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After some extra help with your holiday homework?

Companies, Investing Education, Value.able | Comments (87)

After some extra help with your holiday homework?

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

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

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

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

Posted by Roger Montgomery, 6 January 2011.

INVEST WITH MONTGOMERY

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

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

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87 Comments

  1. Ronald Parsons
    :

    I am still reading your book and practising from Westpac 2010 annual report.My figures are shares on issue:24496m,s/equity 40118m,roe 17.4,equity p/s 214.2c,div p/s 139c,equity p/s $1.64, pay out ratio 65%,
    then I do the calculation: 1.50 x 1.64 = 2.52 x 65%
    2.75x 1.64 = 3.486 x35%

    =1.64 + 1.22 = $2.86 I/V
    Oh! Can any one tell me how i’ve gone wrong.

  2. Todd
    :

    Hello all,

    Just finished reading Valueable and found it very insightful and echoes another book I have read called the Buffet Way, as most here i suspect looking to learn from this forum as well as trialing my IV values with others to see how they compare, so would like to ask has anyone done any work on firstly QBE and secondly ORG, Origin energy is a little trickier as they have an exagerated NPAT as well as Equity from 09. Any feedback would be appreciated and hopefully I can add something to this forum.

    • John M
      :

      In response to your query regarding Origin, I don’t believe it would fall into the value.able spectrum, mainly because of a very low ROE and a moderately high Debt to equity. Roger has valued ORG in the past and its intrinsic value is probably less then half of its current trading price.

      As a tip, go back through this blog and you will find stacks of A1 and A2 stocks to value. Roger is most recently suggesting to have a look at MCE, ORL and JBH. But always remember, anything that is suggested is not a recommendation, only a starting point to begin your own investigations. Remember to always seek personal professional advice.

      Here is the link to the Category for A1 stocks on this blog as a starting point. http://rogermontgomery.com/category/a1/

      Have a look at this excellent summary that Ken Millhinch produced to help people make sense of Annual Reports.
      http://rogermontgomery.com/how-do-your-value-able-valuations-compare/#comment-6865

      Roger also has an excellent summary
      http://rogermontgomery.com/how-do-value-able-graduates-calculate-forecast-valuations-2/

      The more you read this blog and practice Roger’s techniques, the easier it will become. Just remember that calculating Intrinsic value is only necessary once you have established that the company in question has a sustainable competitive advantage, high ROE, low Debt/Equity (preferably no debt), makes a profit, good quality (A1, A2 MQR), positive cashflow and good future prospects. If it satisfies all these criteria then calculate the IV.

      Also remember that when you have calculated the IV, it is only an approximate value. In order to obtain a large margin of safety, you would probably want to see a good 20% discount to this IV before considering a purchase. It can be painful waiting for opportunities, but it is certainly worth it when you see your the difference in your investment returns. The last criteria to consider before purchasing a stock is that it must have this intrinsic value rising at a good clip in the future.

      Hope this gives you a starting point.

      Your questions,comments and thoughts are always welcome here. Keep them coming.

      • Todd
        :

        Thanks John,

        Much appreciated, thankyou for taking the time to respond, I was only looking at ORG as I had a reasonable number of shares purchased 12 months ago, your links are certainly helpful, thanks again.

  3. Manny
    :

    Matthew and others

    Thanks for replying above to my query on estimating outstanding shares for future years. I guess it is relatively easy to add number of shares if they company has a DRP policy but for other points you mentioned like capital raisings and share buy back, how do you estimate that for the next 1-3 years. Do the companies clearly mention that in their annual reports? A bit more insight/knowledge would be useful from the room.

    My research so far shows me that for more mature businesses (like WOW, BHP etc) it is easier to estimate future number of total shares based on historicall increases/decreases in share numbers and even if your estimate is not totally accurate the IV will not differ so much and margin of safety will mitigate this.

    For less mature and small-mid sized business and especially then ones that have only started generating profts only in the last few years an in accurate future number of shares can give a very wrong result.

    Thanks

    Manny

    • Matthew R
      :

      It comes down to an educated guess – get as much information you can find and make the most accurate guess you can

      you will rarely find guidance in the annual report about upcoming/current capital raisings, but that doesn’t mean you can’t make a guess based on previous years, the cashflow of the business, management’s goals etc

      the small businesses are always going to be more difficult because as you mention, their capital base is not mature yet

      I would suggest not getting too caught up with estimating a pin point accurate future IV, instead think about competitive advantages…. you want the companies where that is predictable

  5. fred
    :

    I do remember some time ago Roger saying that he had lost his attraction towards The Reject Shop and then after the $5.00 drop then saying that it ( might ) be a good stock to watch for 2011.

    I hope that The Reject Shop is not effected dramatically by the flood’s.

    • Matthew R
      :

      On the contrary Fred – as net buyers of stocks we should be hopeful that the market sees the Asthma attack that TRS might have, and interprets it as Emphysema

      It will be interesting watching the TRS announcements & market reaction

      • John M
        :

        Well said Matthew,

        I concur with your diagnosis Doctor, it may give you the chance to do so smooth operating.

      • Matthew R
        :

        Thanks Ash and John – however no fruit thus far

        Crazily enough the price jumped 5.5%, obviously Mr Market was very manic that day!

        There is an argument to make for the potentially inflationary effect of these floods, but TRS is not the only (or even the best in my opinion) way to beat that game, and they have the waterlogged warehouse….

  6. fred
    :

    Wayne I agree that its expensive but I will start my attack @ $2.65 or so. Ash I respect what you have to say about JBH but to me its a little dear . Grant harvey norman debt is 25% about.

    Thanks all

    • Ash Little
      :

      Hey Fred

      I admit to owning JBH but i have had them since 2005……….I am not buying either JBH or HNV atm.

      Really realy good oportunities will present themselves if we are patient

  7. Wayne G
    :

    “Posted by fred on January 12, 2011 at 1:49 pm
    Hi Room,

    Harvey norman ( hvn ) is starting to look good in my view.

    What do you good people think?”

    The ROE is currently 11%. My Discount to IV is still alot lower than its currnet price. Needs to drop below 1.70 to hit my screen.

    Wayne G

  8. Simon Anthony
    :

    TRS intrinsic value calculations for 2011 & 2012 will need to be revised. The company’s operations will be adversely impacted as a
    result of the floods in Queensland and in particular the impact
    of the floods upon the operation of TRS Ipswich based
    Distribution Centre which currently services 90 of their 211 stores. Expect another profit downgrade.

    • Ash Little
      :

      Yes very true paul

      But the time to buy is when things look the worst.

      If Mr Market gets really silly we can take advantage of his wallet rather than listening to his insights…It is still a pretty good business and the flood like this does not occur very often….TRS has tried to grow too quickly in my opinion but it still has a very good footprint.

      Lets see how silly the market gets over this

  9. Wayne G
    :

    Hi all,

    Happy NY

    Grant, Rodger M has mentioned TSM and I think has it at A2 on his ratings but don’t quote me on that one.

    The IV will vary from person to person so rather than comment on IV I will put my 2 cents in relating to when to get interested.

    My discount to IV is at 0.54 cents. So it should hit my screen when and if it drops a little.

    Wayne G

  10. Matt
    :

    Just noticed that TRS has gone into a trading halt, someone picking it up reasonably cheap perhaps?

    • Paul Kloeden
      :

      They have a large distribution centre at Ipswich Qld, now under water. The trading halt is so that they can inform the market as to the impact.

  11. fred
    :

    Hi Room,

    Harvey norman ( hvn ) is starting to look good in my view.

    What do you good people think?

    Thank you

    • Andrew
      :

      Have not had an in depth look at harvey norman. My concern with that company is that it does not make the grade for me in regards to competitive advantage. Jb hifi has been killing harvey norman and has cost-leadership amongst other competitive advantages. Think harvey norman will continue to struggle to compete and perhaps another reason as to him being the most vocal person about online retailing. It will be interesting to see what their next results are like as I think there is more to gerry harveys complaints and I think their next results might show it. Seek your own advice however.

    • John M
      :

      Purely borrowing the thoughts of Gerry Harvey, I would be very careful in the retail sector. Many headwinds are present. The high Aussie dollar is causing smaller margins so that they Gerry has to sell twice as many widgets to make the same profit. A lot of people are purchasing goods on-line as they are getting better value with the strong Aussie dollar and the absence of the GST. Many mortgage encumbered consumers have had to endure several interest rate hikes and it is likely there will be more hikes at some time in the next twelve months – therefore they are reluctant to part with their hard earned currency.

      It is the first time I can remember Gerry not be positive for the future of HVN.

    • Grant
      :

      I will have another look at HVN but as far as I can recall, they have quite a large chunk of debt..which is not so good!

  12. Roger Gibson
    :

    I picked up my January edition of Smart Investor the other day and found an article on page 42 by Trevor Hoey – Futureproof Your Portfolio. What surprised me was how many of the recommended shares looked familiar. Trevor’s list was: FRI, CWP, DVN, REA, RPX, WTF, FLT, ARP, SUL, JBH, HVN, BRG, RFG, ONT AND GLG.

    They don’t all make the grade but its such a good list as a starting point that I wonder if Trevor Hoey is a Value-able graduate?

    • Ash Little
      :

      Hi Roger,

      I actually think I read somewhere Trevor actually admiting reading Value.able

      So Yes I think he is

      • Trevor Hoey
        :

        Just read your post Ash when browsing Google for something I had covered in the past. Wasn’t aware of Value.able but must have a read sometime. Glad you liked the SI piece.

        Cheers
        Trevor Hoey

  13. Manny
    :

    Another question, please if I may..

    Has anyone looked at ACR (Acrux) IV lately. It appears in Roger’s A1 list. When I do IV calculations the IV is very high (greater than $10) using actual numbers for year ending 06/2010 from comsec. The IV is coming down substantially in 2011 (around $5) and 2012 (around $1.70).

    The shares are currently trading around $3.45

    I was thinking of buying this stock today but am a bit concerned now. One reason the IV is coming down substantially is because they will start paying dividends from 2011 and their POR will be between 75% to 99% over the next couple of years (as per data in comsec).

    What does everyone else think about ACR in 2011? Does it matter if POR goes from 0% to 99% over the next two years? Have you got future year IV’s for this stock. Thanks for your help.

  14. Manny
    :

    Q? Do you guys use the same number of total shares on issue as per the last company reporting when calculating the future year IV. The total number of shares rarely remain the same year after year and making an assumption on a future number without any facts can result in incorrect IV. I am sure few people will say, just keep a high margin of safety to mitigate this. Is this what everyone does? Would be good to know. Thanks

    • Ash Little
      :

      Hi Manny,

      Roger has said a number of times that you should take into account future capitial raising

    • Pat Fitzgerald
      :

      Hi Manny

      If they have a DRP I estimate the number of new shares/capital that might be issued/raised in the following years. Also if they regularly grant bonus shares to executives I do likewise. Also if they regularly do share buybacks I estimate this as well. In the USA many companies do large share buybacks regularly and these will have an impact on valuations.

    • Matthew R
      :

      there are companies which are not issuing new shares each year…

      but for those that do – you might consider estimating future shares on issue. It is reasonably straight forward: adjust for capital raisings/buybacks as they are announced and estimate DRP and executive share options plans based on recent years.

      I don’t know if this is correct, but it *might* be the case that if you use EPS/DPS figures from your broking site the analyst(s) have allowed for expected changes due to the above events in issued equity in their calculation. But you know what happens to you and I when we ass-u-me. You would hope they have – but I wouldn’t assume it, human nature being what it is.

      Sadly, I have seen many research reports where they have just ignored any future changes in shares on issue and just extended the status quo to infinity.

  15. Ash Little
    :

    Hi Guys,

    The biggest discount to IV I can find at the moment is the Qld Economy so make sure you all give generously to our flood appeal.

    I will even allow you to take some profits in MCE & FGE to do so.

    Don’t worry you will be paid back in spades if you back a Queenslander

  16. Grant
    :

    Hey guys,
    been trying to get alot of research done over the xmas break.
    Ive uncovered a few good stocks – but can’t find all that much around at the moment. Hopefully half yearly reports will lend some more light!

    One company that I discovered through this blog was TSM. They operate business-to-business IT financing.
    They appear a fairly good company, however, with a recent capital raising the half yearly report will be a vital one for TSM.
    Im wondering what other similar companies (competitiors) are listed on the asx. Is there a simple way for me to search for various companies within industries? It would be a fantastic way for us all to debate over companies and decide on who is a leader in their respective field!

    • Ash Little
      :

      Hey Grant,

      Nice work………..I too like TSM but much will be learned in the next report.

      Sorry No short cuts to research about competitive advantage and competitors……This hard work is what makes our returns so mach higher than the index.

      I am known for taking a few short cuts on guessing IV but this area is very important…I think you should never take short cuts in this area

  17. Mike Hall
    :

    An interesting extract from Berkshire Hathaways 1986 Chairmans Letter to shareholders states:

    ~ Business value is a soft number: in our own case, two equally well-informed observers [Warren and Charlie] might make judgments more than 10% apart. ~

    So there’s no need to ‘sweat-it’ trying to get a precise number.

    • Ash Little
      :

      Hi Mike,

      Yes well done.

      Better to be approximately right than precisely wrong.

      Many people trying to get the exact Montgomery valuation should listen to this

    • Matt
      :

      Thanks Mike. Evaluating business value, quality and outlook, then applying a margin of safety are all steps in a process.

  19. Christopher
    :

    My two cents on equity and RR:

    Average equity is a good starting point, but always check the changes in share capital and the balance sheet to see whether there is anything which would make this inaccurate, e.g. MCE.

    Use a 10% RR unless there is a reason not to. A good example here is ORL, an A1 with a massive ROE and competitive advantage. Using a 10% RR would significantly undervalue the company. Like Andrew says, risks specific to the company and the industry can also require you to use a lower return. I don’t worry so much about this, as I’ve given up valuing low quality or extremely high risk companies!

    • Ash Little
      :

      Hi Christopher,

      I have a different view,

      Never use 10% rr unless it is so obvious that you have to………I am using a much higher RR than 10% for ORL and i am happy to hold ATM as it is still slightly undervalued

      • David Sinclair
        :

        I have to agree with Ash on this one. Better to start out with a high RR then lower it only if further research gives you confidence in the business, the industry it works in, its competitive advantages, etc.

        David S.

      • Christopher
        :

        Hi Ash,

        Your approach will help avoid those tempting “line-ball” purchases, but I suspect this isn’t a problem for you anyway.

        Of course, in the end it doesn’t actually matter which RR you use, as it won’t produce an “incorrect” result. Using 10% for basically all A1’s as I do, I’ll be happy to buy something I find trading at a 30%-40% discount, and avoid anything else. The same stocks will be attractive to you, using 12-15% RR!

    • Matt
      :

      I just wanted to add how ROE can be such a good initial indicator for selecting a starting set of companies. A quick commsec query gives a set of 160 companies from approximately 1800.

    • Andrew
      :

      I hear what your saying and as i said in my post, a lot of people will have big or suttle differences as to how they arrive at their RR. Mine is not so scientific as some and comes down to more of a gut feel about the factors i listed in my post.

      I don’t start at any RR%. I only have two companies at the moment on 10% and that is CBA and WOW.

      ORL is a good example of how i arrive at my RR.

      I have ORL on a 11% RR. They are a good company with a big competitive advantage and very little competition in the little niche they have carved out of affordable luxury fashion accessories as well as a strong brand following.

      The main company risk for me is:
      -They are a small company and only really have two brands. They will reach saturation point sooner rather than later and when that happens profitability will start to drop unless they can find some new avenues for growth which will end up being higher risk.
      -Also, it is not yet clear how successfull their asian expansion will be but could itself be a result of the need to try and find newer avenues for growth as the Australian market is drying up for them.

      Industry Risks for ORL:
      -Little barriers to entry. An overseas player can easily come in and start taking market share. I was in LA mid last year and heard Micheal Korrs could be opening stores in Australia soon. his accessories products would prbably be in a similar market to Oroton.
      -It’s fashion, the design team need to stay relevant with what is and not in fashion for that period. ORL does a good job at this.
      -It’s Australian, Australian fashion companies are not easily accepted overseas which makes overseas expansion harder.

      These are just some risks. The company has more strengths than weaknesses in my opinion however.

      Also, with my personal knowledge. I can go into a store and see how popular this brand is, i can go to the DFO in homebush and see if there is still a lineup outside their store. I can see how many Oroton Umbrellas i can see when it rains. I also know people in the industry who are aware of the upcoming trends and can let me know whether they are still producing products which will sell or if they have missed the boat. I also feel i know a bit about the retail sector myself.

      All of this has ended up with me choosing a 11% RR.

      Its interesting to see how people come up to their figure and i can see your logic in basing it off the variables you have mentioned.

  20. Andrew
    :

    A lot has been mentioned previously about the discount rate or RR.

    I think it might be interesting for people to share their thoughts on how they arrive at the RR as this is the most subjective thing out of the formula and has probably the biggest impact on IV.

    I don’t think there is any right or wrong way to do it but would make a good discussion i think.

    Personally, mine is made up of a few different variables
    -The industry probably has the biggest impact on my choice, are there a lot of competitors that could challenge the company, risks such as technological change, external factors like base prices, the products that are being offered etc and how important they are in the consumers mind etc. I perform a SWOT analysis on all the companies as well as keep a little blurb on the market landscape to help paint a picture of this. Eg of this is that i put companies like REA, carsales.com.au etc on a 12% RR due to the fact that there are low barriers to entry and the internet is a fast moving landscape and technology changes (think mobile phone apps coming into power etC).

    -The next is the company, what is the companies position in the market. Are they a new, growing or mature business? Are they the market leader or challenger? Growing companies would usually for me command a higher RR as there are more risks attached to it than a mature company that is a market leader. They don’t have to play catch up.

    -What is my knowledge of the marketplace? Am i on top of the industry and market environment enough that i would be able to spot any upcoming troubles. The less knowledge i have about a specific industry i will either stay away from it until i do learn about it or i will command a greater RR and margin of Safety.

    Personally i only want to buy companies that fit into my “safety raneg” 10% to 12% RR’s. If they fall outside that range my opinion is that i am starting to head into speculative territory and i am not in countrol of the investment and its future potential. This also means that i will miss out on a lot of good companies but i am more than happy knowing that the ones i do own will be well within my circle of competence and will be good investments. Also, 9% regardless of the company is not enough of a discount for me to consider purchasing. I like a bigger margin of safety.

    I am not trying to run valuations in order to justify me buying, i want the market to work very hard in order to prove to me that it is a good investment.

    An example of a company that fits outside my “safety range” and there for is that i stay away from mining companies as i cannot due to my little knowledge of what and how they do things understand if they are doing a good job and whether this is likely to continue, the market is also very attached to commodity prices and other external factors outside of their control and is a very competitive marketplace.

    Not to say i won’t analyse them as something may change but they will be put at the end of the list and i still would not be interested in buying them.

    However, WOW is one of two that fit into 10%. This is because it is a great company that offers products people need to buy in order to survive. It is the market leader and competitors really need to push them selves in order to challenge them due to their superior systems and processes, i also can gauge how they are being received by the consumers by just visting some stores.

    How do you come up with your RR?

    • JonH
      :

      Andrew

      Thanks for your reply to my wotif.com query. Interestingly my valuation of $2.98 is for 2010 whereas 2011 is $3.20, so that’s a little more reassuring.

      I found your comment about RR a good read and you are quite right it is the ‘subjective’ component and can cause quite large swings in the eventual IV. I have tried a couple of approaches to working out a RR using among other things the Capital asset pricing model which I know that Roger is not a fan of. The formula I used is:

      risk free rate + (market rate – risk free rate) x Beta.

      The problem is that it’s too simplistic and if the beta of that company is less than 1 you end up with a RR that is less than you get in the bank. (Montgomery: 1 Me: 0).

      My general rule now is that my RR increases as the companies track record deceases so I might dip below 10% for a Westpac, but I use 12% or higher for a company like REA or Carsales.com etc. I did wonder if there is a more scientific method, maybe taking the historical returns but I haven’t got far with that as yet.

      Thanks again for your help and the advice about Comsec, I shall treat them with suspicion from here on

      • Ash Little
        :

        Hi JonH,

        Just my opinion but I would scrap that method of selecting RR.

        Beta is garbarge….. Andrews comments on select RR is very good……I will add stability and predicibility of earnings being high up in the calculationn of RR

        Andrew has loads of good points about selecting RR

      • David Sinclair
        :

        Hi Ash,

        I personally think that a conservative choice of ROE to use in the valuation is a better way of making allowances for stability (or lack of…) in earnings.

        I am still in the process of thinking through the issue of required return, but my starting point is that the required return should be the best proxy I can find for a risk free return plus a weighting for the risk presented by each individual investment.

        The ‘risk free return’ proxy could be government bonds (which Buffett refers to in his 1980 shareholder letter), a savings account, or you mortgage if you have one. It probably depends a bit on the individual investor.

        For investments in shares I think the risk weigting should reflect two major risks: 1) the risk of the business failing; and 2) the risk that future returns are not as good as the predicted returns used to generate the valuation (which take stability of past returns into account, as I mentioned previously).

        Andrew’s comments are very good, but I still need to think through which factors are important enough to include in a risk weighting and which ones are more peripheral (and which are deal-breakers that rule the company out as a possible investment). I don’t have enough time to go into a huge amount of detail for every possible investment, so I am trying to pick out the key issues that will help me do a quick screen so I can focus on a more detailed analysis of the best prospects.

        I have already written much more than I was intending to, so I will stop now and see what everyone else thinks.

        David S.

      • Ash Little
        :

        .Hi David,

        Nice post,

        Much has been posted here about RR and it is all good stuff…..A few years ago I had a scoring system that rated RR….. This was

        1) What factors externally beyond the managements control can affect profits.

        2) How good are the people rowing the boat that I am in and how predictable are the company’s earnings

        3) How liquid is the stock because if I make a mistake I want to get out

        These are scores over and above the risk free return. So when interest rates go up …….despite what your broker or advisor tells you……..your businesses are worth less

        The actual scoring metric is more complicated than this but we don’t really want an essay……..I have been doing this for awhile now and I don’t really need to go to the scoring metrics. I just know what it is while analysing the business

        Hope this is of some help

      • Roger D
        :

        Problem with using CAPM is that its based under an EMH. Which contradicts with value investing in general, as it seeks profits under an irrational market.
        Roger Montgomery even gives explainations of why CAPM should not be used in his book.

        I think youre better off just using 12% RR for all companies (I know this is absolutely ridiculous) than using CAPM, thats how negatively I feel towards it.

        Cheers,
        Roger D

  22. JonH
    :

    Hello Roger.
    I recently purchased your book which was excellent, it really has changed my view of the share market.
    Since reading it I have been working to learn the valuation method taught in the book but my results do vary somewhat from yours. I get my data from Comsec as suggested and I’ve checked my formulas thoroughly but can’t see where I’m going wrong.

    An example of this is Wotif.com. On a previous post you gave it a current Intrinsic Value of $4.54 whereas I get $2.98. The only variable is rate of return for which I’m using 12%. Even if I reduce this to 10% the values are considerably different. Am I missing some valuation inputs beyond those shown in the book or do I need to add value for things like brand strength etc.

    Any advice here would be gratefully received.

    • Andrew
      :

      Not sure what inputs you are using, perhaps if you post them someone can tell you what they think of the information.

      One thing i have noticed is a trend towards getting the information from a comsec or etrade. As a comsec user may i warn you about this as more often than not the information tends to be a bit wrong. I think you can find a discussion like this on nealry every blog post.

      I think everyone should get historical information from the annual reports. The information might be harder to find but it will be more correct.

      I would agree witht he 12% RR. I use that for most internet based companies. I also got on my old valuation system a IV of $3.18 so your not that far off what i got when i first had a look at it. Going to look at it again soon and i would expect it to be a bit higher.

      • Kent Bermingham
        :

        One thing i have noticed is a trend towards getting the information from a comsec or etrade. As a comsec user may i warn you about this as more often than not the information tends to be a bit wrong. I think you can find a discussion like this on nealry every blog post.

        I think everyone should get historical information from the annual reports. The information might be harder to find but it will be more correct.

        I would agree witht he 12% RR. I use that for most internet based companies

        It is really sad when Investors are looking for accurate data that Comsec cannot provide the info?
        To evaluate over 2000 companies using Annual Reports is to time consuming and as with comsec query tables that gives you all the data you need there must be another source that provides bulk company info more reliably?.- typical of the finance industry
        Roger’s formula can have dramatic variation in IV eg get the RR wrong by 5%, a 5% variance in ROE projected, a variance in payout ratio projections. It should only be used as a ” guide ” to get to companies worth having a further look at, so just remain constant with your formula and the same companies will rise above the water then look at your formula in more detail for these companies and other items eg management, debt, competitiveness etc etc , it is not the be all and end all – too may variables..

      • JonH
        :

        Hi Ash,

        Here are my inputs for WTF:
        Equity: 2010=85 2011=94 (formula uses average of the two)
        Shares on issue: 2010= 209 2011=209
        Profit: 2010=52 2011=55.8
        DPS: 2010=21.5 2011=22.4
        EPS: 2010= 25 2011= 26.7
        Payout ratio: 2010=86% 2011=83.9%
        EQPS: 2010=41c 2011=45c
        ROE: 2010=66.7% 2011=62.3%

        Multiplier Table 1: 2010= 5.25 (a guess as the table ran out of data)
        Multiplier Table 1: 2011=5.00 (another guess as above)

        Multiplier table 2: 2010= 20.00
        Multiplier table 2: 2011=18.1

        I thinks that’s all. I’d really appreciate your input on this as I can’t see where I’m going wrong. Your comments are also duly noted about CAPM, and I think you are right. It is a seductively simple formula but not much use beyond that. It’s now in the round file.

        As a matter of interest though, do you find that most of your RRs fall into a range, for example, 10 – 15%. This is the area I have the most problems with and there are so many different opinions out there about it.

        cheers

        Jon

      • Ash Little
        :

        Hi JonH,

        I am not the best person to ask about about RR for Rogers formulae as I use a slightly different before tax formulae so my RR is allways higher……I can convert my model to a Value.able formulae but I have been using this for a few years now and I am used to it so I dont really want to change it.

        It is not significantly different

        That said if a companies RR is over 15% you should not really be wasting time on it……The quality is not really there.

        Cash rates with AAA guarantee ratings are paying about 6% so RR should never be under 10%…..Very few companies get 10% for me

        Lots of people have had trouble with IV’s when sustainable ROE is over 60%……PTM and ORL immediately come to mind.

        I dont have a copy of value.able at hand as i have said in other posts but your maths may be wrong. At this stage I would sugest just using the 60% ROE tables and see what you come up with….Your figures for equity per share and ROE are sound so you should be getting an IV of well over $3..

        I have actually relooked at WTF( Which I should have done before I said it was IV over $5…..On new figures it is now at mid $4)

        If you get lower it is merely a factor of compounding at returns at above 60%…This may be the big difference

  23. Steven Lee
    :

    Dear Roger
    I find your book very helpful on understanding stocks. However, a company that has a high return on equity and pays out little in dividends has a very high intrinsic value, relative to one that pays out a larger proportion in dividend, with the same return on equity.
    There must be something wrong about this logic, because it suggests that all woolworths(for example) has to do is to stop paying dividends and eventually the share price will rise by the return on equity. (27%p.a).
    If this is true, every board of directors should take this path, why not then?

    • Greg Mc
      :

      G’day Steven

      As long as the company can continue to reinvest profits at the same high rate of return, what you say holds. It is difficult for a company to do this indefinitely though, particularly one the size of Woolies in Australia. Also, the dividend payout ratio often is determined by what the directors think will support the share price (and themselves) moreso than increase the intrinsic value of the company. Indeed, you’d have to suspect that many do not understand the concept as described in your post.
      All the best,
      Greg

    • Andrew
      :

      I understand what you mean but it is not a blanket rule that any company above X% ROE should retain all their earnings.

      The company is worth more by retaining earnings as long as they can sustain and compund that high ROE. Think of it as a bank account. If you can invest money in a bank account that compunds your money at 30% per annum it is worth more than the bank account compunding your money at 5% per annum. However as companies are not bank accounts there is a bit of a grey area.

      Woolworths has a ROE of around 27-30%. It is however a very mature business, there is very little room for future growth one might say. If Woolworths was to retain all their earnings it would add that same figure to the shareholders equity however it would be unlikely that the earnings (profits) would rise enough for the company to sustain that ROE.

      The ROE would then drop and the valuation would be worth even less.

      Some companies are too big to retain all their money and retaining the money might actually hurt their return on equity and there for their profitablitlity. The only sound thing to do is pay out anything they don’t need to retain as a dividend.

      Hope this makes sense and has helped you.

    • Graeme
      :

      That does make sense, but some companies have a great ROE but little or no growth. Take West Australian Newspapers (WAN) has a great ROE for 2010 of 74% and also great competitive advantage as it pretty much has a monopoly over the newspapers in Perth and WA, but has little or no growth prospects as it rules that scene. A little bit of growth in streamlining the business and a bit in classifieds adds. But because it can’t grow the business it pays out all it profits in dividends after paying some debt. Hence why the yield is about 7%.

      Graeme

    • Roger Montgomery
      :

      Hi Steven,

      Have a look at Berkshire Hathaway’s share price. The last time the Chairman of that company paid a dividend was 1967. Why don’t directors take this path indeed! Only reason franking credits and small relative finite size in Australia.

  24. William Mark
    :

    Hey guys,

    I am doing a valuation for TRS. I got $11.23 for 2011, $14.05 for 2012, $18.32 for 2013. I would like to think know what others got for TRS so that I can double check on my calculation.

    On top of that, regarding average of shareholders equity over 2 years, do we use the known shareholders equity for the previous 2 years or we use the beginning shareholders equity and the forecast ending shareholders equity for the current FY?

  25. Kent Bermingham
    :

    You can use the Comsec sites to run a query that allows you to download all the info into an excel spreadsheet such as book Value ( Equity Per Share) , Payout ratio, and ROE for all the companies on the ASX, you can also get the closing stock value, saving a lot of time in looking at individual stocks.
    However you can’t get opening stock – as a query – any suggestions????.

    • Ash Little
      :

      Hi Kent,

      That ROE figure on the comsec site is wrong as it uses closing eqps to calculate ROE.

      • Kent Bermingham
        :

        Thankyou, I have made the adjustment and will carry the current opening equity to the closing equity after this years AGM’s and that way I will have all the figures to do the new valuations.
        I am learning so appreciate your help.

  26. Andrew Grey
    :

    Thanks heaps Roger for that video I have your book but its great to see it simplified like that. I`ve got two 14 year old twin daughters looking at anual reports for me for pocket money and you should see how fast they are! i`ve got them looking at every company on the asx and it won`t take them long at all! the new generation are awsome to behold with an ipad in front of them.

  27. Peter
    :

    Hi Roger,

    I hope you had a great Christmas and all the best for the New Year…Let’s hope it’s one which produces many great opportunities.

    I have read your book a few times now as I love the content and clear presentation of your thoughts, methods and psychology for value investing.

    I currently use both your’s and Warren Buffets Methods for evaluating “Business Intrinsic Value’s” which i hope offers me a sanity chech plus that added confidence when both values are within reasonable tolerance.
    The system/methods are part of trading but the other part is gathering and maintaining the latest information for each company. I find it hard to keep ontop of this and get time to systematically go looking for other companies which aren’t on my short list but may now be worthy of consideration and number crunching.

    My Question to you is; How do you produce this short list and maintain your records?
    I have excel spreadsheets at present for number crunching and updating of the latest data, however this doesnt help me refine my short list for new opportunities so i’m left to wade through the companies.

    Any advice on how you go about this would be very much appreciated!

    Kind Regards,

    Peter

    • John M
      :

      Hi Peter,

      I believe Roger is on holidays, so I will try to recall for you, some of the answers that Roger has provided in the past.

      Roger doesn’t have any shortcuts. He and his team work on this full time. He values companies on a daily basis (company announcements) and works out his Montgomery Quality Rating (MQR) at least twice a year (half and full year reports) for each and every stock on the ASX.

      Roger then sifts through the investment quality companies MQR of A1,A2,B1 mainly (which Roger most generously provides for us) and works out if any of these fit the rest of his investment criteria. Do they have a sustainable competitive advantage, high ROE, no debt, positive cashflow, significant discount to intrinsic value, is the intrinsic value rising at a good clip, does it have good prospects?

      No real shortcuts for Roger. We have the shortcut, in the fact that Roger screens the larger population of companies and provides for us which companies are investment grade – which really saves lots and lots of time.

      The only other thing I can think of is experimenting with a stock screener. Maybe start by screening by high ROE and low debt, which is what Roger used to do to uncover stocks prior to formulating his MQR scoring system. Commsec has a stockscreener. The money website at ninemsn also has stockscreener – choose create your own search and go from there.

  28. Andrew
    :

    Always go by what the book says. Remember that these presentations are for educational purposes only. I haven’t seen it so i can’t comment on the figures used in the example but if roger gave all the info away for free in his presentations nobody would buy his book so he would probably simplify it.

    I personally always use the ROE averaged over the biginning and ending if that helps.

      • Ash Little
        :

        Hi Room,

        Personally I don’t average ROE… But if a company raise equity during the year I will weight it…… Just my view and most here disagree with it

      • Matthew R
        :

        not everyone disagrees :)

        but average equity is a quick solution, and the most easily applied method to use retrospectively

        I have found it interesting, and I think it is a result of all the Value.Able Christmas Gifts, but we have really got into the technicalities of determining IV in the last couple of weeks

        The time will come on it’s own I hope, but there needs to be an equal or greater weighting of discussion on competitive advantages. I’m going to try to start doing more of it as I’m as guilty as anyone else. I think about it a lot, but I don’t post about it much.

        Thinking about competitive advantages and qualitative aspects of intrinsic value is Munger’s “my guess is better than yours” that produces the really outsized returns

      • Andrew
        :

        I agree Matthew. I think Roger has touched on this a number of times as well.

        I find the discussions about the companies fundamentals and competitive advantage far more interesting and insightful and is what makes this little community we have so great as everyone is willing to share.

        It will be a cycle as the more experienced value.able graduates will move towards learning about the business and the newer grads will start with the valuation.

        Perhaps it is one way for the blog and community to innovate and change in 2011 with a forum where people can ask for help on their valuations, discuss companies etc but i will leave that up to Roger.

        I personally skew my company analysis towards the competitive advantage area as i feel it is more playing to my strengths than a really deep financial analysis. But slightly changing things and innovation is something that i tend to always do.

        I think innovation is another thing that should be encouraged. I think many people here want to get the exact same results as Roger and are getting pre-occupied with this. I think people should use what they have learned in value.able to further learn from there and then expand on that.

        For example, I know detailed financial analysis isn’t a great strength as mine but the more marketing, competive advantage areas are in my strengths. Another weakness is my knowledge on mining and resources but i think i have a good handle on the competitive advantages of certain retailers and other companies so i disregard one and focus on the other. I also have developed my own scoring system that measures certain financial information and then the competitive advantage to come up with a list of companies that i think are and are not investment quality.

      • Rob
        :

        Hi Andrew I totally agree.

        When we start out, we like to know we are following the correct process. Perhaps an FAQ suggesting to undergrads, among other things, if they post on IVs they include their inputs to assist those helping them.

        I have found the more research you do the easier and more interesting it gets. For the novices, of which I’m one, i found doing Roger’s exercises builds confidence and understanding. When you’re confident of the process you then start to understand where he builds in his saHi Andrew I totally agree.

        When we start out, we like to know we are following the correct process. Perhaps an FAQ suggesting to undergrads, among other things, if they post on IVs they include their inputs to assist those helping them.

        I have found the more research you do the easier and more interesting it gets. For the novices, of which I’m one, i found doing Roger’s exercises builds confidence and understanding. When you’re confident of the process you then start to understand where he builds in his safety nets and then it’s up to you to build in the ones you are comfortable with. This is why you notice the grads talking from their subjective view and that’s why IVs differ.

        The quality and the level of help and support on this site is fantastic and i really appreciate it. I think a forum would be a great addition to Roger’s site but it needs to come from him.
        Thanks to all the helpful grads on this site and to Roger for providing such a wonderful resource.
        Cheers
        Rob

  29. Geoff Cruickshank
    :

    Oh dear, Roger: I spent quite a while discussing with a friend who has only recently bought value.able about calculating ROE on the average of opening and closing equity- and here I see you are calculating it on the closing equity for WOW. I know you said it doesn’t matter so long as one is consistent, but I reckon we need a rule about this one way or the other, if we are going to discuss valuations on the blog..
    .

    • Matthew R
      :

      Roger made a comment somewhere in one of the comments here that for this WOW example that he used ending equity because it made it easier to present it in the time that was allowed. To use Average Equity would have required more explanation and the potential for confusing the viewer.

      In reality he uses average equity

      (he has given this same WOW presentation a few times and posted it to the blog on previous occasions)

      Hope that helps!

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