Hands up if you asked; What is the intrinsic value of…
The requests for valuations and insights have been coming in thick and fast, and I have to confess to being a little surprised. The vast majority of requests have been for great quality businesses, some of them even the ‘A1’ companies that I alluded to on the Sky Business Channel a few weeks ago (the highlights will be on my YouTube channel in the next week or so).
If you have sent me an email requesting my insights and valuation for a particular business, thank you. You have uncovered some really interesting stories.
Lloyd, who was kind enough to drive me to the airport following my ASX Investor Hour presentation in Perth last November, suggested one such company to me, Forge Group Limited (FGE). At the time, FGE was trading at a bit more than a dollar.
If my memory serves me correctly, Lloyd bought the stock around 30 cents. I looked at it, ran it through my models and liked it a lot. For a tiny little company it was a true A1 – very high quality on all counts. It had also doubled its profits a few times.
Today it trades at $2.82 and has received a bid for 50% from Clough Limited. They have a hide! This company is potentially worth a great deal more, but don’t take my word for it – remember that you should see my view as just one more opinion, should always conduct your own valuations and research, and if necessary, seek independent advice from someone familiar with your financial circumstances and needs.
If you asked me to value a particular business, and there have been a few requests, I would have explained that I will do my best to post a valuation up as soon as possible but those companies that received the most requests would be posted first.
So here are my insights, and valuations, for the most popular businesses, as requested by you over recent weeks and even months.
Electrical contractor, Southern Cross Electrical Engineering Ltd (SXE)
Prior to its capital raising and downgrade, SXE was expected to generate Returns on Equity in excess of 37% in 2010 and 30% in 2012. Recent events however are likely to see these numbers fall to 22% and 27% respectively. The value today is 96 cents and lower than the current price, however the value next year, if it can earn the new forecast numbers, will be higher than the current price. You need to satisfy yourself that the revised expectations are indeed achievable.
Pawn shop chain (and commercial microfinance operator), Cash Converters International (CCV)
There has been a lot of interest in Cash Converters. I have seen these stores and while I cannot see them becoming a retailing powerhouse like a JB Hi-Fi or even The Reject Shop, that may not be the company’s intention. More than 2/3rds of reported profits are generated from secured and unsecured small personal loans that are distributed by a network of 509 second hand goods stores. CCV has the metrics of an attractive business indeed its an “A” class stock, but scale is the issue. Just how big can they ever be? If we remember that we want a) Big Equity and b) Big Returns on Equity, then I can see the big returns on equity but Big Equity may be someway off.
The value of CCV today however is 74 cents – about ten cents higher than the current price, and based on current estimates is worth 93 cents in a couple of years. Those valuations compare favourably to the current price and very favourably to the 32 cents the shares traded at in March 2009. Always keep in mind that you want to buy these sorts of stories at very big discounts to intrinsic value.
Figure 1. CCV’s historical and forecast earnings and dividends per share
On the surface here’s a company that has the quality characteristics I like and is at a discount to intrinsic value. The only question mark is about how big they can get. If you intend to trade shares of CCV seek independent financial advice from a qualified professional who is familiar with your needs and circumstances and do not rely on the general nature of comments posted here.
Investors must also be aware of the impact of the intention of the Consumer Credit Code Amendment Bill 2007 and the subsequent Fee, Credit and Transition Bills as they relate to the nationalisation of regulation of operators such as Cash Converters and its perceived competitors, such as City Finance.
(Postscript: ‘Reg’s’ comment below and my response are worth reading and considering and investors should pay attention to the growth of the company’s loan book and the relationship with its new largest shareholder and try to get answers to the questions I pose about continued growth and the ongoing relationship of loan book growth to retail stores)
Online job lister, Seek Limited (SEK)
Seek is a great business. Like all of the world’s most successful internet stories, it’s a plain old list. And it has developed that competitive advantage some companies achieve when scale and popularity leads to ‘essentialness’. People search for jobs at seek.com.au because there are lots of jobs, and there are lots of jobs because lots of people look for jobs there. I haven’t worked out if reaching this point is a function of strategy or dumb luck, but by definition someone has to make it to this point and he who gets there generates a lot of money and a high Return on Equity that is protected from imitation.
Seek is no exception, and its Return on Equity is expected to exceed 30% over the next two and half years. But while ROE is good and its earnings and intrinsic value growth is heading in a smooth north easterly direction, the fact remains that its popularity, as reflected in the current price of $7.90, is well in excess of the value, which is closer to $5.00 and rising to $6.30 in a couple of years. Sorry guys! Of course it was available to buy below $5.00 as recently as August last year, but that is of little use to you now. Patience is required.
Cranes for hire company, Boom Logistics Limited (BOL)
Boom Logistics is a business I remember reviewing when it floated. I was there at the IPO briefing and even then I didn’t like it. And didn’t I look foolish not taking any stock – it shot up from its listing price of 99 cents to almost $4.00 in less than 28 months.
I can sometimes get very frustrated knowing what a business is really worth and since 2005, the value of this business has been declining, along with its Returns on Equity. In 2004 ROE was 30% and today it is expected to approach 4.5%. Because you can do better in a bank account with no risk, you should think very carefully about investing in BOL. It is trading at 33 cents, but its value is less than 10 cents.
Hospital operator, Ramsay Health Care Limited (RHC)
Ramsay Healthcare is a business whose ‘theme’ I like. The population of Australia is ageing – the number of people over 75 will double in the next decade and a half, and while that will bring much sadness, the reality is that hospitals are there to provide the care that an ageing population needs. Despite a great story, hospitals aren’t that easy to run well.
You see, unlike most other businesses, hospitals can’t simply place a price on a service based on its cost and add a mark-up. Instead, they have to deal with insurance pay scales, meaning hospitals will make more money taking care of some patients and not others, and this is often not within their control.
Generally, hospitals make more money when more things happen to patients, such as pathology tests, diagnostic and therapeutic procedures, and operations. Operations are usually reimbursed at a higher rate than a medical patient, and while length of stay counts, its usually the hospital that has more surgical patients is the one that makes more money.
Conversely, a patient who lingers in a hospital is costing them money as their ongoing care may not be justified and they are blocking that bed from receiving another, better paying patient. Ever had a baby in hospital and felt like you were being booted out before your were ready? Anyone?
This is just the tip of the iceberg, but explains why running a hospital is so much more challenging than selling DVD’s to teenagers.
Having said that, Ramsay is doing a good job, as Figure 1 testifies.
Figure 2. RHC’s historical and forecast earnings and dividends per share
Of course, there is a bit of hockey-stick optimism in the forecasts, and you can thank my peers in the analyst community for that. More importantly however, the hospital is generating Returns on Equity of about 14% over the next three years, up from circa 10% in the last few years.
The value of the business is rising, along with the returns. In 2000 Ramsay’s intrinsic value was just 58 cents. In 2012 its forecast intrinsic value is $8.13. – that’s an increase of 25 percent per year! Exceptional, but the price has never allowed investors to buy at a discount to intrinsic value.
In April 2000 RHC shares traded as low as 74 cents, but never below the 2001 valuation of 91 cents. Since then you have had to buy the shares above intrinsic value in order to participate in the growth in intrinsic value. But whereas in 2000 you only needed to wait a year for intrinsic value to catch up, you would be waiting much longer today. With the shares currently priced at $13.50, even a 2 -year wait won’t see the value catch up. It looks a little pricey now.
Keep in mind that I cannot predict share prices. I can tell you what things are really worth and tell you that over time price and value catch up with each other one way or another, but that is all I can tell you. I guess I can also vouch, having managed a couple of hundred million dollars, that if you buy good businesses below intrinsic value, things tend to work out ok.
Mining laboratory operator and cleaning solution seller, Campbell Brothers Limited (CPB)
Second last on the list is Campbell Brothers. Its been generating a decent Return on Equity for a decade, and its intrinsic value has been rising every year in that time. But like Ramsay, CPB’s intrinsic value will still not have reached the current price, even in 2012. I reckon it is worth $20 in 2011, and today its trading at $29.
Finally, one that needs no introduction, ASX Limited (ASX)
I have written about the ASX in my forthcoming book, Value.able. The ASX is worth less than $21 today and intrinsic value should rise to $26 in 2012. But Returns on Equity are not a patch on other companies, averaging 13.5% over the next few years. And despite the monopoly characteristics the company evidently has, it has not been able to charge what it wants for fear of emigration to rivals applying to set up. As a result, there is some correlation to the direction of the stock market, and predicting it is like predicting the price of a commodity – difficult.
Is your hand still up?
I have deliberately left out any discussion about debt, so be sure the companies you are investing in have little or none. There is much more on this in Value.able, including a chapter devoted to when to sell.
I hope you are getting a great deal of use from these valuations and I look forward to your comments and input.
Posted by Roger Montgomery, 19 March 2009
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.
AndyC
:
Oops, a correction, my last post re SXE KPIs were for last year. This year’s ROE is closer to 22% and Debt to equity is up a little to 10%.
AndyC
:
Hi Roger,
I’m surprised that no-one is talking about Southern Cross Electrical. I’ve been ogling their KPIs for what seems like years now – SXE seem to always jump out at me via my basic filters.
ROE > 30% for last 2 years
Profit margins > 20% last 2 years
Debt is zero
Stable earnings and increasing last 2 years
Chairman owns a huge chunk of the shares (too much maybe?)
Their price recently has come down. Do you have any scuttlebutt indicating the business quality of this electrical engineering contractor and what earnings are likely to do?
Thanks in advance :)
Cheers,
Andrew
Roger Montgomery
:
Hi Andy,
On the contrary, I may have mentioned SXE in the past. Sounds like its time to revisit.
David King
:
HI Roger
I wrote and asked about Fleetwood, but I now see you have covered it recently on SkyBusiness. Thanks. It’s presently over $9 and intrinsic value apears to be around $6.
Question: When good businesses like Fleetwood, CSL, Ramsay and so on consistently trade above their intrinsic value, should one ever buy, or only ever in serious downturns?
admin
:
Hi David,
Over the last ten years I have bought FWD twice and sold it once. Once at around $5.50 before it first rallied towards $9.00 then sold it. I bought it again more recently at $3.50 and continue to own it. SO the answer is; you need to be patient and buy good businesses when they are cheap. All investors must extend what they regard as ‘long term’.
John
:
Hello Roger,
Firstly, thankyou very much for sharing your value investing insights.
I was interested in a company called Austin Engineering. Would this company meet your criteria for an A1 business? If so, could please add it to your very long list of valuation requests.
Counting down the days till the publication of your book.
Much appreciated.
admin
:
Hi John,
Put it on the list for a valuation but it more a ‘B’ than an ‘A’ in terms of quality.
Shuo
:
Hi Roger,
I am taught at uni to value businesses using the DCF approach or dividend growth model (the latter of which is definitely flawed). Do you feel that the DCF model is also flawed but because the majority of analysts use this method, everyone thinks it’s the right method and stock prices follow accordingly.
admin
:
Hi Shuo,
There is a lot that is taught at university that is useful and the post grads that stay on to continue teaching and learning are much more lateral in their thinking than they used to be. There is little to fault the basic DCF but you have to look at the present value of what goes in AND comes out of a business to get it right.
Alan
:
Hi Roger,
Any thoughts TPG Telecom (TPM) they came out with some pretty good results recently and the share has had a very good run over the past 12 or so months.
Thanks
Alan
admin
:
Hi Alan,
On the list! if I get multiple requests they’re covered first.
Keith
:
P.S. What do you think is happening with Sigma Pharmaceuticals
admin
:
Hi Kieth,
I suspect issues related to their off-balance-sheet debt. The real net debt position is not circa $80 million. Its more like $650-$700 million. More will be revealed shortly I am sure.
Keith
:
Hi Roger
I love your attitude … if your book is written in the genre of your replies i look forward to a good read to feed my megolamania. If you shorten your comments you could get the book out sooner … and I sincerely hope you will do a book signing in Brisbane so we can meet the great man!
I have been a private trader for a number of years … where else can you get a job where you put your jocks on each morning and go to work. I would skite about my successes (that exceed yours), but I would have to confess to the failures that make me just average. I have a request … despite my hermitage, I would venture outside to seek help from someone who could help me resist the temptation (pleasure prompted) to speculate … perhaps you could include an appendix in your book listing such professionals (besides ‘Gamblers Anonymous’ … i’m not a gambler … really).
Look forward to your book.
Cheers.
admin
:
Hi Keith,
With your love of punctuation, I should have made you the editor! Thanks for the encouragement and I look forward to your feedback.
Neil Shuker
:
I really appreciate your valuations and common sense approach to investing Roger. You say you like the health theme … is PRY now valu-able according to your calculations? Neil
admin
:
Take a look at my latest post Neil. The URL is http://rogermontgomery.com/which-businesses-excel-in-the-business-of-wellbeing/
PRY is expensive, and in my opinion, not a quality business.
Nan
:
As a fan of WB, I believe intrinsic value is cash flow from a business in further and discount back to today’s value.
I can understand tomorrow, when we wake up and something happens and we have to re-value a business with new intrinsic value.
But I can’t understand, you can have two intrinsic values for a business at once. One for this year and another for next year. If your answer to me is “because next year lalala.. might happen, so I have to have another valuation “and that to me is speculating. I think we should always have one valuation (or a range) for a business at time. Where am I missing?
admin
:
Hi Nan,
Its a great question and I was debating it at lunch with an analyst who is a friend and advocate.
Instead of repeating the contents of my book, it is perhaps worth asking you to do a search of Warren Buffett and find the material where he says, “you want to buy a business who’s intrinsic value is rising at a good clip”. Have you noticed that the intrinsic value of Berkshire Hathaway has been rising over the years? If you stood at the door of the year 1969 and looked forward you might have seen Berkshire’s intrinsic value going up. So its not that hard to imagine intrinsic values rising or falling in the future too, just as they have in the past. All things being equal, changes in book value approximate changes in intrinsic value. And you know that book values change. If you can get this part of the puzzle, you have really worked it out.
Nan
:
Just want to say thank you very much for your answer and am looking forwards to reading your book.
admin
:
Hi Nan,
A pleasure. I look forward to hearing your feedback once you have read it.
David
:
Hi Roger,
Two analysts I admire are you and Marcus Padley.
Interestingly Marcus wrote in an article that there is only one Buffett and immitators will never do what he does so why bother.
After all, he has been in the game for quite a few years. Obviously you would disagree. Where do you think Marcus has gone wrong?
admin
:
Hi David,
Very, very funny. High entertainment value. Not a fund manager. His comments towards value investing do appear to be intended to stir controversy but you should be able to differentiate opinions from fact. Its best to use evidence rather than unsubstantiated denunciations and invective.
I have been in this industry for 18 years and I haven’t found anything as reliable as value investing. I founded, ran and then sold a funds management business that outperformed the market over 1, 3 and five years. During the global financial crisis, the market fell 23% and my old firm’s clients earned +11%. I also published a portfolio last year using the value investing techniques I discuss in my book and that portfolio has returned over 43% in a market that went up 24% – and there wasn’t a speculative mining company or resource stock in sight.
I used the same techniques to explain that the Myer float would lose people money at $4.10 (it did) and that Telstra was not attractive at $3.55 (it fell to less than $3.00). When ABC Learning was trading at $8.00, I was quoted in the Financial Review and SMH saying it was worth less than $3.00, and it was a sound understanding of value investing that formed the basis of the remarks.
Other well known US investors have produced even more impressive results. The likes of Bill Ruane, Irving Kahn, Charles Brandes, Mario Gabelli and Bruce Greenwald have all beaten the market with their own brand of value investing while Joel Greenblatt opened Gotham Capital, produced 50% annual returns for ten years to 1995 and then closed his fund, returning the capital.
Value investing works.
But its not my job to convince you of Value Investing’s merits. You either get it or you don’t. If a practical alternative that you can actually follow (without asking the barber whether you need a haircut) is provided, then give it a go and see how you go. I will stick to value investing. It just makes sense.
Chris
:
Sorry that I can’t share your positive sentiment re: Mr Padley; I found his recent book to be pretty depressing. I’m fortunately not a new investor but I could see that some new investors would think “Why bother in shares ? It’s all too difficult and you’ll never win”.
I emailed him (complete with a successfully returned read receipt) with some of these points but didn’t receive a response.
The general theme was “find a stock that has a rocket underneath it and ride it to the top”. Yeah, great. Speculation, anyone ? FMG was one of them, but how many people picked that ? It had negative earnings, no sales and a huge debt load, but went all the way to $100+ before anyone had dug anything out of the ground !
Buffett and Munger have said “If you don’t know what you’re doing, put your money in an index fund and you’re likely to outperform the majority of fund managers”.
Contrast with Marcus from his book (and in his recent Investor Hour, which is a podcast on the ASX website) where he says that you are lucky to get anywhere doing this.
It is no wonder people get confused.
Peter
:
Hi Roger
Thanks for all these great insights…
when you wrote about FGE and Clough’s bid, you said this company is potentially worth a great deal more. In your opinion, how much more do you think and what is your current valuation?
cheers
Damian
:
Thanks for the valuations Roger, I have a few of these on my watchlist (SEK, CCV, CPB), so it’s good to hear your thoughts.
I have been watching in frustration the continual price rise of these online businesses like SEK, REA, WTF. As you mentioned with SEK, I could have bought these much cheaper last year, but I didn’t have the courage to be “greedy when others are fearful”.
You mentioned that you discuss debt in your book. It’s interesting to me how the market punishes some stocks with high debt, but not others. Banks will force some companies to raise capital to reduce their debt, yet allow others like RHC to have debt to equity greater than 100%. The major losses I’ve suffered have all been caused by companies having too much debt, so I am now very wary of high debt levels. Frankly, I’d prefer a company have no debt, I just don’t want to read the term “banking covenants” in an annual report ever again.
For example, I like the consistent ROE of BKL, but the 80% debt to equity concerns me.
Roger, do you discuss in the book which type of companies can handle high debt?
admin
:
Hi Damian,
many businesses can handle high debt when times are good. Its when things go wrong that the debt balloon becomes a concrete block on the feet of a business. What to look for is all covered in the book.
Kim Jordan
:
So, we’re at ‘late March’ and ‘the book’ is desperately needed here, so have I got long to wait? My wallet is ready and open *_*
admin
:
Hi Kim,
I appreciate your very gentle prodding. I won’t release something that is not perfect and its not as though I am doing it for financial gain, so I am not in any great rush. There has been a couple of really obvious themes in the questions I have received here and via email so I have added some additional chapters and added some material elsewhere in the book. The plan is an April release. Thank you for your patience – the hallmark of a great value investor!
Reg
:
Roger.
CCV’s core business is the provision of personal finance.
If you read their latest pres, you could deduce this.
Cheers
Reg
admin
:
Hi Reg,
Thanks for your assessment. I am particularly glad you visited the blog. As the former chairman of a public company I am fortunately very experienced in reading and preparing annual reports and market releases and my access to annual reports and presentations is at an institutional level and pretty good. While a company is more than “their latest pres” and while CCV’s ‘financial services’ produces more than double the profit of ‘Store Operations’, here’s some copy from the last annual report that would have been approved at the board meeting held before its publication:
“The core business of Cash Converters is the ownership and franchising of retail and financial services stores, which operate as retailers of second hand goods and suppliers of financial products…Cash Converters has been able to position its corporate and franchised outlets as alternative retail merchandise and financial service stores…”
and
“The directors see the following as the principal corporate objectives of the group: …To be recognized as a world leader in the retail of second hand goods and the provision of micro-lending products”
Notice how “franchising of retail” and “retailers of second hand goods” comes before “financial services” and “financial products” respectively in the first section, and “retail of second hand goods” comes before “provision of micro lending” in the second excerpt? That’s telling. I have seen the most recent presentation too and the first bullet point under the heading “Services Offered” is “Sale of Second Hand Goods”.
While the company may be trying to reposition and rebrand itself, these comments and particularly their order – perhaps inappropriately – reflect a continued emphasis on the second hand goods business.
I appreciate that profits from Finance Operations are double the profits from Store Operations but currently the stores are the predominant vehicles through which “secured and unsecured loans” are provided. I appreciate your reminder to keep my comments up-to-date.
I am very interested in how the online platform will assist in expanding the provision of “Financial Services” & “Personal Finance Products” beyond the bounds of the retail footprint here and O/S and what the company believes the competitive landscape will look like in three to five years if the company does this – in other words, who it might be up against in this space? For example are operations like City Finance – a company that nearly floated some years ago but was not well received by my peers in funds management – seen as a competitor? Answers to such questions will have a material impact on my assessment of the sustainability of the company’s competitive advantage and high rates of return on equity – which I should say are presently very attractive. Perhaps its moot and EXCorp’s 30% stake will result in a Corporate-Express or Bidvest-style’ outcome in the next few years? But of course that IS speculation.
Most of the time here, I am asked for a valuation of a company, not a complete analysis or SWOT report. Given that I am providing my thoughts at no cost, you can understand why a full analytical reporting is not going to be presented here. Nevertheless the short remarks I do make, I try to make sure they hit their mark. Cash converters runs a chain of predominantly franchised second-hand goods shops within which financial services are provided. I appreciate profits from Financial Services exceed those from Store Operations, that the company has a strategy to consolidate the franchised ops, roll out another distribution model for the financial services and the company is rebranding itself. I do wonder however whether a survey of customers, before they walk into a store, would reveal that they still associate the brand with a chain of pawn shops. In the event that my assessment is incorrect, I would be quite happy to change the title. What do you propose?
Thanks again for making your comments. Oh and one of my colleagues have held a parcel of shares since 5 cents.
JohnC
:
My two cents. I have examined CCV’s reports before and looking at how its model has developed over the years, one thing that struck me was that actual business operation itself has been volatile and generates sometimes unimpressive returns. It is the franchising operations that have brought in the majority of the profits, which to me was not a sustainable growth story over say, a decade ahead. Some people might be happy to hold on to it for shorter periods but I am unable to anticipate when and how the franchising profitability may change from tomorrow onwards.
As for RHC, my stance is that it’s a growth story and has been priced like one for a few years now, until the day the story gets shaky and the price shakier. Kind of like CSL up until just a few weeks ago. For example, we might see regulatory discussions that could result in public health somehow much more attractive and private health much more expensive. Partnerships with other businesses may hit turbulent waters. That is when a solid understanding of RHC’s intrinsic value matters most – do people truly understand how RHC is growing and what such growth depends on?
So in short, let me paraphrase GMO’s Jeremy Grantham: “After 20 years of more or less permanent overpricing, we get five months of underpricing. There is no justice in life.”
admin
:
Hi John,
CCV does make a great deal out of ‘financial services’. It appears however these are the result of the 509 franchised stores’ footprint. The company has 24 company owned stores in the UK and 17 in Australia. The most recent performance presentation does emphasise the franchise model which of course defrays risk and reduces establishment expenses. The presentation however also emphasises a strategy of consolidating the franchised stores (buying them back). If the company can execute this by paying 3-4 times EBIT or less, it should contribute positively to the share price and represent the outcome of a simple arbitrage. The structure of the funding of course will have an impact on risk and returns on equity.
I will make the comment or suggestion; that I think the company’s true competitive advantage is not listed in the table the presentation provided.
For those patient enough and willing to speculate, the strategic stake could help fund the consolidation strategy which could be followed by a Bidvest or Corporate Express outcome – where a strategic owner ‘mops up’ the shares it doesn’t already own.
Finally, I do like Jeremy’s very quotable quip. Thanks for sharing it.
Mariusz
:
Roger,
Firstly thank you very much for sharing all your knowledge and sharing your beliefs in your investing strategies. I always look forward to your presence and comments on “Your Money, Your Call” and “Market Moves” as well as your current blog.
My question to you is about potential. Do you ever view companies that have the potential (i guess tied to some probability of fulfilling this potential) to become a great business. The great attraction to many investors on stock market is speculating on the next BHP or Woodside which at some stage I am sure had only potential.
A good example would be Arrow (AOE) which I think you valued based on its current fundamentals in cents but as we can see now Shell and PetroChina are valuing this business (or is it its potential) much higher.
I would like your opinion on whether there is a room in the portfolio for businesses that would fail your current ways of measuring value?
Again, thank you for all your wonderful work.
admin
:
Hi Mauiusz,
Yes I do believe there is some room in a portfolio for the kind of speculation you describe. However, because speculation is involved and the valuation model I rely on (which has generated terrific returns in its own right and without speculation) cannot attribute a valuation with certainty to the company’s undemonstrated ‘potential’, the exposure to a portfolio should be small. The problem of course is that many investors don’t know when the are investing and when they are speculating and so their ability to appropriately size the exposure in their portfolios is naturally impaired. And don’t forget with regard to Arrow, Buffett’s wonderful comments about the frog kissing princess. Taking those comments further, in reality corporate kisses usually end with a backyard full of toads. Company COE’s can be as influenced by hope and hot-blooded speculation as a retail investor hoping to turn $10,000 into $20,000.
Tim
:
Hi Roger,
Thanks for your insights; its great to learn more about proper investment.
Can I ask, if one develops a skill for analysing and valuing companies, could they use this to profit from ridiculously overpriced shares by ‘shorting’ and still call themselves an investor? I’m not saying I want to do it, but what are the implications of a strategy like this? Does real investment only involve long term growth?
Many thanks,
Tim
admin
:
Hi Tim,
The risks are asymmetric. By that I mean that if you buy and get it wrong the shares go to zero and you only lose what you put in (provided you didn’t borrow). if you short however the shares can go to infinity so you can lose a great deal more. In reality of course, I have never seen a share go to infinity. I think there is merit in your approach but as you will see from a blog post that will go up today or tomorrow, the best bubbles to short are those where someone has to make a monthly repayments. In other words high prices alone aren’t enough to ensure you will make money from shorting. You want the people pushing up the prices to be gearing into it. Then you have debt-fuelled asset inflation and THAT can be shorted.
Ian
:
Hi Roger,
Do you ever by an A1 business at higher than its intrinsic value?
Taking RHC as an example (not saying that it is an A1 company). It would be a shame not to buy it in 2000 for less than a dollar when today, 10 years later the value is over $8 and the share price over $13.
Surely it is better to buy a great company at, or slightly above, the intrinsic value than a mediocre company below the intrinsic value.
If a great company never falls below the intrinsic value in a 10 year period and you want to buy it then you have to pay over the intrinsic value or buy something else instead.
admin
:
Hi Ian,
Its a valid question and I have a solution for this, which as you might now expect me to say, you will discover in the book! Seriously though, thats the reason for establishing what the likely range of future outcomes will be.