What is the highest quality business on ASX?
Regular readers will know that the first question we ask in evaluating possible investments is usually a question about business quality. We take the view that over long periods of time, high quality businesses are far more likely to deliver the sort of investment performance we are looking for in terms of investment growth with a low risk of loss of capital.
Buying them at a sensible valuation is obviously important, but unless the quality is there we tend to lose interest in trying to gauge value.
Quality is a matter of judgement, and one investor’s idea of quality may not align with those of others. However, any quality-oriented investor needs to be able to organise their investment opportunities into some sort of rank order, to distinguish the better quality opportunities from the not-so-good.
For us, saying that a business is “high” quality typically implies three things:
1. The business has the ability to earn high rates of return on incremental investment. Often this means having the ability to raise prices without losing share, or the ability to serve the market at a lower cost than others can achieve;
2. Those high rates of return can be sustained a long way into the future. ie, it is very difficult for others to copy what the business does and thereby compete on equal terms, and there is no imminent threat of disruption through regulatory, technological or business model change; and
3. There is scope for the business to grow. Earning attractive rates of return on incremental capital is much more fun when there is scope to do a lot more of it in future, either by increasing invested capital, or by earning more revenue from the existing capital base.
Owing a business that meets these criteria can be a very rewarding long-term experience. They tend to be priced above the level of ordinary businesses, but every now and then a patient investor will be offered opportunities to acquire one at attractive prices. Taking advantage of those opportunities can make a big difference to long run investment results.
With that in mind, what is the highest quality business currently listed on the Australian stock exchange?
I’m going to put forward Ramsay Health Care as my nominee. What’s yours?
Tim Kelley is Montgomery’s Head of Research and the Portfolio Manager of The Montgomery Fund. To invest with Montgomery domestically and globally, find out more.
Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.
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.
Roger Gibson
:
Hi Tim
I think that by picking RHC you have highlighted a major problem with Skaffold. You picked as the Highest Quality business on the ASX a firm Skaffold rates as poor quality with a poor performance and greatly overvalued. No words can reconcile these diametrically opposed views. One of you is wildly misguided! Skaffold and the team need some tighter definitions. Quality should not exist in your rating system independent of value for money. Few punters see paying double the ‘value’ for a share as a ‘quality’ buy and are not appeased by being told that you mean its a quality company but an awful buy at that price.
Tim Kelley
:
Thanks for those comments Roger. I think we should expect that an individual analyst will at times disagree with the results of an automated system like Skaffold, and what I was presenting was my personal judgement. As to value and quality, we think it is helpful to think of them as separate concepts, quality being something that doesn’t change with the share price.
Xavier
:
Skaffold may be right Tim.
1. Healthcare spending in the West is totally unsustainable – unsustainable situations never last
2. RHC is trading at 7.15 x book value, so you are paying a huge premium for management vs say Primary health at 0.43. (Yes I do realise Primary health has numerous issues RHC does not have)
3. RHC is reasonable leveraged with $7.6 bill of assets vs $5.7 bill liabilities the reason for the large debt load is acquisitions like their French hospitals
I could go on. You are essentially paying a huge premium for what is an excellent management team. Warren Buffett says he wants a business so good that even an idiot could run it. On that metric he would stay well clear of RHC as their management is excellent and navigates a very complex industry.
Hospitals are arguably the most regulated industry in the country. Yet regulations change and this can effect RHC enormously. For example rules around private health insurers not being allowed to operate hospitals are already beginning to loosen. Medibank have their own clinics in Brisbane and expect more to follow. Obviously private insurers will have their clients use their own hospitals. Private insurers are also really cracking down on what they will pay for. Medibank are already refusing to pay for post procedure complications like an infection.
The regulatory risks in a stock like RHC I think are under appreciated by the market. You pay a huge – enormous – premium and have risk in regulation that is very difficult to quantify or control . Little of that risk (along with all the other risks) seems to be priced into the stock.
Health spending is simply unsustainable and there is going to be far more government focus on stopping rampant overspending, so I think there are far better businesses out there.
So what would a guy like me know about this stuff anyway? Well if you bought Ellex when I first posted, you would be happy man right now and I discovered it on the free MSN stockscreener.
Neville Benson
:
I subscribed to Skaffold for 2 years from inception and found it a “time saving” research tool but nothing else. It cost me a lot of money in the end and I wouldn’t recommend to anybody ! Unless you can pick the future leave share investing to the experts who get all the inside info before it happens. Actually I think the stock market is totally corrupt and the ASX and ASIC monitoring a joke.
Gav J
:
Hi Tim, do you think the government review of the prosthetic list prices may end up affecting private hospitals like RHC if they may have been getting rebates/kickbacks from medical device manufacturers for purchasing over-priced prosthesis?
Bob Muirhead
:
Capilano Honey (CZZ) has been good, original investment at 70 cents, now around $22.00 with fully franked dividends along the way. Liquidity is an issue.
Andrew Wright
:
Nick Scali and CSL, though probably not at these prices and agree that the banks and in particular CBA have prospects.
mikimoto
:
Blackmores looks good to me, china is a BIG market
Derek
:
Vocus
Xavier
:
Whilst Ramsay has had a stellar run there are a few areas for concern:
1. Growth by acquisition – this you need to always be wary of
2. Heavily exposed to government regulation. A major risk you cannot control
3. Very highly priced to underlying book value
4. Health spending in the western world is unsustainable and unsustainable situations never last indefinitely. The new health minister Susan Ley is determined to do something about rampant over servicing and she will no doubt receive some form of bi-partisan support.
5. Insurers putting increasing pressure on hospitals and what treatments they will and will not pay for.
For me it would be Freedom Foods or Ellex
Roger Montgomery
:
Always great to hear the countervailing view. Thanks Xavier.
David King
:
You have never published my previous comments about RHC, my attraction to it, my disappointment in Skaffold, and therefore in its connections, that it was never considered a vlue buy in 2011 – 13, or recommend, my disappointment therefore that I was never encouraged to invest in this company, which has the most fantastic, smooth-curve track record on the ASX, my disastrous side tracking into inferior stocks that you did recommend, MYE, FGE, SLR and many other duds, and I could go on..and I dare say you won’t publish this comment either.
Tim Kelley
:
Sorry to hear you have had a disappointing experience, David. While we certainly get some of our calls wrong, the experience for investors in our funds has generally been very positive.
Brian Podem
:
I also lost some money in SLR, but to be fair to Roger, I think it was around mid 2012 that he said the mining boom was over. If I listened to that, I would have sold a lot earlier and my losses would have been a much less. The same would have applied to MYE and FGE.
Roger Montgomery
:
Thank you Brian. We will inevitably make every kind of mistake in our own investing and that’s with an understanding of portfolio construction and a view about the prospects. Always essential investors seek and take personal professional advice.
Roger Montgomery
:
Understanding a company’s prospects and appreciating portfolio construction techniques are just as important as quality and value assessments. Because the topics are so large and beyond the scope of any blog or automated research platform, we don’t recommend any stock and instead always recommend one seek and take personal professional advice .
alan
:
PMV has been good. Some upside there I think.
Roselyne Parsons
:
Most interesting from Tim and also the comments.Wishing all of you at Montgomery All the best for Christmas and the New Year.
Neville Parker
:
It might be OK on the stockmarket but I don’t rate it highly as a hospital
Bob Cairns
:
I’ve recently started investments in both Montgomery Fund nd Montgomery Global – so far so good. They are mainly seed investments as I’m still a little unsure if Roger has completely learned from some of his glitches when at Clime. I could be wrong, but while it has performed very well over the last few years I am nervous that RHC must be very close to a ‘sell and take profits’ at its current price. I’m impressed by the nominations in the comments above, which are quite diverse but to me all seem well thought through. Full marks to Peter Hall, who was almost solely the reason why Sirtex wasn’t taken over for less than a couple of dollars way back. At about $1.30 I was too wise to risk it though – ah well!!
Barry
:
Hi Tim, as a new stock I would go with IPH, as a long-term proven stock would be CSL.
steve cocker
:
I would say HSN as my first choice. My second would be AMA as a great growth stock. Cheers
Richard
:
I suppose that most would have said BHP and WOW were in that basket only a few years ago.
Tim Kelley
:
I think many would have put WOW in that basket, and we would have agreed with them (although in 2014 we changed our view and sold). To our way of thinking though, its usually hard to find a resources business with the necessary attributes. Being price takers with wasting assets and a need to constantly pour in capital counts strongly against them in our view. Some are certainly better than others, but not many get high up on the list.
Gav J
:
Not sure about best on ASX as no time to read about every stock! But of those I’ve read about, understand and own it would be RHC, CGF and ISD.
Tracey Oberg
:
Hello Tim
Thank you to you and your colleagues for the processes you have in place to educate and inform us. I know that you know what you are doing, and as a Skaffold member, I find both it and your blog invaluable tools.
For me, the primary consideration in judging whether a business is a ‘quality’ one, is what it achieves for the ‘positive development’ of humanity. It could be in healthcare, technology, food, mining or any other sector. The financials of a business come second in importance. I am not necessarily talking about ethical investing, although that is included, but something more encompassing.
Which brings me to Apple.
I know that it has great financials and you love it as a business, but even prior to Roger’s recent post regarding the use of technology (fit-bit, apple watches) to monitor people in ways that we haven’t even considered, and the probable outcomes, it is a business that I can’t bring myself to own.
That said, we have a number of Apple devices in our home.
The tricky thing here is that everyone has a different view of what the ‘positive development’ of humanity looks like, which is fine, as long as we are awake as individuals to what we choose to support, and the possible consequences of the decisions we make.
David McDonald
:
Sirtex. Great metrics, and at the cutting edge of medical developments. Wish I bought more of them.
Michael Shapiro
:
ALU, RKN, OFX in that order
Phil Crossan
:
The C rating would be driven by the current liabilities being higher than the current assets. However most of the current liabilities for Ramsay are trade debtors for one and can be funded out of this year’s cashflow anyway.
Jim Hasn
:
Tim, the way I use Skaffold means that C companies are screened out before I continue the search. Due to potential conflict of interest reasons (surgeon admitting patients to a Ramsay facility), I have never owned RHC. To me, Skaffold’s greatest value is filtering out B4, B5 and C grade companies so that I can focus on A1-3 and B1-3 companies. My choice, by the way, is CSL.
zoran arnautovic
:
ARB would be my first choice.
TNE would be my second.
Cheers
Brett
:
REA group. Was very pleased when they dropped to low $40 a month or so ago. They have the “network effect”, expanding overseas and great management.
Sam
:
1300 Smiles
Richard Prince
:
Hi Tim. in your opinion, what sort of value does Ramsay offer. Is it way overvalued or moderately. And what about its massive debt levels. Can we actually rely on skaffold?
Thanks. Richard.
Tim Kelley
:
The price is not at a level where we feel compelled to sell it. As for the debt levels, you need to think about how dependable the earnings and cash flows are. There’s no substitute for your own research and careful thought.
Andrew Carley
:
Hi Tim,
My latest review of RHC in Skaffold shows it as a C4 company with an intrinsic value of approximately 50% of the current market price. I’m pleased with your assessment but find it difficult to reconcile to the Skaffold analysis.
Regards
Andrew
Tim Kelley
:
I should probably have noted the Skaffold rating in my post. Without wanting to go into specific financial ratios, I would say that Skaffold is a good way to screen a large universe of opportunities to find potentially interesting candidates. However, for individual companies, more detailed research and analysis will provide a much more powerful assessment of business quality, sometimes leading to a view contrary to the Skaffold view. RHC, which we hold in the Montgomery Fund, is one such case. Note also I am not arguing that RHC is undervalued at the current price. Merely observing on its quality.
Patrick Poke
:
It’s too hard to pick just one. For big caps I’ll go with CSL, mid caps would have to be Challenger, for small caps I think Credit Corp (though Nick Scali is a close 2nd). By the way, I haven’t intentionally picked stocks from the Montgomery portfolio, we just happen to agree on a lot of stocks (though certainly not all!).
Jeff Tairi
:
CSL
Andrew
:
Hi Tim,
Firstly, I do trust you guys & know that you know what you’re doing. I have been in the Montgomery through my Netwealth platform now for just under a month & it has already returned me a solid 4.6%. So clearly what you are doing works.
But you’ll have to help me with this. I am no analyst so my exposure to direct shares is small (almost a hobby you’d say). I subscribed to Skaffold and I just looked at Ramsay Health Care, and everything I see there screams “don’t touch this business!”. Quality Rating “C”. Performance rating “4”. Debt/Equity of 174%, Market price of nearly $68 vs valuation (the most bullish) of $36. To me as a “hack” this stock is overpriced, poor quality, debt-burdened. What is it that you see that I don’t? Is Skaffold a useful analysis tool or not?
Andrew
David King
:
Ramsay is a well run company in a wonderful area of business, with the improving aging demographic offering even more upside. Its senior management has skin in the game, and in the way that CBA and Woolworths do, it has a large pile of borrowings which allow it through gearing to obtain a high return on equity.Look at its growth curve on the ASX. It has never let a shareholder down in all of its history. If this business deserves a C4 rating because some combination of metrics, well so be it. But if you read my earlier remarks, you’ll see that Skaffold’s analyses over time have stopped me personally from making a very profitable investment, and for that and other reasons I have given, Skaffold is not for me.
Michael Leslie
:
Tim
Thank you for a most interesting nomination. I don’t have a nomination to make as the highest quality business on the ASX. However I rely very much on Skaffold which gives C (poor) for quality and 4 (poor) for performance. This does make me rather nervous!
Cheers
Michael
Carlos Cobelas
:
Michael Leslie , RHC share price performance and company earnings per share growth has been astronomical over the past decade. For Skaffold to say the company’s performance has been poor is ridiculous, and means Skaffold does not rate highly as an investing tool in my view.
Michael Leslie
:
Thank you, Carlos. It’s got me thinking.
Scott T
:
Hi Tim,
A nice succinct article. The highest quality business on the ASX? my vote is for either CSL or Sirtex, they both tick all the boxes mentioned in your post. And to be controversial, CBA is a very high quality business, and some commentators are only looking ahead to the next 6 months, not the next 20 years, If the road ahead becomes a bit rocky for the banks, CBA will outperform and outlast the others.
All the Best
Scott T
Roger Montgomery
:
I’ll leave Tim to also share his thoughts. For mine, if the population is to double in the next 25-35 years, one would have to concur with your view about the prospects for the CBA and perhaps others.