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Another warning Roger?

Companies, Insightful Insights, Investing Education, Value.able | Comments (52)

Another warning Roger?

Last night on Peter’s Switzer TV I shared five stocks moving up the Montgomery Quality Ratings (MQR) – B3 to A3, C4 to B3, A4 to A3, C5 to A2 and A4 to A2.

There are about thirty-seven ratios that contribute to the Montgomery Quality Rating. Like the Value.able method for valuing businesses, the MQR is my own unique system of assessing the quality and performance of businesses. Its objective is to weed out those with a high risk of catastrophe and highlight those with a very low risk.

I also spoke about Zicom, a very thinly traded micro-cap that we began buying for the Fund at $0.32, up to $0.42. Yesterday Zicom closed at $0.52 – my estimate of its Value.able intrinsic value.

If you read my ValueLine column for Alan’s Eureka Report on Wednesday evening you will recognise the following warning:

A WARNING FROM ROGER MONTGOMERY: The subject of today’s column is a thinly traded microcap in which I have bought shares because it meets my criteria. It may not meet yours. It is therefore information that is general in nature and NOT a recommendation or a solicitation to deal in any security. The information is provided for educational purposes only and your personal financial circumstances have not been taken into account. That is why you must also seek and take personal professional advice before dealing in any securities. Buying shares in this company without conducting your own research is irresponsible. Buying shares in this company will drive the price up, which will benefit me more than you. The higher the price you pay the lower your return. If the share price rises well beyond my estimate of intrinsic value, I could sell my shares. A share price that rises beyond my estimate of intrinsic value is one of my triggers for selling. I have no ability to predict share prices and despite a margin of safety being estimated, the share price could halve tomorrow or worse. There are serious and significant risks in investing. Be sure to familiarise yourself with these risks before buying or selling any security. Further, my intrinsic value could change tomorrow, if new information comes to light or I simply change my view about the prospects of a company. This could be another trigger for me to sell. Value investing requires patience. You must seek and take personal professional advice and perform your own research.

I reiterated these same concerns last night with Peter (and early last year I wrote a blog post specifically about the problem).

With those warnings in mind, here are the highlights from Peter’s show.

What stocks are on your ‘Improving MQRs’ watchlist? Thank you in advance for sharing your ideas with our Value.able community.

Posted by Roger Montgomery, author and fund manager, 8 April 2010.

INVEST WITH MONTGOMERY

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

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

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52 Comments

  2. Ron shamgar
    :

    This reminds me of the Rivkin affect, whereby the late Rene rivkin would recommend stocks in his reports while tin some cases owning them.

    The BIG difference here is that Roger is not doing it for that purpose, but it is only the results of having many followers/admirers!

    unintended consequences of being too popular Roger….

  3. Brian
    :

    Hi Roger,
    I don’t know where is best to post this, but I wonder whether you’d mind writing your thoughts on the various quality scoring systems and how applicable to the Australian market. It was a relatively easy thing to program for, since I enter most of the inputs anyway, and so I look at it when I’m weighing up potential investments. But I tend to look at the individual terms in the equation separately (for a start, how worthwhile is a term like: Market Cap / Total Liabilities?) Obviously unsuitable for financial stocks, and clearly favours older companies, and I tend mainly to look how a company’s score changes over time. Do you think it is useful in an Australian context for graduates wanting to develop their own quality rating system?
    Great website, as usual. Great book. Thanks for everything.
    Regards,
    Brian.

    • Roger Montgomery
      :

      Hi Brian,

      Too many issues with the one you mentioned and to avoid having the same questions asked of each of them (there are about twenty – for service/emerging/private etc) I have answered for all. There are superior alternatives to the popular ones because they have so many limitations.. Inapplicability to a range of companies not only financials and insurance – many more. Transfer geographically, different versions for emerging, for services, for private companies) suggests curve fitting. Service versus manufacturing (built for manufacturing) and of course the inclusion of market cap – just because a bunch of people want to pay a lot for something doesn’t make it better, etc etc. As you have probably already found many flaws – you would already know this. A few will look right but the edge cases (where the opportunities are) will be wrong. Hope that helps.

      • Brian
        :

        Too true, I think, Roger. Thanks for your comments. Looks like there’s nothing for it, I’ll just going to have to wait for you to finish penning “Quality.able”. Put me down for 10 copies!
        Cheers,
        Brian.

  4. Brad J
    :

    Hi Guys,

    Jim Rogers predictions have been nothing short of excellent. Interesting his prediction on the AUD going to $1.40. WB has been right all the way as well though and has also been a lot more bullish on the us equities market than JR and so far has been correct. As WB has said you would be crazy to bet against the US so what this means for the AUD/US I don’t know. Having a more competitive currency could and probably will be good for the US.

    If WB is no good at the macro stuff what hope do we have. At the end of the day it is the business that counts and in my opinion what the focus should be on. The macro stuff is important but not knowable, so we need to differentiate between what is important and not knowable and what is important and knowable as WB would say.

    On the warning Roger, I can understand your concerns. I for one look at most of the businesses on this blog and brought ZGL before you went public on it or mentioned it. I try to find businesses that fit the Valuable criteria but also look for catalysts to their share price.Fortunately good business normally surprise the market on the upside and this acts as a catalyst anyway. When you go public this acts as a big catalyst and in my opinion the business reflects its true value faster than would happen under normal circumstances, but it would happen anyway as value and price catch up to one another, so it is no big deal. Hopefully us graduates are also making you aware of companies that may have gone under the radar worth investing in, since you have taught us so well, so we all benefit.

    Thanks again Roger and graduates for all your insights.

      • Jarrod
        :

        Roger. The way it is written in the post of 8th April 2011, suggests that Jim concurs with the $1.40 AUD/US thought! If someone has interpreted that Jim believes this, I would also agree with them, as that is the way it comes accross in the post.

        Anyway, the rest are my thoughts only. And everybody, bear in mind I am a scepical person by nature.

        One thing I have come to believe lately, Is that Roger only releases info to you when it suits him. Zicom has been investment grade for quite a while, and well before Roger started to publish his thoughts. If you are true valuable graduates, you would have found this stock when it was around 21c and have been invested in it well before the current run!

        I have also come to the belief that some of Rogers IV’s are on the very conservative side, allowing him time to increase his holdings before the masses of sheep follow him. Insert, I think ZGL’s IV (and others) are well above his postings.

        I fully support Rogers warnings!

        Start thinking for yourself everyone!

      • Andrew
        :

        I think what you mention in your first paragraph Jarrod is pretty much what Roger is warning about. Even if people read the post you mention and come to the conclusion that Jim agrees with the $1.40, that doesn’t mean that they should then run out and invest based on this information. Instead they need to investigate themselves and seek advice not only on whether the investment is any good but also the risks to them involved in the investment.

        Of course Roger puts a company up on his blog when the time suits him and everyone should realise that by the time Roger puts a company up he has already made his decision (if any) and probably did a long time ago when the prices were a lot cheaper. He has a business to run and his business involves finding high quality stocks at cheap prices and investing in them for his customers and thats how he makes a living so that comes first.

        I think we will all agree that the information he does give us is extremely valuable but we should bear that in mind and never invest because Roger had.

        I disagree with the “if you are a true valueable graduate” line, i know what you mean though, i just don’t like the generalisation that the whole “if you are a true so and so” can have in a discussion forum. One thing i like is that although we all, well most, follow the process and we have all come up with our own little approach to it which helps facilitate great discoveries, innovations, viewpoints and information for discussion.

        The last thing is completley spot on though. Everyone needs to start thinking for themselves. Hopefully this is the last time we need to worry about it (i expect not) but lets remember the aim of this blog is education, this isn’t an investment advice blog.

      • Emily
        :

        I think Roger programs a margin of safety above his IV which makes the IV appear conservative. Others like Ashley will have a higher IV (= to Roger’s IV + Roger’s MOS) but then say “I like to buy at huge discounts to IV, like 50%”. Nothing sinister, just two different ways of saying the same thing – both have the same perception of value of the business and both buy at the same discounts.

      • Ash Little
        :

        Hi Emily,

        I thought you were still in Europe. Hope it is going or went well.

        Very jealous.

  5. Jonesy
    :

    This was good – often when you appear on Peter’s show, you’ll say something like “Company X,Y,Z is an A1 and I have it’s intrinsic value at $5 which is currently a 20% discount on the current price” – no matter what you say, or how many warnings you give, people will rush out and buy X,Y,Z.
    For those 5 companies, you didn’t give any estimates of intrinsic value on this show. This will forces people to go out and do their own research and discover a) whether it currently represents a discount or premium to IV and b) whether it is right for their portfolio. Maybe this is something you should do more often?

    • Jonesy
      :

      Had a look at those non resources stocks.

      Calliden is in insurance, with a combined operating ratio in 2010 of 96%. (Compare this with QBE which I think is one of the best insurers in the country, which has consistently had a combined operating ratio of less than 90% putting it in the same league as Berkshire when it comes to the insurance side of business). Healthy balance sheet, ROE 9.8%. 1cent dividend gives a payout ratio of 23%. Equity per share of 47c. First quarter results will be severely affected by the floods and cyclone in QLD and the forecast for 2011 is “flat” NPAT. Therefore, if profit is maintained at approx $10m, the ROE will decrease to 9% and IV will also decrease compared with it’s current value. Using a RR of 13%, there is a small discount to IV but not enough for me, but will keep it on my watch list.

      G8 Education is in childcare, and I’m sure lots of “mum and dad investors” (sorry – really hate that term!) will be very hesitant after the ABC debarcle. Therefore I was hoping there might have been an opportunity. No luck. Looking like it could be quite profitable with anticipated NPAT of $14m in 2011, but the dividend payout policy is in the range 50-60% of profit. Forecast ROE around 20% but even with RR of 12%, the forecast IV for Dec 2011 is around 88c. It’s also on the watchlist, as I’m interested to see how it plays out and whether the lessons learnt from ABC can be implemented.

      • Ash Little
        :

        Hi Jonesy,

        I had a look at G8 a month or so ago.

        The growth via acquisition strategy reminded me too much of ABC learning.

        Plus equity of 67M and Intangibles of $60M and long term debt of 13M.

        Plus I saw the name Kemp on the board and I know it’s not the same one but enough for me to have déjà vu

        Through to the keeper for me

      • Jonesy
        :

        Through to the keeper – love it! I’ve got it (and several other similar stocks) on my watch list. These are companies that have sparked some interest in me but I haven’t pulled the trigger for whatever reason. I think it’s important to follow them up and see how they pan out – ie learn from your near misses as well as your successes.

      • Ron shamgar
        :

        The only thing going for G8 is the fact that it was founded by the same guys who setup S8 holiday properties and got taken over by MSF before it collapsed during the GFC.

        I don’t see any competitive advantage what so ever.

        If you give me millions of dollars I could do the same thing they are doing…

      • Greg Mc
        :

        But realistically Ron, if someone gave you millions of dollars you’d be better off retiring then playing golf and going fishing than doing what these guys are doing.

  6. Dave P
    :

    Watched “Wall Street: Money Never Sleeps” on DVD the other night. Roger’s reference to “G for gecko” (or was it Gekko) made me smile.

  7. Chris
    :

    Hi everyone,

    I have noticed that Roger has started looking at smaller businesses that typically have low payout ratios and high return on equity. However as he has mentioned many times, these kinds of businesses eventually mature and are unable to sustain their rate of growth. I believe that many us are forgetting his explanation of the implied growth rate, which is the return on equity multiplied by the retained portion of earnings. All else being equal, the implied growth rate equals the earnings growth rate. If a business produces ‘an unrealistic earnings growth rate’, then you probably need to raise the payout ratio or lower the return on equity.

    My question is what determines a ‘realistic’ implied growth rate. I believe that there is no single magic number as each industry has different conditions affecting the sustainability of growth. As a rule of thumb, I usually raise the payout ratio to give an implied growth rate no higher than 20%, or lower if I believe the business cannot grow at this rate. I am by no means an expert on this, just trying to contribute back to the blog and thank Roger for his excellent book.

    • Pat Fitzgerald
      :

      Hi Chris

      ‘Implied growth rate’ is one column in my spreadsheet. For businesses with an unrealistically high implied growth rate I currently adjust the payout ratio to bring the ‘Implied growth rate’ down to what I consider to be the rate the business will grow annually over the next 5 years. I am not sure if this is a good idea but I think Roger has stated that we should make an adjustment to POR or ROE if the Implied growth rate is too high.

  8. Tyler
    :

    (sorry Tyler, Roger Here…I have decided that a post that reads: “I have just bought XYZ corp” and says nothing else is not fit for publication. You can either spend the time explaining the reasons and the calculations and educate the value investors here, or post the original comment on a forum. Sorry to make an example but this is precisely the kind of comment that I suspect others may consider spruiking.

    • Roger Montgomery
      :

      Yes I did and fortunately, we own some too.

      Quote: “ThinkSmart (TSM), Thorn Group (TGA), Flexi-Group (FXL) and Credit Corp (CCP). All have climbed strongly this month – in the case of FXL and CCLP by 30 per cent and 25 per cent, respectively.”

  10. Simon Anthony
    :

    Perhaps its time for the Value.able Graduates to compile their own list of say 20 random companies from ASX 200 and then vote on ranking them MQR. Then getting Roger to compare his MQR with ours ? An interesting experiment test no ?

  11. EdM
    :

    I am getting an IV for ZGL of over 60C per share based on $14 mill full year earnings. (disclosure – I own ZGL)

    Roger I also think you need t relax on the warnings. For those of us who have read your book, understand the methodology you use etc. etc. etc. making a call based on a statement such as ” I (Roger)have bought these shares and they are at an 18% discount to IV” is a pretty sound strategy.

    To me, the fact that you are a buyer is more reassuring than anything. I would far rather buy a company at a smaller discount that you are buying than a company at larger discount that you you are not buying. And quite right I am not expecting you to notify me when you are a seller.
    You also underestimate how much research can be done between Switzer and the market opening the next day!! As a retail investor, accessing management of these companies is simply not possible. Therefore the analsis we can do is really only quantitive.
    Throw in a few google searches etc.

    Buying these companies right is only a start. Closely following all announcements etc. going forward is now part of the deal. However, I for one do really appreciate your offerings on Switzer and in this blog.

    Every time BerkshireH. buys, the market responds. Similarly if you write a book and appear on TV, you can’t expect NOT to have a following. Especially when what you are saying makes sense and at the moment you keep” kicking goals.”

    I am sure you feel the weight of that responsibility – which is even more reason to follow your “tips”. Believe me, I have had plenty of rubbish shovelled my way by brokers, in my more formative years without understanding what I was buying.

    • Roger Montgomery
      :

      Thanks Ed, I did have a picture of a dedicated and studious researcher in my head when I wrote about how little research can be done overnight and I did consider it, but I also concluded such people, while dominating this site, are in the minority. The warning is also not for “those of us who have read your book”. It is for all. Thanks for the very encouraging post.

      • Steve
        :

        I definitely agree with EdM’s comments above. It is reasonable to expect that people who have read Roger’s book and have decided that this is the investment approach they want to follow, would consider (depending on their circumstances) investing in companies mentioned by him (particularly when they are trading at a discount, are top quality and meet Roger’s conservative criteria). This is obviously going to lead to a price rise in many cases, just like the Berkshire effect as Ed mentioned above. I don’t think this is a bad thing – the more people become aware of a company’s quality and prospects, the more likely it is to reach its real IV sooner. Great for holders of the stock.

        If someone decides they want to take a risk and put their money into shares, then that is up to them and it is a risk they have to bear (and I think everyone is well aware of the risks by now!). But in saying this, not all shares mentioned have shot up to RM’s intrinsic value estimate. There are a number of companies that have been spoken about many times that are still below their IV’s. ZGL was already rocketing up for quite some time before RM mentioned it.

        I have a theory that Roger actually has an ‘evil’ master plan when it comes to Value.Able and this blog. I think he has set out to train an army in his value investing principles then let them loose onto this blog to discuss various companies. This enables the discovery of a number of companies that might have otherwise gone unnoticed. In all seriousness though, this is one of the things I love about this blog. This shared information that can at times be quite beneficial (and even lucrative) for all of us. I am happy if it comes from both RM himself and/or other bloggers. Keep up the great work!

  13. James
    :

    Hi everyone,

    I was wondering whether anyone had a souce to a filtering tool to determine investments in US based companies (i.e. similar to Comsec’s advanced filter tools for ASX listed stocks)? I think now is a good time for international diversification given the high $A so would appreciate it if anybody has a source to obtain this info.

    • Pat gavin
      :

      Google is pretty good but doesn’t seem to pick up all companies ,worth a try though.I’m using it at the moment

      • Ash Little
        :

        Hi Guys

        Just be mindfully of what the $A was during the last commodity boom.

        Admittedly it was not free floating but are dollar could go much high.

        To paraphrase Jim Roger we will be surprised on how high it goes and how high it stays

    • Robert
      :

      Hi James,

      Try ADFN. You have to sign up to it (it costs nothing to do so), but it has useful tools. Once signed up, use the stock screener dropdown… add ROE or whatever you like to the US (UK, US, CA) scan. As far as investing overseas, be careful.. if the prediction of $1.40 AUD/USD is anything like correct.. and watching the news today of the US shutting down government would indicate to me that it is a possibility.

      Rob

    • Michael
      :

      Hi James,

      This site will let you analyse US stocks, including on ROE, and just about anything else you can think of:

      [ROGER HERE: I have had to remove the link, I just don’t have time to check them out and I don’t want readers to come to this blog, click a link and find their computers infected or worse..]

      Note however that in next post Jim Rogers is predicting the $A may go to $1.40. If he is right, then buying US stocks may not be a good idea.

      • James
        :

        Hi everyone who has contributed,

        My aim is to build a portfolio in US dollars whereby I would reinvest all profits back into US companies and dividends etc… I would keep it there for a number of years and then when the $A is low again (which it inevitably will be at some point) I will transfer some/all profits back.

        Thanks for the suggestions though. I will check ADFN out and start scanning. As Roger mentioned; the US is 15 times bigger than Australia. So if I can find the next JB Hi-Fi in America, there could be substantial gains made over long periods of time. Peter Lynch has perfected this strategy imo and I highly reccomend his books – this is a strategy I will employ in my seach for US stocks.

      • William Gill
        :

        Hi James
        re US Dollars
        (which it inevitably will be at some point)
        Your statement,how can you be absolutely certain that this is a fact, could you put a time frame on it to within 10% or even 50% of when this inevitable will happen, or are you only speculating. In which case allowing for a higher required return and MOS may be in your best interests. Good Luck

      • Ash Little
        :

        Hi William & James,

        This is just my view and you must do your own work.

        The US debt per taxpayer is currently 125K. They can’t possible pay it back in real terms so the only way to do this is to keep debasing their currency.

        Just my view but we will be suprised by how high the $A goes and how high it stays.(Untill the commodity bubble finishes……………….next week or in 20 years time)

        Personally I would be avoiding US & Euro Investments no matter how big the MOS or how big the competitive advantage

      • william gill
        :

        HI Ash
        My view is similar to yours, I was only pointing out if James is intent on doing it at least have some half hearted safety measures in place.

      • Gavin
        :

        It’s only the net foreign debt position that has an impact on a currencies likelihood of default. Look at the Yen. Domestic debt and fiscal imbalance are domestic transfer issues and really only have an impact on the likelihood of currency default via future growth implications.

        And what about the other side of the balance sheet, the net foreign equity.

        The USA’s International Investment position is approximately negative 20% of GDP.

        Australia is approx negative 60%, even after a near decade of commodity boom.

        It seems to me that the general consensus around the whole area of debt and currencies is off track to such an extent that it is creating major opportunity. Timing is the unknown, for how much longer will the historically high terms of trade conceal our flaws? Or is it different this time!!!!

      • Ash Little
        :

        Hi Gavin,

        Australia has problems no doubt about that and you point to external debt being more significant as governments are more likely to default of foreigners that people who vote which is very true. But Debt is debt

        US external debt to GDP is about 100% and Australia’s is 92%. Both are really high
        .
        Yes I know our debt is way too high

        But government debt per tax payer is US 125K and Australia is about $5K

        Much easier to extract $5K from tax payers over time than $125K

        If you are interested have a look at this site

        http://www.usdebtclock.org/

        LOL gone up $3K per taxpayer since last I looked

      • James
        :

        Hi William

        The $A is at historically high levels currently. This to me seems like a good opportunity for international diversification (not saying the $A won’t go higher though.) Since my timeframe for holding the $US is for a decade/s, the likelihood of the $A falling back to much lower levels (when the mining boom goes bust perhaps – which it inevitably will also at some point too [supply/demand]) I can then transfer back to the $A.

        This way I will make money from the stock market gains and also eventually currency gains.

        Of course there are risks I see the opportunities outweighing this risk.

      • Steve I
        :

        Roger,

        You misunderstood me. I was referring to the view that the Aussie is currently high priced and that some view it as ‘overpriced’ or too high. When I said high Aussie compared to what, it was a rhetorical question.

        If the USD is debased to almost worthless paper, then the Aussie dollar is not high, it is the other side of the equation that is low – specifically that the USD is on its way to zero.

      • Ash Little
        :

        Yep we are stronger against most currencies particularly against the ones that keep printing money.

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