I have written an eight-page note on how to build the perfect share portfolio using my approach to identifying great businesses and valuing them.
This article first appeared in the October 2009 issue of Money Magazine. An addendum to my original article, which can be downloaded below, is a brief explanation of how to value a company that pays all of its earnings out as a dividend. Only a handful of companies consistently pay 100% of their earnings as a dividend. Many more companies in Australia and around the world retain a portion of their profits. I suspect you will have many more questions about valuing companies and I am happy to say that most if not all your questions have been anticipated and answered in Value.able.
Purchase a First Edition copy of Value.able at www.RogerMontgomery.com.
To read the note Building the Perfect Portfolio, click here.
Greg
:
Hi Roger,
Regarding – How to build the perfect portfolio
On the bottom of page 6 there is a hyperlink to 1981 Berkshire Hathaway letters to shareholders. I cant get the link to work on two different computers.
I have downloaded and studied the 1981 letter (released in Feb 1982). I have trouble following Warren Buffet examples. Maybe it is my unfamiliarity with some of the American financial language and products.
I really hope your book’s examples are as clear as your ASX lunchtime presentations, and in an Australian context, of course.
High Return on Equity (very specific easy to compare), little or no debt (vague, no preferred measurement method and no maximum threshold), bright prospects (the real art investment).
How should debt be measured and companies compared, interest cover or debt to equity or net debt to equity? What about junk assets like goodwill and intangibles (newspapers masthead)? I vote for net debt to tangible assets. But it does not matter what I think, in reality it matters what data I can source, and I am stuck with however they calculate their numbers. The brokers I use all source data from Morningstar. Of cause NO DEBT is NO DEBT, no matter how you calculate it. What debt measurement do you recommend and what max threshold?
Bright prospects, if we could get this right the other two criteria would not be so important. Time would fix any poor valuation issue at purchase. This is the hard bit, researching and thinking about an industry and its prospects in an unknowable future. I guess doing your best and reacting when things don’t go to plan, is all we can do. Running numbers through a filter is easy. There is little one can do about out of the blue legislative risk (eg MMS and IMF). But putting on the rose colour glasses these two could be a great opportunity.
Many regards
Greg
rogermontgomeryinsights
:
Hi Greg,
Great to hear from you and thanks for taking the time to write. The book makes following that passage really easy and uses 99.9% Australian examples ( I think I mention Coke in the context of a discussion about the long term and in the chapter about the five rules for selling) but of course even though the examples are Australian, the principles are universal. I am sorry you have had some trouble with the link. Its seems to be working for me.
When it comes to debt, less is more and none is best. Really, you cannot put hard and fast rules on it, but I cover off the upper limits in the book where I also discuss the importance of cash flow in these matters. Intangibles gets a chapter as well and net debt to tangible assets is as conservative as you can be. When you talk about data, don’t forget the good old annual report. Slow, boring and sometimes tedious, but it is the ‘horses mouth’. I should really refrain from gambling analogies.
Regarding “Bright Prospects”: You are right Greg when you say that ‘time would fix any valuation issue at purchase’ but time is money. There are a few things to consider. For example, I bought Fleetwood at $3.50 or so in Feb or March 2009 and the dividend yield was 27%. Today the shares are above their value. As long as the value is rising and that valuation rises to the current price within a couple of years, I would generally be happy to hold because I am earning a 27% yield arguably on my investment. If however the value began to decline or it looked like it might take twenty years for the value to catch up to the price, I may not be so keen to hold on.
Bright prospects are important and the most valuable prospects result in the intrinsic value of the company rising at an attractive rate.
Chris Turnley
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Hi Roger, can’t wait for your book. In the meantime I attempted to work out the intrinsic value of NAB. Based on ROE of 6.57% RR of 12% & equity per share of $18.02 (calculated share holder equity Book Value $37, 815m divided by no of shares 2,098,076m =$9.87 per share. Which cannot be right? I sourced figures from Commsec. Pay out ratio was 119% that means they paid out more than they earned? I am confused.
rogermontgomeryinsights
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I think I may have already replied to this comment on another post. Your ROE seems a little low. The NAB’s valuation should it proceed with it purchase of Axa, will drop from $25.50 to $21.30 on present estimates. Of course my valuation could change but that will only happen when more information becomes available. AT present the information I have about Axa and the terms of the deal have a negative impact on NAB’s valuation. They are paying $4.6 billion for businesses that earn $240 million! Not a great return on equity.
Roger