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.
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We are pleased to make the following Announcement. Chris Mackay, Hamish Douglass and I worked patiently to bring this together. I am delighted to see it announced. By way of background, in addition to their roles at Magellan Financial Group, Hamish Douglass is a member of the Foreign Investment Review Board and a member of the Takeovers Panel. Chris Mackay sits on the Financial Sector Advisory Council that is one of the main conduits of industry insights to the Treasurer and is on the board of James Packer’s Consolidated Media. Thank you.
Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 29 February 2012.
We have been delighted with the reports coming out from the smaller industrial companies and note again the growing divergence in the performance of the XJO versus the XNJ (ASX 200 versus All Industrials). We attribute this to a declining enthusiasm for the ‘resource story’ and the fact that many of the industrial companies we like (and own, including MTU) are producing such fantastic results despite evidence of a terrible domestic economic backdrop.
Headline revenue was down 14% as a result of the reduction of unprofitable EDirect business activity. Thats good. Underlying revenue (excluding the zero margin Edirect business) rose 8% and the dividend was up 29%. Business cash flow was $17.5mln compared to reported profit of $16.7mln. The impact on valuations should be positive again but ultimately will be determined by the returns generated on the $21.8mln paid for the two acquisitions made in the current half.
Since 2003 (the year before MTU listed) the company has increased profits by more than 91% per annum and is forecast to grow profits again to $36 mln in 2012. To generate the increase in profits (of $27mln to 2011) $60 million has been raised and $30 million borrowed. The return on incremental equity is about 50% suggesting the acquisitions made thus far have reflected an astute allocation of capital. We’ll be keeping an eye on the debt but reckon a recovery in the local economy (as interest rates are lowered and hopefully passed on by the banks) will give MTU another boost.
According to one of our brokers who has a buy recommendation on the stock, the following stocks are at risk of reducing their dividends: Examining for factors…”forecast earnings revisions, payout ratios, stock price stability and free operating cashflows, the companies that are most at risk of further dividend cuts are SWM, GWA, TTS, HVN, QBE and MYR. Those that have reduced dividends but continue to pose a risk include BBG, CSR, DJS, GFF, HIL, MQG, OST, PPT, PBG, PTM, TAH, and TEN.”
Not a recommendation of course. Seek and take personal professional advice before engaging in ANY securities transactions.
Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 27 February 2012.
Their is something prescient in the name John Deason and Richard Oates gave to their 1869 gold nugget the ‘Welcome Stranger’ and the one Kevin Hillier gave to his 875 troy ounce find ‘The Hand of Faith’. Today’s gold price is indeed very welcome to gold bugs and there is plenty of faith needed that prices will rise even further. But gold bugs have received a terse warning from none other than Warren Buffett who has just released Berkshire’s 2011 letter. For those of you who believe gold (A.K.A. the barbarous relic) is the best investment you won’t find any more support from Warren this year than any other (with the exception of his 1999 dalliance into silver) . You can find his complete letter here: Berkshire 2011 Annual Report.
Here’s the section on gold:
“The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else – who also knows that the assets will be forever unproductive – will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century.
This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it even more avidly in the future.
The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.
What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis.
As “bandwagon” investors join any party, they create their own truth – for a while. Over the past 15 years, both Internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well-publicized rising prices. In these bubbles, an army of originally skeptical investors succumbed to the “proof” delivered by the market, and the pool of buyers – for a time – expanded sufficiently to keep the bandwagon rolling. But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again: “What the wise man does in the beginning, the fool does in the end.”
Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A. Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge).
Can you imagine an investor with $9.6 trillion selecting pile A over pile B? Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers – whether jewelry and industrial users, frightened individuals, or speculators – must continually absorb this additional supply to merely maintain an equilibrium at present prices.
A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.
Admittedly, when people a century from now are fearful, it’s likely many will still rush to gold. I’m confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.”
Before simply believing Warren WILL be right…There’s this in the annual report as well: “Last year, I told you that “a housing recovery will probably begin within a year or so.” I was dead wrong”
A much older quote that summarizes Buffett’s long-held view is this one “It gets dug out in Africa or some place. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”
In my earlier post on this subject HERE, I note; “But I trust you can see the irony in claiming gold is ‘useless’ and yet it can buy [all the agricultural land in the United States, sixteen companies as valuable as Exxon and a trillion dollars in walking-around money].
For those of you who are interested in two alternative perspectives, (assuming the debasing of fiat money across the globe is not enough to encourage you), I thought you might find some of what you need in the following points, and also Warren Buffett’s father’s views. (Note: we only own three or four gold stocks all of which have rising production profiles and do not require ever increasing gold prices to support the returns on equity that justify much higher valuations. So we aren’t quite in the ‘carried-away’ camp even though some have doubled in price. This latter development delights us in this market).
And now a short commercial break…
Here are two Skaffold screenshots, each gold stocks we currently own. If you are a member of Skaffold, you should be able to pick them right away. If you aren’t a member, what are you waiting for? Head over to www.skaffold.com and become a member today.
And now back to our regular programming…
From gold’s mouth itself;
Let’s start with the basics of my enduring characteristics. I have some characteristics that no other matter on Earth has…
I cannot be:
Printed (ask a miner how long it takes to find me and dig me up)
Counterfeited (you can try, but a scale will catch it every time)
Inflated (I can’t be reproduced)
I cannot be destroyed by;
Fire (it takes heat at least 1945.4° F. to melt me)
Water (I don’t rust or tarnish)
Time (my coins remain recognizable after a thousand years)
I don’t need:
Feeding (like cattle)
Fertilizer (like corn)
Maintenance (like printing presses)
I have no:
Time limit (most metal is still in existence)
Counterparty risk (remember MF Global?)
Shelf life (I never expire)
As a metal, I am uniquely:
Malleable (I spread without cracking)
Ductile (I stretch without breaking)
Beautiful (just ask an Indian bride)
As money, I am:
Liquid (easily convertible to cash)
Portable (you can conveniently hold $50,000 in one hand)
Divisible (you can use me in tiny fractions)
Consistent (I am the same in any quantity, at any place)
Private (no one has to know you own me)
From an entirely different perspective on gold it may be worth reading the Hon. Howard Buffett. Congressman Buffett argues that without a redeemable currency, an individual’s freedoms both financial and more broadly is dependent on politicians. He goes on to observe that fiat (paper) money systems tend to collapse eventually, producing economic chaos. His argument that the US should return to the gold standard was not adopted.
Human Freedom Rests of Gold Redeemable Money
Posted Thursday, May 6, 1948
By HON. HOWARD BUFFETT
U. S. Congressman from Nebraska
Reprinted from The Commercial and Financial Chronicle 5/6/48
Is there a connection between Human Freedom and A Gold Redeemable Money? At first glance it would seem that money belongs to the world of economics and human freedom to the political sphere.
But when you recall that one of the first moves by Lenin, Mussolini and Hitler was to outlaw individual ownership of gold, you begin to sense that there may be some connection between money, redeemable in gold, and the rare prize known as human liberty.
Also, when you find that Lenin declared and demonstrated that a sure way to overturn the existing social order and bring about communism was by printing press paper money, then again you are impressed with the possibility of a relationship between a gold-backed money and human freedom.
In that case then certainly you and I as Americans should know the connection. We must find it even if money is a difficult and tricky subject. I suppose that if most people were asked for their views on money the almost universal answer would be that they didn’t have enough of it.
In a free country the monetary unit rests upon a fixed foundation of gold or gold and silver independent of the ruling politicians. Our dollar was that kind of money before 1933. Under that system paper currency is redeemable for a certain weight of gold, at the free option and choice of the holder of paper money.
Redemption Right Insures Stability
That redemption right gives money a large degree of stability. The owner of such gold redeemable currency has economic independence. He can move around either within or without his country because his money holdings have accepted value anywhere.
For example, I hold here what is called a $20 gold piece. Before 1933, if you possessed paper money you could exchange it at your option for gold coin. This gold coin had a recognizable and definite value all over the world. It does so today. In most countries of the world this gold piece, if you have enough of them, will give you much independence. But today the ownership of such gold pieces as money in this country, Russia, and all divers other places is outlawed.
The subject of a Hitler or a Stalin is a serf by the mere fact that his money can be called in and depreciated at the whim of his rulers. That actually happened in Russia a few months ago, when the Russian people, holding cash, had to turn it in — 10 old rubles and receive back one new ruble.
I hold here a small packet of this second kind of money – printing press paper money — technically known as fiat money because its value is arbitrarily fixed by rulers or statute. The amount of this money in numerals is very large. This little packet amounts to CNC $680,000. It cost me $5 at regular exchange rates. I understand I got clipped on the deal. I could have gotten $2½ million if I had purchased in the black market. But you can readily see that this Chinese money, which is a fine grade of paper money, gives the individual who owns it no independence, because it has no redemptive value.
Under such conditions the individual citizen is deprived of freedom of movement. He is prevented from laying away purchasing power for the future. He becomes dependent upon the goodwill of the politicians for his daily bread. Unless he lives on land that will sustain him, freedom for him does not exist.
You have heard a lot of oratory on inflation from politicians in both parties. Actually that oratory and the inflation maneuvering around here are mostly sly efforts designed to lay the blame on the other party’s doorstep. All our politicians regularly announce their intention to stop inflation. I believe I can show that until they move to restore your right to own gold that talk is hogwash.
Paper Systems End in Collapse
But first let me clear away a bit of underbrush. I will not take time to review the history of paper money experiments. So far as I can discover, paper money systems have always wound up with collapse and economic chaos.
Here somebody might like to interrupt and ask if we are not now on the gold standard. That is true, internationally, but not domestically. Even though there is a lot of gold buried down at Fort Knox, that gold is not subject to demand by American citizens. It could all be shipped out of this country without the people having any chance to prevent it. That is not probable in the near future, for a small trickle of gold is still coming in. But it can happen in the future. This gold is temporarily and theoretically partial security for our paper currency. But in reality it is not.
Also, currently, we are enjoying a large surplus in tax revenues, but this happy condition is only a phenomenon of postwar inflation and our global WPA. It cannot be relied upon as an accurate gauge of our financial condition. So we should disregard the current flush treasury in considering this problem.
From 1930-1946 your government went into the red every year and the debt steadily mounted. Various plans have been proposed to reverse this spiral of debt. One is that a fixed amount of tax revenue each year would go for debt reduction. Another is that Congress be prohibited by statute from appropriating more than anticipated revenues in peacetime. Still another is that 10% of the taxes be set aside each year for debt reduction.
All of these proposals look good. But they are unrealistic under our paper money system. They will not stand against postwar spending pressures. The accuracy of this conclusion has already been demonstrated.
The Budget and Paper Money
Under the streamlining Act passed by Congress in 1946, the Senate and the House were required to fix a maximum budget each year. In 1947 the Senate and the House could not reach an agreement on this maximum budget so that the law was ignored.
On March 4 this year the House and Senate agreed on a budget of $37½ billion. Appropriations already passed or on the docket will most certainly take expenditures past the $40 billion mark. The statute providing for a maximum budget has fallen by the wayside even in the first two years it has been operating and in a period of prosperity.
There is only one way that these spending pressures can be halted, and that is to restore the final decision on public spending to the producers of the nation. The producers of wealth — taxpayers — must regain their right to obtain gold in exchange for the fruits of their labor. This restoration would give the people the final say-so on governmental spending, and would enable wealth producers to control the issuance of paper money and bonds.
I do not ask you to accept this contention outright. But if you look at the political facts of life, I think you will agree that this action is the only genuine cure. There is a parallel between business and politics which quickly illustrates the weakness in political control of money.
Each of you is in business to make profits. If your firm does not make profits, it goes out of business. If I were to bring a product to you and say, this item is splendid for your customers, but you would have to sell it without profit, or even at a loss that would put you out of business. — well, I would get thrown out of your office, perhaps politely, but certainly quickly. Your business must have profits.
In politics votes have a similar vital importance to an elected official. That situation is not ideal, but it exists, probably because generally no one gives up power willingly.
Perhaps you are right now saying to yourself: “That’s just what I have always thought. The politicians are thinking of votes when they ought to think about the future of the country. What we need is a Congress with some ‘guts.’ If we elected a Congress with intestinal fortitude, it would stop the spending all right!”
I went to Washington with exactly that hope and belief. But I have had to discard it as unrealistic. Why? Because an economy Congressman under our printingpress money system is in the position of a fireman running into a burning building with a hose that is not connected with the water plug. His courage may be commendable, but he is not hooked up right at the other end of the line. So it is now with a Congressman working for economy. There is no sustained hookup with the taxpayers to give him strength.
When the people’s right to restrain public spending by demanding gold coin was taken from them, the automatic flow of strength from the grass-roots to enforce economy in Washington was disconnected. I’ll come back to this later.
In January you heard the President’s message to Congress or at least you heard about it. It made Harry Hopkins, in memory, look like Old Scrooge himself.
Truman’s State of the Union message was “pie-in-the-sky” for everybody except business. These promises were to be expected under our paper currency system. Why? Because his continuance in office depends upon pleasing a majority of the pressure groups.
Before you judge him too harshly for that performance, let us speculate on his thinking. Certainly he can persuade himself that the Republicans would do the same thing if they were In power. Already he has characterized our talk of economy as “just conversation.” To date we have been proving him right. Neither the President nor the Republican Congress is under real compulsion to cut Federal spending. And so neither one does so, and the people are largely helpless.
But it was not always this way.
Before 1933 the people themselves had an effective way to demand economy. Before 1933, whenever the people became disturbed over Federal spending, they could go to the banks, redeem their paper currency in gold, and wait for common sense to return to Washington.
Raids on Treasury
That happened on various occasions and conditions sometimes became strained, but nothing occurred like the ultimate consequences of paper money inflation.
Today Congress is constantly besieged by minority groups seeking benefits from the public treasury. Often these groups. control enough votes in many Congressional districts to change the outcome of elections. And so Congressmen find it difficult to persuade themselves not to give in to pressure groups. With no bad immediate consequence it becomes expedient to accede to a spending demand. The Treasury is seemingly inexhaustible. Besides the unorganized taxpayers back home may not notice this particular expenditure — and so it goes.
Let’s take a quick look at just the payroll pressure elements. On June 30, 1932, there were 2,196,151 people receiving regular monthly checks from the Federal Treasury. On June 30, 1947, this number had risen to the fantastic total of 14,416,393 persons.
This 14½ million figure does not include about 2 million receiving either unemployment benefits of soil conservation checks. However, it includes about 2 million GI’s getting schooling or on-the-job-training. Excluding them, the total is about 12½ million or 500% more than in 1932. If each beneficiary accounted for four votes (and only half exhibited this payroll allegiance response) this group would account for 25 million votes, almost by itself enough votes to win any national election.
Besides these direct payroll voters, there are a large number of State, county and local employees whose compensation in part comes from Federal subsidies and grants-in-aid.
Then there are many other kinds of pressure groups. There are businesses that are being enriched by national defense spending and foreign handouts. These firms, because of the money they can spend on propaganda, may be the most dangerous of all.
If the Marshall Plan meant $100 million worth of profitable business for your firm, wouldn’t you Invest a few thousands or so to successfully propagandize for the Marshall Plan? And if you were a foreign government, getting billions, perhaps you could persuade your prospective suppliers here to lend a hand in putting that deal through Congress.
Taxpayer the Forgotten Man
Far away from Congress is the real forgotten man, the taxpayer who foots the bill. He is in a different spot from the tax-eater or the business that makes millions from spending schemes. He cannot afford to spend his time trying to oppose Federal expenditures. He has to earn his own living and carry the burden of taxes as well.
But for most beneficiaries a Federal paycheck soon becomes vital in his life. He usually will spend his full energies if necessary to hang onto this income.
The taxpayer is completely outmatched in such an unequal contest. Always heretofore he possessed an equalizer. If government finances weren’t run according to his idea of soundness he had an individual right to protect himself by obtaining gold.
With a restoration of the gold standard, Congress would have to again resist handouts. That would work this way. If Congress seemed receptive to reckless spending schemes, depositors’ demands over the country for gold would soon become serious. That alarm in turn would quickly be reflected in the halls of Congress. The legislators would learn from the banks back home and from the Treasury officials that confidence in the Treasury was endangered.
Congress would be forced to confront spending demands with firmness. The gold standard acted as a silent watchdog to prevent unlimited public spending.
I have only briefly outlined the inability of Congress to resist spending pressures during periods of prosperity. What Congress would do when a depression comes is a question I leave to your imagination. I have not time to portray the end of the road of all paper money experiments.
It is worse than just the high prices that you have heard about. Monetary chaos was followed in Germany by a Hitler; in Russia by all-out Bolshevism; and in other nations by more or less tyranny. It can take a nation to communism without external influences. Suppose the frugal savings of the humble people of America continue to deteriorate in the next 10 years as they have in the past 10 years? Some day the people will almost certainly flock to “a man on horseback” who says he will stop inflation by price-fixing, wage-fixing, and rationing. When currency loses its exchange value the processes of production and distribution are demoralized.
For example, we still have rent-fixing and rental housing remains a desperate situation.
For a long time shrewd people have been quietly hoarding tangibles in one way or another. Eventually, this individual movement into tangibles will become a general stampede unless corrective action comes soon.
Is Time Propitious
Most opponents of free coinage of gold admit that that restoration is essential, but claim the time is not propitious. Some argue that there would be a scramble for gold and our enormous gold reserves would soon be exhausted.
Actually this argument simply points up the case. If there is so little confidence in our currency that restoration of gold coin would cause our gold stocks to disappear, then we must act promptly.
The danger was recently highlighted by Mr. Allan Sproul, President of the Federal Reserve Bank of New York, who said:
“Without our support (the Federal Reserve System), under present conditions, almost any sale of government bonds, undertaken for whatever purpose, laudable or otherwise, would be likely to find an almost bottomless market on the first day support was withdrawn.”
Our finances will never be brought into order until Congress is compelled to do so. Making our money redeemable in gold will create this compulsion.
The paper money disease has been a pleasant habit thus far and will not he dropped voluntarily any more than a dope user will without a struggle give up narcotics. But in each case the end of the road is not a desirable prospect.
I can find no evidence to support a hope that our fiat paper money venture will fare better ultimately than such experiments in other lands. Because of our economic strength the paper money disease here may take many years to run its course.
But we can be approaching the critical stage. When that day arrives, our political rulers will probably find that foreign war and ruthless regimentation is the cunning alternative to domestic strife. That was the way out for the paper-money economy of Hitler and others.
In these remarks I have only touched the high points of this problem. I hope that I have given you enough information to challenge you to make a serious study of it.
I warn you that politicians of both parties will oppose the restoration of gold, although they may outwardly seemingly favor it. Also those elements here and abroad who are getting rich from the continued American inflation will oppose a return to sound money. You must be prepared to meet their opposition intelligently and vigorously. They have had 15 years of unbroken victory.
But, unless you are willing to surrender your children and your country to galloping inflation, war and slavery, then this cause demands your support. For if human liberty is to survive in America, we must win the battle to restore honest money.
There is no more important challenge facing us than this issue — the restoration of your freedom to secure gold in exchange for the fruits of your labors.
I am internationally accepted, last for thousands of years, and probably most important, you can’t make any more of me.”
Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 26 February 2012.
We all know retail businesses are swimming against the tide. We have written about that subject here at the blog on many occasions and below is a brief list of more recent posts:
We are not investors in momentum or sentiment however this blog allows me to share our thoughts with you and we are noticing a shift in investor sentiment now. The stock market indices with exposure to resources are underperforming the indices without. The industrial indices are rising at a faster rate and falling at a slower rate than their resource-rich bretheren. Today is a classic example, This tells us that a shift is afoot. If you have been reading this blog regularly, you will know that we are also not enthusiastic about Iron Ore prices and believe prices of $100 per tonne or less are possible in coming years. On air, I have explained that is our reason for not purchasing BHP despite optimistic earnings forecasts by analysts.
I think the lower-iron-ore price story is catching on and quietly but surely investors are reducing their relative weighting to resource heavyweights.
With that in mind, it could be that most down-in-the-dumps retail sector that now holds a few gems. Next week we’ll explore the results of the reporting season but for today I thought we should revisit The Reject SHop following its half year results.
Here’s the list of recent posts covering retail stocks and the retail sector.
http://rogermontgomery.com/invest-in-kfc-or-just-eat-it/
http://rogermontgomery.com/is-it-just-harvey-norman-or-bricks-mortar-retailing-generally/
http://rogermontgomery.com/are-bargains-available-at-woolworths/
http://rogermontgomery.com/now-waving-drowning/
http://rogermontgomery.com/not-so-high-at-jb-hi-fi/
http://rogermontgomery.com/dumped-by-the-wave-of-fashion/
Way back in September 2009, I published my reason for selling The Reject Shop:
“I can’t stop thinking that the value of the business just cannot rise at a fast enough clip to justify the current price. I really don’t like trading things that I have bought but I don’t think the value of the business can continue to rise indefinitely. With a share price of $13.45 (intraday today) and a valuation of $11.27, the shares are 24% above their intrinsic value. This combination of factors tells me we are safer in cash.”
Like many value investors, I was a little premature and the price first rallied to more than $17.00. Since then the price has steadily declined to $11.80 after hitting a low of $9.12.
More recently – in December – I wrote:
“The Reject Shop still enjoys its high brand awareness but, as is typical in many store roll out stories, as the offer matures the later sites are less profitable than the early sites.
This doesn’t fully explain the fact that during a period in the economy where one would expect a bargain offering to shine, it hasn’t. Eighty percent of Australians still know the brand but I believe consumer experience and mismanagement has done it some damage.
According to one report, 20% of the population believe the company offers rubbish – cheap Chinese junk that quickly breaks after use and fills our tips. It’s the very reputation China itself is trying, but frequently failing, to shake off.
The other reason for damage to the brand is confusion brought on by mismanagement. Several years ago the average unit price was about $9 and basket size was $11, but over the years one cannot help but have noticed many higher-priced items creeping into the stores.”
Value investors are often early to buy and early to sell but over the long run, being certain of a good return is safer than being hopeful of an exceptional one and so, when it comes to buying decisions a demonstrated record is often essential.
In TRS’s FY12 earnings guidance, the company noted “Significant expenditure on increasing brand awareness”. This is a real shame because at the time the company float The Reject Shop enjoyed 90% brand recognition and thats why its store roll out was working so well – shoppers knew the company, the store and the offer even though they had never been into a store in their area.
The company has provided earnings guidance for the full year 2012 of $20.5 to $22 million and while some smart analysts will note this is a 53 week year – we don’t care about such arbitrary lines in the sand. Our approach to investing is involves treating any purchase and ownership as if we owned the whole company. In that light and over the long term it doesn’t matter whether there are 52 weeks in a year or 52.5 or 53.
Thirteen analysts cover the stock and this week, eight have upgraded (only one downgraded) their forecasts for 2012 (remember the downgrade could be an error on the part of teh analyst rather than the company disappointing) . I still believe the business will mature but there could be some value in the turnaround and a stabilisation of strong cash flows, and returns on equity over the next few years around 35%. This is the rate of return on equity the company generated on $21 million of equity in 2005 (its intrinsic value then was around $4.00). Today the company is expected to return to 35% returns on equity but on 3 times the equity. You should be able to estimate the intrinsic value from those metrics.
There have been terrific results amongst our fund holdings such as Credit Corp, Seek, Breville Group, ARB, Decmil and Maca. Have you been encouraged by any of the results? Start a discussion by clicking on the Comments button below.
Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 24 February 2012.
In his ASX Investor Hour presentation of 21 February 2012, Roger argues that whether you invest on the basis of fundamentals or technical analysis, your buying and selling decisions should always be made in the light of your valuation of the company. Roger explains the factors he takes into account in assessing the value of companies, the systems he uses to do those valuations and talks about some of the companies that he currently regards as good value. Watch video here and view the slides here.
Roger Montgomery shows investors how he uses Skaffold to find great value stocks at the ASX Investor Hour Sydney. Watch the video.
Roger Montgomery shows investors how he uses Skaffold to find great value stocks at the ASX Investor Hour Sydney. Watch the video.
Investor Point: Andrew observes that companies in fast changing industries are prone to misguided adventures with shareholders funds after they mature (which they do very quickly in a country with a population of a mere 23 million).
(if you’d like to contribute a post send it to roger@rogermontgomery.com with the word CONTRIBUTION in the subject line)
The internet list companies have long been considered favourites of some of the community here (including myself). Their ability to generate lots of free cash and earnings against very little equity makes them prime considerations as a company some would like to own, especially as some have great competitive moats around them. However, is there an inherent risk that needs to be considered and compensated for when choosing to value and/or invest in these companies? This is a question I have been considering as of late and would like some help to answer.
Valuing companies is a forward looking exercise and so we must make certain decisions and adjustments based on how we think this company will grow over the years.
A company must be able to earn attractive rates of return on the incremental capital it puts to work. As a company moves further along on its life cycle this gets harder to do. When a company reaches maturity, earning these attractive returns becomes even more difficult and organic growth opportunities dry up. A company must then look for other avenues of growth and/or use its capital wisely to increase shareholder value whether it’s through increased dividends or share buy backs.
Usually a company can grow organically by opening up new stores for example, however you cannot do this on the internet. This lack of organic growth opportunities causes the growth stage of the business to be shorter and therefore the maturity stage to come around in a quicker timeframe than a tangible business. The lack of costs needed to operate this kind of business also means that when these companies reach maturity, there is very little scope to increase profits by becoming leaner.
This only leaves the option of new product offerings, purchased growth (M&A) and/or offshore expansion as the remaining avenues for growth. All of these options have risk to both the company and investor and could see real damage done to the return on equity of the business if not done well (for example paying too much for another company).
The growth versus profitability conundrum is one that has seen many companies go down a route, which leaves the investor worse off.
It is my opinion that acquisitions cannot be seen as abnormal or opportunistic exercises for these internet businesses. They are, instead, an inevitable result of the companies journey through the life cycle and therefore needs to be considered when making investment and valuation decisions. As an investor cannot know exactly when and where this acquisition will be made nor how much it will cost until it happens it therefore clouds the waters of valuation.
As has been said many times, it is better to be conservative and wrong than optimistic than wrong and one could easily use more conservative inputs to compensate for this unknown. Another option to consider is that there is a higher implied risk for this investment and there for an investor should ask for a higher required return (higher risk premium) or seek much larger margins of safety.
The investor cannot with the same certainty be able to invest in these companies over a long-term time horizon as some other businesses as the expected life cycle of such a business is shorter and involve constant corporate activity, which will require a meaningful amount of analysis. So far the main companies (REA, SEK, WEB, CRZ, WTF) have been negotiating the path reasonably well and hopefully that continues. However, some have been especially active in purchasing growth and/or going offshore. If this continues it is my opinion that the risk becomes higher as the risk of management error (paying too much etc) becomes greater.
Posted by Andrew
Postscript: Paying too much for the companies themselves is also possible (see valuation/price chart below for WEB)!
Posted by Andrew L with permission of Roger Montgomery, Value.able and Skaffoldauthor and Fund Manager, 21 February 2012.
Bloomberg:
“Walter Schloss, the money manager who earned accolades from Warren Buffett for the steady returns he achieved by applying lessons learned directly from the father of value investing, Benjamin Graham, has died. He was 95.
He died yesterday at his home in Manhattan, according to his son, Edwin. The cause was leukemia.
From 1955 to 2002, by Schloss’s estimate, his investments returned 16 percent annually on average after fees, compared with 10 percent for the Standard & Poor’s 500 Index. (SPX) His firm, Walter J. Schloss Associates, became a partnership, Walter & Edwin Schloss Associates, when his son joined him in 1973.
“He was a true fundamentalist,” Edwin Schloss, now retired, said today in an interview. “He did his fundamental analysis and was very concerned that he was buying something at a discount. Margin of safety was always essential.”
Buffett, another Graham disciple, called Schloss a “superinvestor” in a 1984 speech at Columbia Business School. He again saluted Schloss as “one of the good guys of Wall Street” in his 2006 letter to shareholders of his Berkshire Hathaway Inc.
“Following a strategy that involved no real risk — defined as permanent loss of capital — Walter produced results over his 47 partnership years that dramatically surpassed those of the S&P 500,” wrote Buffett (BRK/A), whose stewardship of Berkshire Hathaway (BRK) has made him one of the world’s richest men and most emulated investors. “It’s particularly noteworthy that he built this record by investing in about 1,000 securities, mostly of a lackluster type. A few big winners did not account for his success.”
Biography: While Walter Schloss’s name is not nearly as ubiquitous as Warren Buffett, Schloss was arguably one of the best investors ever. Like Buffett, Schloss was a student of Ben Graham, worked at Graham’s firm with Buffett , and is one of ” Super Investors” mentioned by Buffett in his famous essay The Super Investors of Graham-And-Doddsville.
Here’s a table of Schloss’s returns to 1984.
Walter Schloss was born in 1916. At 18 years old he worked as a Wall Street runner for on Wall Street. While he didn’t attend college he enrolled in several classes given by legendary investor Benjamin Graham. Schloss eventually went to work for the Graham-Newton Partnership. In 1955 Schloss launched his own value fund. He ran the fund until 2000.
Schloss was reportedly very frugal. In one year, legend has it that his total office expense was $11,000 while his partnership generated a net profit of $19,000,000.
Schloss stopped actively managing other people’s money in 2003 and was a treasurer for the Freedom House a non-profit group devoted to furthering democracy, and human rights.
Over the 45 years Schloss managed his fund he trounced the S&P 500 by producing returns of 15.3% versus 10% for the S&P 500. A $10,000 initial investment in Schloss’s fund would have grown to $12,344,268, compared to an initial investment of $10,000 in the S&P 500 which would have produced $1,173,909.
Farewell and Thank You.
Posted by Roger Montgomery, Value.able and Skaffoldauthor and Fund Manager, 21 February 2012.
Click on the image at left to see a close up of the stocks we like.
I reckon 2012 will be the year to get set and fill your portfolio with high quality businesses, demonstrating bright prospects for intrinsic value growth and a margin of safety. That will be the topic of my talk today as I kick off the ASX’s 2012 Investor Hour series. Here are the details:
Topic: Buying opportunity
When: Tuesday 21 February
Where: Wesley Conference Centre, 220 Pitt Street, Sydney (venue location)
Time: 12 noon – 1pm. Please arrive by 12.00 noon for start
Details:
The time to get interested in share investing and make good returns is precisely when everyone else isn’t. But know that the key to slowly and successfully building wealth in the sharemarket is to avoid losing money permanently.
At this event Roger will set out his principles for stock selection.
Roger Montgomery is a highly-regarded value investor, analyst and author and a regular contributor and commentator across the media. Roger is an analyst at Montgomery Investment Management Pty Ltd.
Presenter(s): Roger Montgomery, www.Skaffold.com, www.Montinvest.com
Posted by Roger Montgomery, Value.able and Skaffoldauthor and Fund Manager, 21 February 2012.
