Investing Education

iiNet’s full-year results have been released. I have taken particular interest because communications and data is one sector of the marketplace I believe is relatively less affected, in terms of share-of-wallet, by the ructions in the US Europe.

The results released today (15 August 2011) were marginally below the expectations of several analysts we correspond daily with. Underlying EBITDA was up just shy of 30 per cent to $104.8 million (some analysts were expecting $106 million and a little more).

With DSL (Digital Subscriber Line) – the technology that significantly increases the digital capacity of ordinary telephone lines, and excluding HFC (Hybrid Fiber-Coax network – CABLE) – iiNet is now the number two competitor and the leading “challenger “in the Australian residential telecommunications market. As an investor, I am always interested in the number 1 or 2 player in town. However the gap between number 1 (Telstra) and iiNet (#2) is enormous. iiNet have 641,000 paid DSL subscribers (up 19 per cent). Telstra has 2.4 million.

The company reported its underlying Net Profit After Tax was $39.0m, up 12.4 per cent on FY10, while reported NAPT fell 3.7 per cent to $33.4m (FY10 $34.7m). On a quick glance, I reckon underlying profit was $37 million (you have to add back $3.9 million in deal costs, redundancy costs of $1.2 million and legal costs of $1.4 million but tax effect it). Stripping out the impact of the acquisition, I also estimate cash flow was close to $40 million.

The reason for the less than stellar growth in reported net profit was because iiNet’s tax bill was much higher than last year. The increase in tax wiped out all of the increase in the net profit before tax.

Whilst many analysts will look at the growth in operating profit (EBITDA), I’d look at the net profit before tax. If I add the legal costs in 2010 back to that year’s profit-before-tax and then add the one-offs for 2011, I get a jump in net profit before tax from $43.85 to $53.4 million and a reduction in margins from 9.25 per cent to 7.6 per cent. Hopefully the company’s expected ‘synergies’ (an extra $10 million from porting AAPT customers across to the iiNet billing system?) raise this to 8.5 per cent.

Net debt increased to $96.4m from $56.3m as a result of the AAPT Consumer division. This has had an impact on our Quality Score (the A1-C5 system), which was B2 previously. Gearing will be 40 per cent. And the the balance sheet? It now contains $302 million of goodwill compared to $242 million of equity.

Revenue and operating cash flow was up significantly with the full year’s benefit of the Netspace acquisition and a nine month benefit of the AAPT consumer division. What really would be interesting however is an estimate of what like-for-like revenue and operating cash flow is. Sure iiNet has no ‘stores’, but acquisitions and synergy extraction doesn’t have the same whiff of sustainability as a business that can grow organically. I would like to see how the old business (excluding the acquisitions) is travelling. Value.able Graduates – would you?

And when I hear company say that it is “Ideally positioned for the future“, I want answers as to whether they were previously ideally positioned for ‘now’.

The 19 per cent growth in DSL subscribers includes AAPT’s consumer division, so it doesn’t give us much insight into the organic growth of the company. With ARPU (Average Revenue Per User) largely unchanged, yet network and carrier costs up 56 per cent – above the 47 per cent increase in revenue – some insights into organic growth would be helpful. I suspect subscriber growth will reflect slow organic growth in FY12, and any margin/profit improvement will come from ‘synergies’. While these may be significant ($9 – $12 million from migrating AAPT customers onto iinet billing system), they are not a long-term delivery platform for profit growth.

It is clear that management’s confidence is high. They have significantly increased the dividend from $12.1 million last year to $16.7 million this year and have announced separately a share buy-back of up to 7.6 million shares, or about 5 per cent of the issued capital (about $17 million at current prices), despite the fact that debt has risen substantially by a net $52 million. Perhaps when you have $766 million coming through the door you can afford to be a bit fancy-free with your capital allocation? Thoughts anyone?

I hear whispers in the background… Roger, how do you know all this? Yes, I do listen to company presentations and we do read investor briefings. But nothing compares to the clarity that comes from using our A1 service. It is, quite literally, extaordinary. And we can’t wait to share it with you. Value.able Graduates – expect to receive your invitation very soon. Now, back to the program…

If organic growth is slow and acquisitions begin to thin out, one would expect debt repayment followed by an increase in the payout ratio. Or perhaps the other way around, if share price support is contemplated?

The prices paid for acquisitions does not immediately cause concern for me, because the returns on equity being reported aren’t poor. But they aren’t A1 either.

Investors have tipped in $223 million and left in $15 million. On those amounts, iiNet’s Return on Equity is about 16 per cent.That’s not bad, but are there better opportunities out there. Before you suggest Telstra, keep in mind it is 140 per cent geared and profits are boosted by the failure of the company to recognise software development expenses in the year they are incurred.

The old fashioned Value.able investor in me doesn’t like looking at a balance sheet that reveals the debt-funded acquisition of goodwill. I have witnessed far too many examples of this turning out poorly. Sure, some of you may say that MMS did the same thing? But while debt rose significantly there, the corresponding asset was PP&E, not goodwill. You may instead point out that interest cover is still high at 9 times (20 times last year). That, I accept.

Finally, the NBN. What does it mean for iiNet?

First, some background. An ‘Off-net’ customer is provided a DSL service through another network – usually Telstra wholesale. An ‘On-net’ customer is one that is provided a DSL service through the iiNetwork (iiNet’s own broadband network). The NBN is expected to reduce the average monthly cost of broadband + Voice bundling to $33, which compares favourably to the current off-net cost of $57. This is a potentially major saving, but the reason I am not as excited about this as the company is because as the transition is made, there will be some leakage. It will occur over an unexciting period of time and any number of offsetting factors could adversely impact revenues, costs and profits during that time.

I am more excited about other companies at the moment. A growth by acquisition strategy may offer wonderful potential in the short-term, but it can also be used to mask slow organic growth. The buy-back can be a sign that cashflow will be strong, but it can also be used to merely ‘display’ confidence and support the share price. At Montgomery HQ, we reckon the shares are very close to their Value.able intrinsic value, but iiNet’s fall in quality, from A3 to B2, suggests shifting your attention to other opportunities.

You should be practising your own Value.able valuations. So what do you get for iiNet for 2011, 2012 and 2013?

Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 15 August 2011.

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

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

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With markets falling on fears that political brinkmanship in the US may result in an embarrassing default on the country’s extraordinary debt obligations (not to mention a reputationally damaging event), I wondered whether we could dig anything up with a more-than-slightly different approach to finding value.

As you would know from reading Value.able, I am not a fan of the Price to Earnings Ratio. Nothing has changed on that front. Nevertheless, value may just be in the eye of the beholder and not only is the P/E Ratio common in literature about investing and in market commentary, it is, whether rightly or wrongly, in wide use.

Indeed, if you are like many Baby Boomers now on the cusp of selling your business, you will be spending a great deal of time in negotiations and assisting in due diligence to arrive at a simple multiple of earnings.

The humble P/E Ratio may be misused, misunderstood and relied on far too heavily, but popular it remains.

One version of the earnings multiple that is adopted for comparison purposes by private equity buyers is the enterprise model. The enterprise model takes the market value of the equity (market cap) and debt, less cash, and divides the whole lot by the EBITDA (earnings before interest tax depreciation and amortisation). Of course, if you have a company with high operating margins but lots of property, plant and equipment (PP&E) to maintain, you may find the results a little optimistic.

Simply take a standard price to earnings approach, but subtract the cash the company has in the bank.

If you were to buy a business outright, you may take into account the cash the company has in its bank accounts. After buying the business you may be able to access this cash and withdraw it to lower the purchase price. Alternatively, if you are selling a business, in an IPO for example, you may be just as keen to take the cash out before selling it to maximise the return to you and reduce the return available to otherwise anonymous share market investors (this latter strategy is very popular).

The arithmetic result of taking out the cash is a lower P/E multiple. And that is what I thought you may be interested to discuss.

Are there any companies listed in Australia that are trading on very low multiples of earnings once their cash is taken into consideration? The broad based market declines have ensured there are indeed a few.

Step 1

My search began by opening our next-generation A1 service (Value.able Graduates – your exclusive invitation to pre-register is not far away). I applied a filter to discover those companies whose shares were trading at a P/E-less-cash ratio of less than 6 times. From the more than 2000 companies reviewed, there are 18 such companies that meet the criteria today. Keeping in mind some businesses have cash on their balance sheet that would NOT be accessible to a buyer (legislated, regulation or simply working capital needs), here are the eighteen:

Step 2

Next, I retained only those companies that have a current estimated forecast increase in intrinsic value of 10% or more. This filter reduced the field to just 11 companies, removing ASX, OZL, CGS, CFE, BTA, PBP AND MOC. Here are the eleven:

Step 3

Finally, I removed companies whose previous year’s ROE was less than 15%. I also removed any companies with a C1-C5 Quality Score. Low ROE stocks removed were; CLQ, CLH, SVW AND STS and C-rated companies removed were; SFH AND PEM. That left just five companies. Here they are:

And there you have it, companies trading at enterprise multiples that may be attractive to a buyer who could potentially use the cash on the balance sheet to reduce their purchase price.

Amazing, incredible simple. No manual calculations required (ever again).

Remember, this exercise did not incorporate any of the traditional Value.able investing considerations we usually discuss at the Insights Blog… safety margin, intrinsic value.

For the record, only two of the listed businesses look cheap on the Value.able score today. With reporting season about to begin in ernest, keep in mind the results and cash balances of these companies will all change.

You must do your own research into their prospects and remember to seek and take personal professional advice.

Very soon, finding extraordinary A1 companies offering large safety margins will become simple and even fun. Our next-generation A1 service that my team and I have been tirelessly working on will inspire your investing and re-energise your portfolio.

Value.able Graduates – stay tuned. Your exclusive invitation to pre-register will arrive in your inbox very soon. If you are yet to join the Graduate Class, click here to order your copy of Value.able immediately. Once you have 1. read Value.able and 2. changed some part of the way you think about the stock market, my team and I will be delighted to officially welcome you as a Graduate of the Class of 2011 (and invite you to become a founding member of our soon-to-be-released next-generation A1 service).

Back to the program… this reporting season, who do you think will surprise with better than expected earnings?

Who do you think will struggle?

And what stocks are looking cheap to you right now?

Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 29 July 2011.

by Roger Montgomery Posted in Companies, Investing Education.

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A couple of weeks ago Tony and Stevo made the following suggestion at my Facebook page: If given $100,000 to invest in the stock market, would I spread my money equally across the portfolio or invest a larger percentage in the very best stocks that are trading at prices less than they’re worth?

Here are the highlights from that appearance on Peter’s Switzer TV.

Peter has invited me to join him again this Thursday from 7pm on the Sky Business Channel (Channel 602).

What’s your portfolio construction strategy?

Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 12 July 2011.

by Roger Montgomery Posted in Investing Education, TV Appearances.

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For those interested in Shale Gas stocks, an interesting article was published in the New York Times at the weekend.

Here’s an excerpt or two from the article…

“Money is pouring in” from investors even though shale gas is “inherently unprofitable,” an analyst from PNC Wealth Management, an investment company, wrote to a contractor in a February e-mail. “Reminds you of dot-coms.”

“And now these corporate giants are having an Enron moment,” a retired geologist from a major oil and gas company wrote in a February e-mail about other companies invested in shale gas. “They want to bend light to hide the truth.”

…and here is the link to the story: http://www.nytimes.com/2011 and a link to more than 480 pages of leaked insider emails and reports: http://www.nytimes.com/interactive

And more recently, in this e-mail chain from April 2011, United States Energy Information Administration officials express concerns about the economic realities of shale gas production.

I am not allowing any comments on this subject. Do your own research and seek personal professional advice.

Please continue contributing to the two prior posts, listing the companies you think we should be watching this reporting season (Scroll Down).

Posted by Roger Montgomery, author and fund manager , 27 June 2011.

by Roger Montgomery Posted in Energy / Resources, Investing Education, Value.able.

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I am working tirelessly to generate superior returns for the Montgomery [Private] Fund. That is the number #1 goal. But stay tuned, because I am also writing a post for next week that will list some of the companies you should be seriously watching this reporting season (and there may be a few gems). Stay tuned and keep checking in.

Today’s earlier post (What if the sell off is just a Flash?) lists some out-of-favour A1 companies.

If you have a company that you believe investors should be watching this reporting season, please  start posting them here. Check in next week to see if  they’re on our list too.

Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 23 June 2011.

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

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Jesse, Michael, Young Les, Justin, Matt, Rad, John, Ron, Young Max, Gary, Dan’s mum, Gary, George, Steven, JohnM, Paul, Steven and Sophie, Michael, Alya, Martin, Bernie, Amit, RBS Morgans Gosford, Jim Rogers, Daniel, Keith, Gavin, Graeme, Nick, Gelato Messina, Chris, Rodger, Phil, Vikki, Mark, Hien, Kenneth, Greg, Peter, Bernie, Paul, John, Bill, Bryan, Di and Lesley, Craig, Scotty, Chris, Main Amigo Stan, Charles, Fred, David, Mark, Collin, Nevada Cody and Winston, Peter, John, Nathan, Mal, John, Tony, Les, William Grant, Greg, Mike, Paul, Roger, Mike, David, Paul, Sinaway, Anders, Frank, Jake, Johan, Mark, Rob, Ian, Joan, Claude, Toni, Richard, Matt Jnr, Indrash, Sara, Garry, Jonathan, Ganesh, James, Kevin, Jim, Peter, Greg, Stuart, Craig, Eric, Robert, Ermin, Mike, Syed, Wilma, John, Alf, Tony, Phillip, Robyn, James, Carolyn, Roy, Peter, Jack, Kevin, Howard, Leo, Jonathan, Carole, Eileen, James, John, Martin, Ordan, Warren, Andrew, Liz, Jim, Anthony, Bob, Douglas, Christine, Frank, Martyn, Michael, John, Dave, Peter, Darrell, Jeffrey, David, Joof, Tom, Leigh, Mervin, Paul M, Paul K, Noel, Bob, George, Leigh, Bob, Steve, Monica, Richard, Frank, Brett, Steven, Colin, Wayne, Joanne, Dan, Garry, Lin, Judi, Allan, Stephen, Garth, John, Joab, Phillip, Kevin, John, Robert, Tweety and Bert, Peter, Mike, Patrick, Eugene, Brian, Harold, Russell, Brad, Rajest, Tim, Gemma, William, Bill, Robert, Geoff, Gary, Emily, Kent, Lucas, Neil, Peter, Rowley, Jason, Simon, Charles, Russell, Grahame, Lester, David, John, Richard, Mitra, John, Dave, Peter, Geoff, Paul, Derek and Rod have already submitted their photographs for inclusion in the Graduate album. My team – Russell, Vanessa, Rachel and Chris, will add theirs shortly.

Have you emailed yours?

We plan to frame the album and hang it at the entrance of our office, next to another invaluable piece – Stay Calm and Carry On.

Posted by Roger Montgomery and his A1 team, fund managers and Value.able Graduates, 9 June 2011.

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

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Last night on Sky Business, I discussed a quick back-of-the-envelope way to get to the heart of a company’s true cash flow performance. This will be useful for you during the upcoming reporting season to help you determine whether to investigate further, or to move on.

It’s very simple. The exception being financial services and insurance companies, which can be problematic and require many more ‘edge-case’ explanations that are best kept close to my chest (with apologies).

So here’s what you do.

1. Find the Balance Sheet and Cash Flow Statement of a business you wish to examine (use the current year’s annual report) and lay it out on a table.

2. Pull out the headings you need and arrange them as illustrated below (Cash at Bank, Current Borrowings, Non Current Borrowings, Contributed Equity).

3. Put a negative sign in front of Cash at Bank.

4. Now sum the two columns.

5. Subtract the current year Total from the previous year. You can do this with half-year results too, for example, compare the 1HY11 with the final 2010 results.

6. Finally add back any Dividends actually paid in the 2011 Financial Year (get this from the Cash Flow Statement).

7. Done.

Now you have a number that better reflects the true change in the company’s cash position. The changes in every other item on the balance sheet will explain this number. But this number  – Company Cash Profit – is the number.

The company at left earned a positive cash profit. What about the one on the right? It lost cash during the year (or spent it on an acquisition(s)). Click the image to enlarge.

Why don’t you run the steps yourself on a few companies in your portfolio and see what you come up with. Where there is a big difference between your calculation of the company’s cash position and the reported profit, pop it up here at our Insights Blog.

This simple calculation is just one of over a dozen other simple strategies detailed in Value.able to help you improve your investing. They’re all there in one comprehensive guide.

If you haven’t yet ordered your copy, now isn’t the time to procrastinate. The last print run for a long while is walking out the door right now. Order your copy at my website, www.rogermontgomery.com.

Posted by Roger Montgomery, author and fund manager, 3 June 2011.

by Roger Montgomery Posted in Insightful Insights, Investing Education.

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As a young child growing up, the United States was the world’s policeman and Australia was a friend. Part of that picture will change in the lifetime of my children. The US no longer seems to command the authority it once did.

Its waning imperialism is at least partly reflected by last weeks visit to China by Pakistani Prime Minister Yousef Gilani. He described Beijing as Islamabad’s “best and most trusted friend”. Meanwhile, a petition in Pakistan’s High Court has called for the expulsion of the US ambassador.

Its waning imperialism is also reflected in recent news that major Australian miners are taking an interest in China’s promotion of its local currency, the Yuan, for trade settlement.

These are the first furtive steps towards a switch away from the US Dollar. Global reserve currency is moving towards the Chinese Yuan. Once hedging is made easier, the floodgates will be open and the Yuan’s appreciation will ensure the tide cannot be stopped.

China will continue to leverage its massive foreign reserves – reflecting fiscal power – and its military might, whenever old ties between the US and others flounder. As regime change in the Middle East continues, new leaders look to China rather than the superpower that funded and abetted their old foes.

India’s PM (and a US ally) recently visited Afghanistan, offering half a billion dollars for development while simultaneously saying “India is not like the United States”.

We are witnessing history. Sure there will be speed bumps and set backs, but the die has been cast.

In the absence of a World War, the US influence and more worryingly, its role as global cop and providore of reserve currency, appears now to have commenced a drawn-out death spiral.

As Jim Roger’s noted; “the 19th century was the era of the British Empire, the 20th belonged to the US Empire but the 21st will be the era of the Chinese Empire.”

The impact of this shift cannot be overstated.

Meanwhile, back at the ranch…

Last year Lakshman Achuthan explained his Economic Cycle Research Institute’s view that A) a US slowdown is already a done deal and B) the US faces the unfortunate prospect of more frequent recessions over the next decade.

Evidence of a slowdown is now emerging and Achutan was recently interviewed on the subject here and here.

Let me say at the outset, I am not an economist. And don’t worry, I’m not turning into one. Indeed, even if I was, it still may not help me invest any better than I can following the Value.able methodology.

I have, however, been trying to find a reason to expect to find value sometime soon.

And thanks to Lakshman Achuthan, I have found a reason to become a little optimistic, if not about the economy, then about the prospect of finding value, soon.

Longer-term, Achuthan thinks more frequent US recessions are a given.

In economics, a recession is a business cycle contraction or a general slowdown in economic activity. During recessions, economic indicators such as production – as measured by Gross Domestic Product (GDP) – employment, investment spending, capacity utilisation, household incomes, business profits and inflation all tend to fall. Conversely, unemployment tends to rise, along with the number of employers no longer able to afford them.

In a 1975 New York Times article, economic statistician Julius Shiskin suggested a definition for a recession. In Australia we seem to have adopted it; two quarters of negative growth and a recession is in place.

Because of the stigma for a political party associated with a recession, not to mention the economic hardship associated with one, recessions are something best avoided.

The two ways to do it are to either to raise the trend rate of growth, such that the dips in the business cycle never fall into the area of growth below zero, or lessen the peaks and troughs of the business cycle itself.

Raising the trend rate of growth, however, does not appear to be an option (for the US at least) because the trend rate of growth in employment, GDP, personal income and industrial production has been down since the end of World War II.  As the trend rate of growth declines, and heads closer to zero, the dips in the business cycle need not be very severe to dip below zero.

Reducing the peaks and troughs of the business cycle such that the dips never result in an economic ‘backward step’ has been claimed as a new norm by economic managers who believe the use of monetary policy has been perfected, and also by those who have put their faith in economic globalisation. Monetary policy however is a rather blunt tool and its success in helping us avoid recessions may just be blind luck.

With trend growth declining for 50 years, each dip in the business cycle gets closer to regularly falling below zero. And with luck largely determining the success of policies attempting to smooth out the business cycle, its likely luck will run out, just as the globalisation of the supply chain causes the business cycle to whip even more violently than ever before.

Governments usually respond to recessions by adopting expansionary macroeconomic policies. They can increase the money supply, increase government spending and decrease taxation. But with a flood of US dollars that only Noah could survive, and government deficits already at historic extremes, these measures would only make the situation worse.

If you are investing in equities, the message is simple. Only buy the best quality businesses. And only when large discounts to your estimate of their Value.able intrinsic value are present.

The Value.able recipe is simple and it works. And you don’t need to be an economist to make it work. Whether the idea of more frequent recessions is right or not, the dearth of value suggests one should applaud the fact that markets may react to the risk of more frequent recessions, offering the best stocks for prices less than they’re worth in the process.

Posted by Roger Montgomery, author and fund manager, 1 June 2011.

by Roger Montgomery Posted in Insightful Insights, Investing Education, Market Valuation.

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You may have noticed my recent posts are not filled with stock ideas. Don’t worry. The drought will end, once the market resumes serving up mouthwatering opportunities

For many businesses, Australia may not seem like the ‘lucky country’ right now. A litany of evidence suggests the economy is cool. Recent bank results reveal credit growth is slowing, if not stalling. Significantly fewer homes are being put to auction and of those that are, clearance rates are not inspiring.

Australia’s savings rate has risen and thanks to rising fuel costs and utility bills, we haven’t got as much to spend as we used to. Then there’s the prospect of rising interest rates. I wonder, given all anecdotal evidence of weakness, whether an interest rate cut would be more justified?

Some of Australia’s ‘blue chips’ have reported weakness or downgrades. Seven West Media reported a softer advertising market, which has also affected Fairfax and APN. OneSteel cited a strong Aussie dollar, as did BlueScope. And you can almost guarantee food manufacturers are going to complain about higher commodity input prices.

Indeed higher input prices, combined with pressure on consumers to pay more for daily essentials – gas, electricity and petrol – means many companies have lost their ability to pass on rising costs. Naturally, this leads me to think that this is precisely the combination of influences that will reveal which companies have a true competitive advantage?

The Value.able community has spent a great of time exploring, discussing and naming competitive advantages – retailers, Apple, your insights. The current economic headwind will reveal who actually has one.

Take a look at the companies in your portfolio. Can they pass on rising costs in the form of higher prices, without a detrimental impact on unit sales? Can they grab market share from competitors whose margins are slimmer, by cutting prices? Is your portfolio overflowing with A1 businesses, or are there some C5s in there that may struggle through post-reporting season?

Now despite current pressures, which of course you must refrain from believing is permanent (and indeed cease focusing on), analysts haven’t brought down their earnings expectations.

Macquarie’s equity analysts are forecasting aggregate profit growth of 19 per cent and according to JP Morgan, non-resource companies are expected to grow profits by 13 per cent this year. These growth rates are a significant revision down from 6 months ago. Are more downgrades to come? Thirteen to nineteen per cent does seem more appropriate for a rosier economic environment…

Lower profits have a real impact on intrinsic values. For companies generating attractive rates of return on equity (at last count, 187 listed on the ASX generate a ROE greater than 20 per cent. Of those 103 are A1/A2), lower profits reduce the quantum of that return, as well as the amount of retained earnings and therefore the rate of growth in equity. All of those changes are negative. If Ben Graham was right and in the long run, price does follow value, that means either lower prices or prices that cannot justifiably rise much more.  And this is where Value.able Graduates’ attention should be focused, not on the bailout of Greece or Portugal.

What does this all mean?

I don’t have a crystal ball, so I simply don’t know where the market is headed. Thankfully it isn’t a brake on market-beating returns.

What I do know, is that of approximately 1849 listed entities, 1175 made no money last year. Of the remainder, 56 are A1s and of those, just 13 are trading at a discount to our estimate of intrinsic value. Six are trading at a discount of more than 20 per cent and of those six, The Montgomery [Private] Fund owns two. We have been decidedly slothful in buying and, as a result, while the market has been falling, the Fund’s value hasn’t.

Steven wrote on my Facebook page yesterday “Who cares? this market is… only ugly!” It’s only natural to want to throw up your hands in dismay, but this is where the rubber hist the road – Keep Calm and Carry On Value.able graduates. Look for extraordinary businesses at prices far less than they’re worth.

Just under 11 per cent of The Montgomery [Private] Fund is invested in extraordinary businesses. Even with 89 per cent of the Fund in cash, we are outperforming the S&P ASX/200 Industrials Accumulation Index by 5.29 per cent since inception.

My team and I continue to be inspired by the 1939 poster in which England advised its citizens to “Keep Calm and Carry On”.

Low prices should not bring consternation, but salivation. As sure as the sun rises, low prices for A1 companies will not be permanent.

Beating the market does not mean positive performance every week, every month or even every year. I have no doubt that some investments I will make for myself and the clients we work for will not perform as expected. Not every A1 at a discount will prove spectacular. We can however mitigate some of the risks of course. Sticking to a diversified basket of the highest quality companies (A1s perhaps?) purchased at big discounts to intrinsic value, won’t prevent the market value of the portfolio declining in the short term, but it can help to generate an early, eventual and more satisfying recovery.

With a falling market (and falling prices for A1 companies too) the daggers will come out, so also be prepared for those of weak resolve. They may try to discredit our Value.able way of investing.

A contest isn’t won by watching the score board, looking in the rear view mirror or mimicking those with a demonstrated track record of success. You have to play. And play your own game. Over long periods of time, sticking to good quality A1 companies works. Given that returns are dependent on the price you pay, lower prices (and greater value) works even better!

The issue of course is not the reliability of the Value.able approach, but the patience required to execute it. Remember the ‘fat pitch’?  Irrespective of the turmoil that impacts markets, we must Keep Calm and Carry On.

So what do you think? Where do you think the market is headed? What are the factors you are watching? Have you picked up something in your research that you’d like to share? Go for it!

Posted by Roger Montgomery, author and fund manager, 18 May 2011.

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

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