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  • After some extra help with your holiday homework?

    Roger Montgomery
    January 6, 2011

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

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

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

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

    Posted by Roger Montgomery, 6 January 2011.

    by Roger Montgomery Posted in Companies, Investing Education, Value.able.
  • Have you done your homework?

    Roger Montgomery
    December 22, 2010

    As my last official day at the office draws near, I am delighted with the results we have achieved from combining my approach to quality (The Montgomery Quality Ratings “MQRs”) with Value.able‘s method of calculating intrinsic value. There will always be conjecture and disagreement with these, but that doesn’t matter to me and it shouldn’t bother you either. The market is wide enough and deep enough to cater for us all.

    I am very proud of how far you – the Value.able Graduate Class of 2010 – have come and encourage you to continue questioning and challenging the things you read and learn. It was Elbert Hubbard who said “The recipe for perpetual ignorance is: Be satisfied with your opinion and content with your knowledge.”

    Some of the most memorable results of 2010 for me where the gains in Matrix, Decmil and Forge, as well as the gains in Acrux, Thorn, Fleetwood, MMS, Data#3, and Oroton. I was also delighted to have left QR National alone – missing out on an 11.8% return, but selecting MACA instead, which has produced a 70 per cent return.

    Elsewhere, fund managers have reported good results. But as one Graduate noted via email, when some portfolios, filled with debt-laden, low ROE businesses, rise, it is generally a function of a rising tide rather than sound investing principles. Of course when investing the Value.able way, it matters not what anyone else is doing. All that matters is that your analysis is right and that you are consistent.

    There have been plenty of questions about the Value.able valuation formula this year and perhaps even a little obsession over the source of, reason for and disagreement with the formula/tables. If that resonates with you, I urge you to re-read pages 193 and 194 and consider the following parallel; In the sport of mountain biking, some riders obsess with the weight of their bicycles. Many shop around for a ceramic or titanium rear derailleur pulley so that they might save as few as 5 grams! Paying thousands for their obsession, they fail to realise that the weight of their fettucini carbonara the night before, the water bottle they carry with them and the mud that sticks to their tyres is far greater than the savings they make and that strength, fitness, endurance and momentum are all far more important.  Don’t become too obsessed by the math when its the competitive advantage that is more important and, in any case, value slaps you in the face when it is obvious.

    There are very good reasons why my valuations have differed from those you have produced, and I explain a major source of the difference on pages 193 and 194.

    Far more important is that you are now carrying out your own analysis and focusing your attention on high quality companies, sustainable competitive advantages and intrinsic value. I believe you will continue to do well – as so many of you have shared with our community  – if you stick to the disciplines outlined in Value.able. And if you haven’t purchased your copy yet, do it now!

    Before I leave for the annual Montgomery family holiday, I promised to give you some homework. There are three tasks with a total of two challenges. You can choose those you’d like to complete. You are under no pressure to complete them all. It is the holidays after all!

    Challenge 1, Task 1

    The first task is to print out the Notes to the Financial Statements: Contributed Equity for the number of shares on issue, Balance Sheet, Profit and Loss statement and Statement of Changes in Equity for The Reject Shop for 2010. Links to the statements are below:

    Notes to the Financial Reports: Contributed Equity for the Number of Shares on Issue – click here

    Balance Sheet – click here

    Profit and Loss – click here

    Statement of Change in Equity (Dividends) – click here

    Using the numbers circled on each of the statements and a Required Return of 11%, try your hand at calculating The Reject Shop’s 2010 Value.able Intrinsic Value. Follow Steps A through D on page 195 of Value.able. Be sure to list your outputs for Equity per Share, Return on Equity and Payout Ratio. Click here to download my Value.able Valuation Worksheet. Ken has also provided a great list of guidelines – click here.

    Challenge 1, Task 2

    If you want to obtain extra marks you can have a go at also calculating the 2010 cash flow for The Reject Shop using the method I outline in Value.able on page 152.

    If you haven’t purchased Value.able, don’t worry. My website will continue to accept your orders and my distribution house is working through the holiday season.

    Challenge 1, Task 3

    The final task involves completing one or both challenges on the Christmas Holiday Spreadsheet. The first challenge is for Value.able Undergrads. Use the worksheet to fill out the spreadsheet, then rank the companies by their Safety Margin. The spreadsheet will download automatically to your computer. When I return in late January I will publish my table and we can compare results.

    Challenge 2

    The second challenge is for the Value.able Graduate Class of 2010 (and any Undergrads that fancy a challenge). Your task is to calculate the historical change in intrinsic value and price over the last ten years.

    Don’t worry. You don’t have to calculate ten intrinsic values, just two. Estimate the intrinsic value a decade ago (2001) and compare it to the 2011 intrinsic value. To make things a little less onerous, maintain the same RR for a company for the two years. You can then rank the five companies by their rate of change and you can use the following formula in excel if you like:


    Where, IVn is Intrinsic value for 2011 and IVn-10 is Intrinsic Value for 2001 and ^(1/10) is ‘to the power of 1/10’.

    I expect it will take a few weeks for you to get all the your submissions and I will consider some form of recognition for the winners.  In the meantime enjoy a peaceful and Value.able Christmas and all the very best to you and your loved ones.

    Posted by Roger Montgomery, 22 December 2010

    by Roger Montgomery Posted in Companies, Insightful Insights, Investing Education, Value.able.
  • Who made the Value.able grade?

    Roger Montgomery
    December 16, 2010

    The Value.able class of 2010 is indeed all class.

    Your nominations for the A1 stocks to watch in 2011 are fine examples of the sorts of companies that I eagerly seek for my own portfolio (with the exception of the odd recalcitrant student who diverged from the lessons learned).

    I haven’t yet decided which will be revealed on Sky’s Twelve Shares of Christmas special tonight at 7pm, although the shortlist may be obvious from the numbers presented in the table below.

    If we presume that all A1s have equally bright prospects – they don’t – then the job of picking the top stock comes down to the one that offers the highest return when combining the discount to intrinsic value and the prospective change to intrinsic value over the next two or three years.

    One difficulty with such a simplistic approach is that firstly, varying degrees of certainty about the future cloud the picture. I have also used consensus numbers to produce the valuation changes and these are notorious for being optimistic at precisely the wrong points in the business cycle.

    To avoid this dilemma for the purposes of the exercise (but perhaps not for the purposes of investing), I could elect to go with the choice that received the most recommendations. The winner of that contest would be a tie between Matrix Composite & Engineering (MCE) and Forge Group (FGE) and the equal runners up would be Oroton (ORL), ARB Corp (ARP), Cash Convertors (CCV), Cellestis (CST) and CSL (CSL). The remaining contributions include Acrux (ACR), BHP (BHP), Bradken (BKN), Centrebet (CIL), Coca Cola (CCL), Decmil (DCG), Euroz (EZL), Fleetwood (FWD), Focus Minerals (FML), FSA Group (FSA), Hunter Hall (HHL), iCash Payment Systems (ICP), Industrea (IDL), JB Hi-Fi (JBH), QBE (QBE), REA Group (REA), Resource Equipment (RQL), Seek (SEK), Seymour White (SWL), Sirtex (SRX), Speciality Fashion Group (SFH), The Reject Shop (TRS), ThinkSmart (TSM), Thorn Group (TGA) and Woolworths (WOW).

    Whilst I have identified a universe of A1 companies trading at discounts to intrinsic value that have slipped under your radar, the objective of the exercise was to ask for your picks and now that I have the list, choose a winner I must.

    On tonight’s Summer Money program on Sky Business at 7pm I will reveal the ONE stock that you have selected as the relatively best prospect for 2011. It won’t be Roger Montgomery’s pick. It will be the top pick by the Insights Blog Community –  the Value.able Graduate Class of 2010!

    Posted by Roger Montgomery, 16 December 2010.

    by Roger Montgomery Posted in Companies, Investing Education.
  • What are your Twelve Stocks of Christmas?

    Roger Montgomery
    December 9, 2010


    I have an assignment for you.

    Before we start, two things…

    1. If you are looking for a gift that keeps on giving in 2011, give your loved ones a copy of Value.able. To guarantee your gift makes it into Santa’s sleigh, you must order before 5pm next Monday, 13 December.

    2. Put Thursday 16 December @ 7pm in your diary. Sky Business has invited me to appear on their Summer Money program.

    Within Summer Money, Sky is running a series called The Twelve Stocks of Christmas and I have been asked to present one of the twelve stocks. What I would like to do is let everyone on Sky Business know about you – the Value.able Graduate class of 2010!

    You have been instrumental in contributing to the knowledge and awareness of value investing and I would like to say thank you by reviewing your suggestions on air.

    So, what will it be? You can nominate one of the companies we have already discussed. More points can be earned by contributing a company of which you have industry-level knowledge. Think about your industry or business:

    – Who is the strongest [listed] competitor in your industry?

    – Who would you like to see out of business because they are an emerging threat?

    – What are their competitive advantages, their opportunities for growth and why do you think they will sell more of their product or services in the future or at higher prices?

    – Perhaps they are out of favour in the share market, but you believe it’s a case of a temporary set back being treated like a permanent impairment?

    I encourage you all to post your contribution. There are just two rules:

    1. One stock (your best pick) per Value.able Graduate. The more detailed your information, the better; and

    2. Ideas must be submitted by Wednesday 15 December

    Before the live show at 7pm next Thursday, 16 December, I will run my valuation eye over every suggestion and give each my Montgomery Quality Rating (MQR). But the list will be yours – a contribution from the Value.able Class of 2010.

    Whilst only one stock will make it to the show, EVERY SINGLE STOCK  contributed on this post with sufficient supporting detail will be subsequently listed in my final pre-Christmas post for 2010, complete with MQRs, current valuations and prospective valuations (I have decided to called these MVEs – see below).

    Embrace this opportunity to practice what you have learned over the past twelve months, and get the official Montgomery Quality Rating (MQR) and Montgomery Value Estimate (MVE) for your favourite stock. You never know, your stock may just be the one I contribute on national television to The Twelve Stocks of Christmas.

    Post your suggestion here at the blog by Wednesday 15 December 2010.

    I look forward to reviewing your insights and hearing what you think of your classmates’ suggestions. Simply click the Leave a Comment button below.

    Posted by Roger Montgomery, 9 December 2010.

    Postscript: thank you for your kind words and birthday wishes. I’m thoroughly enjoying my time away and am very much looking forward to reading and replying to your comments when I return to the office next Monday.

    Postscript #2: Steven posted his own Value.able 12 Days of Christmas at my Facebook page last Friday – brilliant!

    On the twelfth day of Christmas,
    My independent analyst’s blog gave to me
    12 A1s humming
    11 valuations piping
    10 C5s a-sleeping
    9 forecasts prancing
    8 capital raisings milking
    7 floats a-sinking
    6 CEOs praying
    5 golden A1s!!
    4 C5 turds
    3 emerging bubbles,
    2 editions of Value.able
    And a market leader with a high ROE!

    Here is Steven with his daughter Sophie.

    Roger, you were good enough to sign my book…

    “To Steven, Your guide to avoiding the dogs you told me you were so worried about, RM”.

    Here I am reading Value.able to my little two year old Sophie at bedtime, holding her toy dogs. The moral of the story for Sophie? Roger shows dogs make fun toys and pets but must be avoided at all costs when investing in great businesses!”


    by Roger Montgomery Posted in Companies, Insightful Insights, Investing Education, Value.able.
  • Has 2010 been a good year for Value.able investing?

    Roger Montgomery
    December 7, 2010

    Christmas is about sharing and joyful memories. With just 18 days to go, I thought it would be educational, if not insightful, to share the performance of some of the securities Value.able Graduates have discussed here at my blog.

    Does the Value.able approach to investing, as advocated some of the world’s leading investors, have merit?

    First Edition Graduates may not be surprised by the results posted below. The higher quality businesses, those scoring A1 and A2 Montgomery Quality Ratings (MQRs), and those at larger discounts to intrinsic value have, in aggregate, beaten the index. Some have trounced it. And with the exception of QR National, the companies that were labeled as poor quality (C4 and C5 MQRs) and overpriced, have under-performed. Some of the maturing higher quality companies (think JB Hi-Fi) have indeed performed.

    The following tables present some of the blog posts and the stocks that I have listed, mentioned or discussed in them. I have consistently suggested investigating an approach that seeks the highest quality businesses and prices that offer the biggest discounts to value.

    Whilst the results are short-term (therefore nothing should be taken from them), they are nevertheless encouraging. The approach advocated in Value.able is worth investigating.

    Many Value.able Graduates have suggested I start a newsletter or a stock market advice service. Thank you for the encouragement. I do enjoy the cross pollination of ideas and look forward to 2011 attracting even more investors to the patient and rational approach shared here at my blog.


    Do these three companies represent the last of good value? Oroton, JB Hi-Fi, DWS, Cogstate, Cash Converters, Slater & Gordon, ITX, Forge, Decmil and United Overseas

    Which 15 companies receive my A1 status? CSL, Worley Parsons, Cochlear, Energy Resources, JB Hi-Fi, Navitas, REA Group, Carsales, Mondaelphous, Iress, Fleetwood, ARB, McMillian Shakesphere, Sirtex, Oroton.

    Is Apple an A1? What A1 companies does Roger Montgomery think are the best value right now? Apple, Forge and Decmil.

    Where are my valuations Roger? Cabcharge.

    JBH’s years of fast growth has slowed.

    What do you think of the QAN, JBH and ITX results Roger? Qantas and ITX

    Telstra profits will continue to drop

    Who is in front of the reporting season avalanche? Navitas, JB Hi-Fi, Cochlear and Matrix.

    Part II: What else has the reporting season avalanche uncovered? Ross Human Directions, Monadelphous, Forge, Carsales, DWS, Finbar, SMS Management, CSL, Consolidated Media, Integrated Research, McMillian Shakesphere, Count Financial, Domino’s Pizza, The Reject Shop, Credit Corp, Chandler Macleod, Primary Healthcare, Slater & Gordon, Noni B, Embelton and Tamawood.

    Retailing Maturity – Roger Montgomery now has reservations about JB Hi-Fi.

    Part III: The avalanche is over – where should you be digging for A1s? Lycopodium, REA Group, Fleetwood, K2 Asset Management, Acrux, Hunterhall, Macquarie Radio, Blackmores, ISS Group, Thorn Group, GUD Holdings, Webjet, Kresta Holdings, Kingsgate, Fiducian and Euroz.

    Foster’s turns down $2b bid.

    How does cash flow through Decmil?

    Part IV: Where should you focus your digging?

    Will Roger Montgomery invest in QR National?

    I thought the performance of Fosters after the wine bid was knocked back was interesting, but only another year or two will confirm whether the opportunity to add value was passed up. Some higher quality businesses also underperformed the market, thanks in part to deteriorating short-term prospects rather than deteriorating quality.

    Remember to look for bright long-term prospects. Of course, in the short-term prospects will swing around – that is business, but longer-term prospects of businesses with true sustainable competitive advantages tend to win out.

    Keep an eye on the blog before Christmas as I will be posting a couple of very handy lists (and possibly some homework) before the annual Montgomery Family Christmas break.

    Posted by Roger Montgomery, 7 December 2010.

    by Roger Montgomery Posted in Companies, Insightful Insights, Investing Education, Value.able.


    Curious about the investment landscape in 2024? It appears that the current market offers a plethora of enticing opportunities for investors, a rarity not experienced since pre-pandemic times. This unique scenario stems from a confluence of factors, including elevated yields and comparatively rational equity valuations.

  • How many of your Chips are Blue?

    Roger Montgomery
    November 26, 2010

    If you are new to the stock market, I believe it is possible that you have been lulled into a false sense of security. I say this because I regularly hear well-meaning advice that goes something like this; “just buy a portfolio of blue chips and hold for the long term”

    But what is a blue chip? Here are some of the definitions I have found around the place:

    “a common stock of a nationally-known company whose value and dividends are reliable; typically have high price and low yield; blue chips are usually safe investments”

    “A blue chip stock is the stock of a well-established company having stable earnings and no extensive liabilities. Blue chip stocks pay regular dividends, even when business is faring worse than usual. …”

    “A large company. Blue chip shares are generally lower risk. FTSE 100 constituents are generally considered blue chips”

    “Shares of companies that are considered to be particularly solid and with a high capitalisation level. Their purchase is presumably associated with minor risk when the Stock Exchange falls”

    And my new favourite definition;

    “Blue Chip is the third album by Acoustic Alchemy, released under the MCA Master Series label in 1989, and again under GRP in 1996.”

    Clearly there is only rough consensus around what a ‘blue chip’ actually is, but I get the distinct impression that a lack of understanding about what truly constitutes ‘high quality’ has meant the resultant definitions are clumsy at best. And if advisors can’t define quality/blue chip with some consensus, then its quite possible new investors are plunging into a blind-leading-the-blind situation.

    Here at my Insights blog, I don’t talk about blue chips. Why? Because they don’t exist. There is no such thing.

    I define quality through my A1-C5 Montgomery Quality Ratings (the MQRs) using a raft of measures and scenarios, combined with measures of the financial relationship a company has articulated over the years with its shareholders and its competitive position.

    Warren Buffett once observed that time is the friend of the wonderful business but the enemy of a poor one. You don’t want to put the shares of a bad business, even if it’s a big one, in the bottom drawer and forget about them. Long term buy-and-hold investing then should only apply to the truly high quality companies – A1 companies.

    To that end I would like to share with you an early Christmas gift (until Value.able arrives under your Christmas tree).

    One of the definitions noted above and a commonly held one is that blue chips have to be large companies. Companies that inhabit the S&P/ASX 50, for example, may be considered Blue Chips. Putting aside for a moment the fact that there are plenty of large companies that have gone to the wall, it is possible to re-rank the so called Blue Chips – the large capitalisation companies – and find out if any are more blue than the rest.

    So in the pursuit of ‘blueness’, below you will find all companies with a current market capitalisation of more than $10 billion sorted by my MQR (followed by Safety Margin for good measure). I have also included my current expected (annual) rate of change in Value.able Intrinsic Value over the next three years and thrown in dividend yields because I know how adored they are.

    Of course, all of this is purely didactic and not intended as advice. YOU MUST SEEK AND TAKE PERSONAL PROFESSIONAL ADVICE. Also remember that I do not know what share prices are going to do, they could all halve or double and my MQRs andValue.able Intrinsic Values could all change tomorrow, possibly by a lot. They could go up or down and I am under no obligation to keep you updated. So please DO NOT RELY ON THE INFORMATION PROVIDED.

    Having made that clear, and I am not joking about such serious matters, here is the list:

    So its seems not all blue chips are entirely blue. As one of my friends – who likes to occasionally catch the amber light – says, “there’s still a bit of green left!”

    Lumping all large companies into the ‘Blue Chip’ camp may not lead you to secure returns. Indeed, it could more likely see you merely lurch from one crisis to the next. If that is an experience you would like to change or avoid, then understanding the factors that indicate good quality is vital.

    Value.able Graduates would have read the chapters about identifying extraordinary businesses in my book. If you haven’t yet secured your copy of Value.able you can do so at my website, www.rogermontgomery.com.

    Posted by Roger Montgomery, 26 November 2010.

    by Roger Montgomery Posted in Companies, Insightful Insights, Value.able.
  • Is that the Second Edition of Value.able?

    Roger Montgomery
    November 19, 2010

    Walking into the stores of some of my ‘A1’ MQR companies lately, it is clear that Christmas is just around the corner. Here at Montgomery Inc, Value.able Second Edition has just arrived.

    At under $50, Value.able is not only easy to wrap, it’s the gift that keeps on giving all year round (and you don’t have to brave the local shopping centre)!

    Many First Edition Graduates have asked me the question “what’s new in the Second Edition?” Aside from an added Appendix, the Second Edition contains all the information of the First Edition that had such a positive impact on people like Graham, who wrote;

    “I’m somewhat of a minimalist and love it when I get a book where it makes me feel like I can throw away all the other books I have on a subject – this is such a book!!”

    Value.able Second Edition is $49.95. The price includes GST and postage to anywhere in Australia (allow 7 business days). You may be able to claim a tax deduction, although you’ll probably want to check.

    Visit my website to purchase your copy. And after reading it, please share your thoughts about Value.able, at Leave a Comment here at the blog.

    Posted by Roger Montgomery, 19 November 2010

    by Roger Montgomery Posted in Companies, Investing Education, Value.able.
  • Have you been getting your daily dose?

    Roger Montgomery
    November 9, 2010

    If only it worked that well all the time!

    Last Thursday evening (4 November) on Peter’s Switzer TV I listed, amongst other companies, Credit Corp and Forge Group as two I would have in the hypothetical Self Managed Super Fund Peter challenged me to set up that day.

    Why did I nominate CCP and FGE? Both receive my A1 or A2 MQR and both have been trading at a discount to their intrinsic value.

    If you are a regular reader of my blog you would have read my insights for some months on these companies. And if you saw today’s announcements, you can imagine why I am a little happier than usual.

    Credit Corp’s previous 2011 NPAT guidance was $16-$18 million. Today the company announced FY11 would likely produce an NPAT result of $18-$20 million.

    Forge Group’s announcement states “The Board wishes to advise that the company forecasts net profit before tax for the half year ending 31st December 2010 to be in the range of $25-$27 million. This represents an improvement on the previous corresponding period (pcp $19.04m) of up to 42%.”

    As I fly to Perth for a presentation and company visit, I am encouraged that several of the companies Value.able graduates mentioned in our lists are also hitting new 52-week highs. In a rising market that lifts all boats, it is perhaps unsurprising, but nevertheless it should be an encouragement to Value.able graduates and value investors that companies like FLT, DCG, MIN, FWD, FGE, CCP, NCK, DTL, MCE, MTU and TGA have all hit year highs – some of them yesterday. More importantly those prices are perhaps justified by their intrinsic values.

    Of course I am not here to predict where those prices will go next, because I simply don’t know. Short-term prices are largely a function of popularity and the market could begin a QE2-inspired correction, an Indian infrastructure-inspired bubble or a China liquidity-inspired bubble tomorrow. I have no way of telling and instead, I focus on intrinsic values and only pay cursory attention to share prices.

    So, as I always say, seek and take personal professional advice before taking any action and remember that 1) I don’t know where the share price is going 2) I am under no obligation to keep you up-to-date with my thoughts about these or any company, my Montgomery Quality Ratings or my valuations and I might change my views, values and MQRs at any time so don’t rely on them and 3) I may buy or sell shares in any company mentioned here at any time without informing you.

    And so I remind you one more time. Please seek and take personal professional advice and always conduct your own research.

    Posted by Roger Montgomery, 9 November 2011.

    by Roger Montgomery Posted in Companies, Insightful Insights, Investing Education, Value.able.
  • Are you drowning in a sea of complexity?

    Roger Montgomery
    November 3, 2010

    I don’t know if you have noticed but some of my recent posts and comments have been getting a little technical. I am sorry about that, I get a bit carried away sometimes.

    Of course on this blog, I am not alone. Joab’s brilliant heads-up on the forthcoming changes to the treatment of leases and the impact on the financial statements is exactly the sort of thing that excites those of us who make investing a full time occupation.

    In this field it’s easy to want to prove how much detail one can accumulate about a company or what one knows about valuations or credit analysis. Then of course debates and polite but pointed arguments begin about whose mousetrap is better.

    Yet for most of us, it’s a storm in a tea cup, and meanwhile someone has made a million dollars quietly accumulating a few shares in the recently listed company XYZ Ltd.

    In most cases there is one pearl that counts and the rest is noise. Our job is to find the pearls. Of course with so much rubbish to sift through it can be challenging to pluck up the enthusiasm to even start searching. For many investors, time is of the essence and short cuts are needed.

    Well, I am here to deliver. But this not a post about buying the next hot uranium or gold explorer – tips I do receive and some I even regret missing sometimes. Today’s post is about a shortlist of A1 companies, their proximity to intrinsic value, my expected change in those intrinsic values and the associated net debt to equity ratios.

    Why? It’s about getting back to basics.

    Investing is simple. Not easy, but simple. Much work went into the classification process to come up with my A1, A2, C5, etc Montgomery Quality Ratings using, for example, industry specific KPI’s to ensure that future sweat was reduced.

    And recently one Value.able Graduate Ken, reinforced my resolve to keep it all very simple. Ken D wrote:

    Hi again Roger,

    Out of curiosity, last week I constructed 2 hypothetical portfolios: 1) with your A1 stocks in equal proportion; and 2) the same with your A2 stocks. I have attached some numbers. I was impressed by the average past performance (i.e. investment performance) from both portfolios and also noted quite a difference between the A1 and A2 portfolios (attached). I doubt whether the result is fortuitous. Without asking you to outline your ranking process, I was wondering whether the strong past performance might be expected as a direct result of criteria used in the A1, A2 classification process – e.g. reference to historical earnings growth for instance, or perhaps more interestingly, a product of the inherent quality of the business as measured by current performance measures.


    In answer to Ken’s question and for everyone’s benefit, remember Ben Graham’s quote about short-term voting machines and long-term weighing machine? Over longer periods of time, price follows intrinsic value and because my Value.able method of calculating intrinsic value is related to the performance of the business, one should expect price to follow performance. Over time A1 businesses should do better and a portfolio filled with just A1s purchased at big discounts to intrinsic value, should, in theory, do best.

    Ken looked at all the A1s that I had mentioned on the blog and went backwards (I’ll ignore survivor bias for now) to have a look at the annual returns a portfolio of A1s would have produced.

    While there is more refinement required, the early results are impressive. Over the last ten years Ken’s portfolio of 16 A1 company stocks returned 24 per cent, per annum. The same 24 per cent per annum result was produced with a portfolio of 23 stocks over five years and there were 31 A1 stocks in the last year that combined, returned 31 per cent.

    Thanks for putting in the time Ken.

    With all that in mind, here is my latest list of A1 companies, their proximities to intrinsic values and a few other salient stats.

    What I would like to see as comments here are your thoughts or insights about any of these companies. Go right ahead and share whatever you know or think. But only about the companies in the list. Keep the comments to the topic set and we will build a useful library of insights. Just click the Leave a Comment link below.

    Posted by Roger Montgomery, 3 November 2010.

    by Roger Montgomery Posted in Companies, Investing Education, Value.able.
  • Is cash made from Sandalwood?

    Roger Montgomery
    October 28, 2010

    A number of Value.able Graduates have asked me to share my view on TFS Corporation Ltd (ASX:TFC), the owner and manager of Indian sandalwood plantations in the east Kimberley region of Western Australia (an area I have visited and can’t wait to get back to).

    The first comment is from SI:

    “I just had a look at TFS… wow is all I can say. I agree this is a monopoly in the making. They have control over customers with many signing up to a % of production years in advance and $$ to be set at point of sale. There appears to be medical interest developing, significant cosmetic and industry demand and cultural/religious needs not wants. So demand is very strong and lacking substitutes. On the supply side I see world supply is dwindling and TFS is really the only viable source – also natural/sustainable and green! There also appears to be huge barriers to entry for any competition and TFS is 15 years ahead of any rivals! So using Porters 5 forces: they have power over customers, power of suppliers, no realistic substitute, huge barriers to entry and a monopoly position… WOW they are also vertically integrated soil to end product! Also trading on a PE of approx 5, making money now growing trees, paying a dividend and yet to benefit from revenue from harvest….which appears to offer huge revenue flows starting in 2 years.”

    And from James:

    “… Their ROE is good, payout low and currently well under value.”

    Putting aside the more than slight promotional tone of SI’s comments – thanks SI, it appears on first blush that TFS has several things going for it: bright prospects, possible competitive advantages, high levels of profitability and a valuation greater than the current price. Thanks SI for openly sharing your thoughts on the business.

    To add my two cents worth, it would be useful to revisit a very important chapter of Value.able: Cashflow and Goodwill. I fear its importance may have been overlooked by readers. There are been precious few questions about, or discussion, of cashflow at my blog, even though it occupies a very large part of my time analysing companies. For TFS, in the current stage of its lifecycle, this chapter has many considerations for investors to take on board before jumping onto the Sandalwood bandwagon.

    Let me start on page 147, third paragraph, bold font: “The cashflow of a company that you invest in must be positive rather than negative”. The reason I have emphasised this statement is because I want to make something very clear – reported accounting profits often bears little resemblance to the cash profits or cashflow of a company.

    In business you can only spend cash. Indeed, cash is ‘king’. Try going to the local grocer, showing him an empty wallet and offering instead some accounting surplus to pay for the weeks fruit and veg. You will get just as far in business without real cash – unless the business has access to external funding to plug the gap. Please make sure you re-visit Chapter 9 of Value.able.

    With re-reading from page 145 in mind, focus your attention to the profits and operating cash flows reported by TFS in 2009 and 2010.

    TFS has not generated a single dollar of cumulative positive cash flow in the past two years. Despite reporting $72m in profits, TFS actually experienced a cash outflow of -$8.9m. In 2010, a record $37.11m in profits is matched by negative operating cash flows of -$25.09m. Remember page 147, third paragraph, bold font?

    It could however be that the cash flow disparity is merely a timing issue. No problem; a longitudinal study will help. Turning our attention to the past 10 years, is the situation any better?

    Total reported profits over this period equate to $141.36m, but this is money TFS cannot spend. The total of operating cash flows produced over the same period, money the business can spend, is significantly lower at $22.91m.

    What if I now told you that over the same 10 years, the business had spent $77.43m on investments including property, plant and equipment, and paid $29.94m in dividends!

    And all this from Cash Flow of only $22.91m? This is generally only achievable if a business has very accommodating shareholders and financiers – who, to date, have tipped in $61.14m in equity and $43.19m in debt to plug the hole.

    Does this business meet Chapter 9’s description of a Value.able business?

    Extraordinary businesses don’t have to wait for cash flow. Their already-entrenched competitive position ensures that cash flows readily into management’s hands to be re-deployed/re-invested (with shareholders best interests at heart), or returned.

    TFS and many other businesses listed on the ASX are able to utilise various accounting standards to depict the appearance of a profitable business when they are in actual fact heavily reliant on external financing to fund and grow operations.

    I am not saying in any way, shape or form that TFS is a business that will head down the same path as many in the sector before it – remember Great Southern Plantations and Timbercorp? TFS may soon produce fruit (so to speak). And if SI and management are right, the business offers “huge revenue flows starting in 2 years”, is a “monopoly in the making” and 2011 will see a significant increase in positive operating cash flow as settlement of institutional sales occurs throughout the year. If this occurs, the business may achieve an investment grade Montgomery Quality Rating (MQR).

    I prefer to see runs on the scoreboard – a demonstrated track record – and profits being backed up by uninhibited cash streaming through the door before I open my wallet. Yes, one will miss opportunities adopting this approach but those fish you do catch are generally very good eating.

    So until such time as TFS’s cash starts to flow, there are other cash-producing listed A1 businesses to choose from.

    This brings up an important point to consider; make sure reported profits are backed up by cash flowing into the business. If it isn’t, be very conservative in your assumptions. Better still, move on to valuing businesses that are extraordinary, those with an MQR of A1, A2 and B1. TFS is a B3.

    I will watch this one from the sidelines for now, even if I miss out on returns in the meantime.

    Posted by Roger Montgomery, 28 October 2010.

    by Roger Montgomery Posted in Companies, Energy / Resources.