Ron and Craig.

        I concur with Roger’s poor quality rating. The reason is that the cash generated by the business is currently significantly less than the accounting profits.

        Be sure to look at the cashflow statement before considering an investment.

        Jarrad.

      • 

        Ron shamgar
        April 14, 2011 at 11:11 pm:

        Don’t sell yet Craig, they will have a good result this year…cash-flow is improving.

73. 

    Ilya
    April 14, 2011 at 9:46 am:

    Great stuff! I am looking forward to it.

    I would like a clarification on one of the points Rodger mentions:

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

    This rules out VOC for example, as try as I might I cannot find EPS and DPS forecasts for it, yet it’s tipped by Rodger.

    Following point 3 rules out most newly floated and some small stocks. Where do you guys look for forecasts or is it matter of making a personal judgement about the stocks prospects based on past performance?

    • 

      ron shamgar
      April 14, 2011 at 3:19 pm:

      etrade and commsec or you can buy analysts reports (sometimes free on company’s website)

    • 

      Mike
      April 15, 2011 at 9:34 am:

      Ord Minnett and Patersons Securities provide earnings estimates for VOC out to 2013, so you should be able to get their estimates from etrade or commsec as Ron suggested.
      Here’s a summary:-
      …………………….EPS……….DPS
      2011……………..11.9………..0.0
      2012……………..15.2………..0.0
      2013……………..18.75………0.0

      • 

        Graeme
        April 15, 2011 at 1:08 pm:

        Etrade only has current year EPS and DPS. There current year EPS is 15.7, but that maybe before the capital raising. I think etrade gets there forecasts from Huntley’s, so if they do not cover it then there are no forecasts.

      • 

        ron shamgar
        April 15, 2011 at 3:37 pm:

        looks a bit pessimistic to me…. i have 14c for fY11

      • 

        Michael
        April 17, 2011 at 12:26 pm:

        I get 11.8, so they the analyst estimate appears reasonable.

    • 

      Dave P
      April 17, 2011 at 12:16 am:

      Yahoo!7 Finance (search for voc.ax, then hit the “Analyst Estimates” tab down on the left hand side) has EPS 2011 $0.12 and EPS 2012 $0.15. Can’t vouch for it’s accuracy, but it’s somewhere (free) to start.

74. 

    Kim jordan
    April 14, 2011 at 7:29 am:

    Oh boy aren’t we lucky – homework for Easter. I was wondering how I would fil the idle hours after I had sorted my sock drawer.
    But with our Leader droping this in on us now, it tells me that he’s in fact off on his Easter break EARLY!!! *_*

    • 

      Blake
      April 15, 2011 at 7:58 pm:

      Geez Kim,

      I dont see how that kind of response is justified. Last time I checked you werent paying a subscription to read this blog.

      • 

        Kerry P
        April 16, 2011 at 4:19 pm:

        I be leave, Kim was being a little facetious.

        Kim?

        :)

      • 

        Kim Jordan
        April 17, 2011 at 8:18 am:

        I think Blake must be an accountant – my accountant seems to have zero sense of humour too *_*

      • 

        Ash Little
        April 17, 2011 at 12:17 pm:

        Hey Kim,

        Lets cut out the accountant jokes.

        We are actually just misunderstood people with a highly developed sense of humour

      • 

        Peter Kruckow
        April 17, 2011 at 7:16 pm:

        If possible Ash I’d like to put up this joke you shared with us last year. I thought it was funny enough to keep and it shows that some accountant’s do have a sense of humour
        Cheers
        Pete

        There once was a business owner who was interviewing people for a division manager position. He decided to select the individual that could answer the question “how much is 2+2?”
        The engineer pulled out his slide rule and shuffled it back and forth, and finally announced, “It lies between 3.98 and 4.02?.
        The mathematician said, “In two hours I can demonstrate it equals 4 with the following short proof.”
        The physicist declared, “It’s in the magnitude of 1×101.”
        The logician paused for a long while and then said, “This problem is solvable.”
        The social worker said, “I don’t know the answer, but I a glad that we discussed this important question.
        The attorney stated, “In the case of Svenson vs. the State, 2+2 was declared to be 4.”
        The trader asked, “Are you buying or selling?”
        The accountant looked at the business owner, then got out of his chair, went to see if anyone was listening at the door and pulled the drapes. Then he returned to the business owner, leaned across the desk and said in a low voice, “What would you like it to be?”

      • 

        Ash Little
        April 18, 2011 at 7:24 am:

        Thanks Peter, I had forgotten about that one

      • 

        Blake
        April 17, 2011 at 11:40 pm:

        not even close Kim :-)