If value nags, are you listening?

If value nags, are you listening?

Value.able investors can be forgiven for giving up.  You wait so long for value to be presented and then when it appears it just hangs around, remaining ‘good value’ for what seems an age.  Value can sometimes nag and nag and by the time action becomes urgent, the newest and least patient value investors are no longer listening.  I can see it in the statistics of my friend’s financial services businesses and no doubt it’ also being felt by tip sheets purveyors and CFD merchants.  For all the talk of value investing, few really have the patience to succeed.

Value.able-style investors can be forgiven for giving up.  You wait so long for value to appear and then when it does, its just hangs around.  STocks that were expensive, become cheap and then, simply, boringly, stay cheap.  Value can sometime nag and nag and by the time action becomes urgent, the newest and least patient investors are no longer listening.  I have no doubt this is impacting the revenues of the tip sheet purveyors and the CFD merchants, indeed any business in financial services whose revenue is dependent on investors maintaining the faith.

That is the situation I was recently delighted to observe as the Cochlear share price plunged another 14% to $51.30, or about 40% since its April 2011 high of $85.

Recently I ascribed to Cochlear’s shares, a valuation of $59. Since 2004 the price has been persistently above my intrinsic value estimate, which means the combination of circumstances that have pushed the share price below value most recently are worth exploring.

Cochlear has the largest market share for cochlear hearing implants worldwide and, after announcing a voluntary recall of its flagship Nucleus CI500 implant range recently (the Nucleus accounts for more than 70% of sales), investors voted with their feet and the stock fell more than 20%.

The recall was voluntary and relates only to those devices that have not been implanted. The devices have a fail rate of about 1% and the fault – due to moisture on 1 of 4 diodes from loss of seal – is not believed to be harmful in any way, the device simply shuts down.

With about 25,000 of the units in use globally, that implies around 250 recipients of the implant will be affected and although that is significant, the proactive and patient-focused response of the company should ensure the reputational damage is contained.

As Cochlear’s technicians work to isolate the problem with the Nucleus 5 range, the company will dust off the Nucleus Freedom range, which it has marketed successfully for many years against products such rivals as Advanced Bionics and Med-El.

Med-El is gaining market share in the US generally but patients waiting for implant surgery have switched to the Cochlear Freedom product and apparently with no delays.

At the same time as Cochlear’s recall, Advanced Bionics received FDA approval to sell its product (which was itself recalled in November last year) into the US market. This turn of events is not unusual for the industry … but it is unusual for Cochlear and that’s why the news came as such a blow. Cochlear is one of the highest-quality companies trading on the ASX today. The company that almost never puts a foot wrong appears to have tripped itself up and investors became spooked.

And in that reaction a potential opportunity may be presented.

The financial impacts of these events won’t be fully known until later in the year but is expected currently to be $130 – $150 mln, translating to an after tax impact of about $20 mln.

Over the past decade, Cochlear has increased profits every year with the exception of 2004. Net profit was just $40 million in 2002 and most recently the company reported profits of $180 million for 2011.

Operating cash flow over the same period has risen from less than a $1 million (an exception for 2002) to more than $201 million, allowing debt to decline to just $63 million from nearly $200 million in 2009. Net gearing is now minus 1.86%.

Those impressive economics have resulted in an intrinsic value that has risen by nearly 18% each year since 2004. If your job as a long-term investor is to find companies with bright prospects for intrinsic value appreciation – believing that in the long run prices follow values – then it quite possible that Cochlear is being served up on a plate.

The recently reported net profit figure of $180.1 million for 2011 was up 16% and in line with consensus analyst estimates, although this occurred despite sales of $809.6 million exceeding analysts’ estimates. It seems the analysts did not expect the EBIT and NPAT margins that were reported. These were flat, which given a very strong Australian dollar, suggests impressive efficiency gains in the operations.

If only that blasted “Australian peso” would go down and stay down!

Back on August 19, 2009, I wrote in the Eureka Report: “Fully franked dividends have risen every year for the past decade, growing by almost 500% (or 22% pa) since 2000. These are not numbers to be sneezed at; the company has produced an impressive and stable return on equity since 2004 of about 47% with very modest debt. Clearly this is a company worth some significant premium to its equity.”

Nothing changed really for 2011. A final dividend of $1.20 per share was 70% franked and up 14%.

Importantly, it seems Cochlear’s market is growing. Unit sales volumes were up 17% for the year and, given in the first half they were up 20%, it suggests the second half were up 14%. Double digit growth was reported in sales volumes for all major regions and Asia was the most impressive, rising more than 30% to the point where it makes up 16% of total revenues.

This really is impressive stuff. Just two years ago the company reported unit sales growth of only 2%, to 18,553 units, and many analysts were blaming slow China sales. Nobody expected the company to ever repeat its 2007 and 2008 volume growth of 24% and 14% respectively, and certainly not off a higher base. Growth has always been viewed as being limited by the high cost of the devices and the reliance on insurance and healthcare schemes to subsidise the costs and those of surgery to implant to them.

According to the World Health Organization however, almost 280 million people suffer from moderate to profound hearing loss and an ageing population means this figure will rise. Cochlear is one of a handful of companies that actively contributes to improving the quality of life of its clients.

When great companies stumble, the impact can be exaggerated by the reaction of shareholders who never believed it could happen. Then comes a wave of selling amid doubts that the company will ever regain its mantle.

But strong market share and strong cash flow, high returns on equity and low debt, are rarely offered at bargain prices so I picked up some Cochlear stock for the Montgomery [Private] Fund. It is expected that I will to add to this position over the coming weeks and months (provided value remains) when the full financial impact of the recall is known.

I must confess I didn’t bet the farm on this particular investment because the financial impact of the recall remains uncertain; when that changes it will impact my intrinsic value estimate.

Whatever the impact, it will be temporary, even though it won’t necessarily preclude lower prices from this point. During the GFC, Cochlear shares fell from $78 to $44. No company is immune to lower share prices and I don’t know when or in what order they will transpire.

What I do know is that in 2021 we aren’t likely to be thinking about this recall, just as nobody now talks about the Wembley Stadium delays that dogged Multiplex back in 2006. Mercifully, investors’ memories tend to be short.

Recalls, competition, marketing gaffes and wayward salary packages are all part of the cut and thrust of business and if lower prices ensue for Cochlear shares, it will be important to determine whether the recall will inflict permanent scars. My guess is that it will not. I wonder whether you are listening for value?

Posted by Roger Montgomery, Value.able author and Fund Manager, 19 October 2011.


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

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

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  1. Hi Roger

    I emailed a week or two ago via your website and I don’t think I’ve had a reply. Just interested to know if you intend setting up another investment fund, for those with less than 1 million dollars to invest? Keep up the great work, I enjoy reading the blog and you media appearances immensely – Regards Jason

    • Hi Jason,

      Just checked and we have absolutely no record of having received your email so, my apologies for not replying. I have sent you an email (to the address you have provided here).

    • Darrin,

      Their debt to equity is about 45%, their liabilities exceed their tangible assets by $7M, their company cash flow was negative $13M. Do you need to know more ?


  2. Roger, I assume you’ll be coming out with more details on Skaffold shortly, but will there be room to compare the product to other offerings. Unless a person signs up for a trial of other products (which always come with the inevitable guilt associated with not continuing) they are unlikely to know how to separate the two offerings. Thanks.

    • Hi Adam,

      There is no comparison! Why would we start the process of developing an application that was inferior to something else that already existed? That’s like expecting Cochlear to set out to build a hearing device that is inferior to an existing cochlear implant built by a competitor. Crazy. Skaffold has simply employed, the best user interface designers, the best application developers and sourced the best data. So free trials are something for would-be competitors, not Skaffold. I see no sense in asking investors to invest in Skaffold and then offer it for free to anyone and everyone that feels like kicking the tyres. The contents of Skaffold are far to valuable to be given away for free. Of course some investors will simply say that they won’t go ahead. That’s ok. Skaffold isn’t trying to be the biggest, its only aim is to be the best. Fortunately, there will be enough information online for you to make a decision about its suitability without giving away anything for free.

      • Thanks, much appreciated. Just to clarify, I wasn’t suggesting that Skaffold offer a free trial – I was referring to others that do. I understand the logic of doing so, but as you say, it is open to abuse.

      • Roger

        I understand Skaffold will outline a company’s MQR, IV and projections into the future, amongst other information. Will it also offer the raw data used to calculate these parameters?


        Will Skaffold offer qualitative insights into companies such as sustainable competitive advantage, management performance etc?



      • Hi Matthew

        Thanks for your question. Skaffold presents the vital information three ways; 1) Graphically, 2) Tabular and 3)Plain English. Skaffold’s plain language engine converts the graphics into text that explains what you are looking at too. When you ask about management performance, what are you hoping to see? Generally, when we talk about performance here at the office, its something measurable – that’s quantitative. Fortunately we are using some of the world’s best data (let me assure you, not all data is the same) and developers so what did you have in mind?

  3. Hi Roger. I would like to recommend “Extreme Money” by Satyajit Das to you all. I have started to read it again as it has so much detail (450 pages) and it is so well written. If you do a search more detail is available. money well spent. it gives great insight into the last thirty years of the money trail in the financial industry to increase profits in an eadevour to be the best and line their pockets as well as a lot more.

    • From the publisher:

      The bestselling author of Traders, Guns & Money on how money and finance enslaved the world.

      Once, we built things – useful things. Now, we construct immense financial structures from thin air and lies. We have crafted a colossal worldwide financial machine that makes a few individuals staggeringly wealthy and sacrifices everyone else at its altar of risk.

      Bestselling author Satyajit Das draws on over thirty years of personal experience at the heart of modern global finance to narrate this story. Das reveals the spectacular, dangerous money games that have generated increasingly massive bubbles of fake growth, ponzi prosperity, sophistication and wealth – while endangering the jobs, possessions and futures of virtually everyone outside the financial industry.

      You’ll learn how everything from home mortgages to climate change has become financialized, as vast fortunes are generated by individuals who build nothing of lasting value. Das shows how ‘extreme money’ has become ever more unreal; how ‘voodoo banking’ continues to generate massive phony profits even now; and how a new generation of ‘Masters of the Universe’ has come to dominate the world.

      Epic in its scope, EXTREME MONEY reveals how we have all become slaves to our own illusory, unsustainable creation: global finance.

  4. Hi Roger,

    I was on a flight to the Gold Coast recently and happened to be reading the Money magazine which you’d written about 9 stocks achieving good returns. One of these is MML which I hold and have done so for a while now after it flowed through my value investing filters.

    I’m interested in your thought on MML if you have any to share, or the thoughts of others. I find it hard to believe a company producing gold at costs of approx $200 USD per ounce hasn’t appreciated more given the gold price has continued to trend up. Not only do these guys produce at a large margin, but are also in the process of reasonable expansion all self funded.

    Based on my valuation calculations I think reaching $10 at least in the next 1-2 years is quite likely. Don’t have access at the moment to my valuation spreadsheet but certainly interested in the views of others.


  5. Roger,

    Are you prepared to now admit that you got MCE wrong ? You have previously said you have never made a bad investment (CCP ring a bell ?).


    • Hi David,

      Of course we’ll get it wrong! That’s why diversification is essential. Indeed I expect to make every mistake there is to make before I am done.WHo hasn’t got calls wrong? Jeremy Grantham, Bill Gross, Buffett et. al.
      All get individual calls wrong. But my question to you with regards to MCE is; Why “now”? My own view on MCE hasn’t changed since I warned about cash-flow earlier in the year. Our fund had a tiny position which was liquidated a long time ago. I first suggested investigating matrix at around $3:00 in 2010. It was over $7:00 when I starting discussing the cash flow issues at the HY11 results…

      1). I warned about cash flow in comments here on the insights blog after the half year result. I think the share price was over $7.00.
      2). I then wrote a scathing piece about the company here and in the Eureka Report even earlier after the full year result and after meeting with the company, for everyone’s consideration, mentioning that I didn’t own stock.
      3) I think you may find if ccp settles the class action against it for misleading the market(?), that will be vindicating. So before ringing any “bells, please check the facts.

      Having said that of course I will get some calls wrong – indeed I expect to make every mistake there is to make before I am done.
      The really interesting question for me is that if you have missed these details then even a blog (remembering I am under no obligation to update the blog with my latest thoughts) is not a perfect medium. Of course, you are free to reach your own conclusion and I wish you well.

      Here’s some of the Matrix thoughts from the Eureka Column after the FY11 results:

      “What is the value of a company with a terrific track record that wakes up to find it has sold very little or even nothing in the past six months? That’s the question I face as I read the annual report for Matrix Composites & Engineering (MCE).”

      “I can just as easily make the argument that they cannot currently be valued any more confidently than a speculative exploration company. This is admittedly a harsh interpretation of the full-year results, but there are many things to be concerned about after reading the report and participating in a conference call for analysts.”

      “To begin with, the company missed analysts’ expectations….”

      “But in this case, analysts’ forecasts were a function of the NPAT guidance provided by the company.”

      “The real issue is that without new orders that cash balance will diminish very quickly.”

      “Administration, marketing, corporate and finance expenses alone are $750,000 per month. My estimate of the cash flow generated by the business reveals the pressure CEO Aaron Begley and his team must be under.”

      “Cash declined in the first half, even though the company borrowed more money and raised more capital. Even adding back the dividends paid and the $25 million spent acquiring property, plant and equipment, cash flow was negative $4.6 million.”

      “There was some hope that cash flow would improve in the second half as the construction of the facility in Henderson, south of Fremantle, wound down. Adding back the dividends and $17.5 million spent on property and plant in the second half, the business generated just $900,000 of cash. Not impressive for a company with a market cap earlier in the year of over $700 million and today is half that.”

      “Reported operating cash flow was just $1.5 million compared to reported profit of $33 million. This is the result of “low order intake” (a technical phrase that means “we didn’t sell anything”) and the fact that reported profits are recording sales completed this year while actual cash was received in the previous year. You can smooth out the timing by averaging the two years but it does not change the fact that the balance sheet shows an amount of $0 under the item labelled “Progress Claims and Deposits”.”

      “The full-year’s results rather proudly noted the $110 million order book but a quick glance at an announcement made six months ago revealed an order book of $180 million. The source of the $70 million of cash from operations in the second half is now explained – at least partially, if not completely.”

      “My biggest concern, relates to the intangibles: the things that aren’t presented and the things that are presented but fail to adequately describe the company’s current predicament.

      “The results presentation contained no slide dedicated to covering cash flow. Not surprisingly this more than any other issue is the one that dominates analyst and funds management thinking.”

      “In the conference call the company described the expanding macro (big) picture and each of the last two results presentation slides contained bar charts showing the growth in the global deep-water oil rig fleet.”

      “Putting aside the fact that six months ago the company estimated 35 “new builds” for 2011, and this week only estimates 21, I also wonder how the statement that “macro conditions are forecast to exhibit strong growth”, combined with Matrix’s 40% market share results in the statement that “some margin pressure exists due to competitive influences”.”

      “One would normally expect that a growing macro backdrop and significant market share would be the perfect environment to exercise any pricing power a company had. Like so many Australian businesses, a valuable sustainable competitive advantage might not be present for Matrix.”

      “The conference call also revealed some confusion about the definition of a “tender pipeline”. Analysts were told that the tender pipeline was in fact not “just” a tender pipeline but opportunities that are in “negotiation”. Why then, your columnist asked, were these opportunities referred to as a “tender pipeline” in the preliminary final report?”

      “I also wanted to know why the company had not won any new business in the year – the item labelled Progress Claims and Deposits in the balance sheet fell from $35.6 million to zero. Conference call participants were told “nobody in the industry had won new business”. Excuse me, but nobody? That was immediately corrected, but without an alternative answer provided. The company has increased its marketing outlay to $2.4 million but without results at this stage.”

      “The company is forecasting revenue growth of 20% and if NPAT margins of 17% can be maintained (running two plants with duplicated staff won’t be repeated), next year’s profit will equate to 52¢ a share. But in the face of few or no new contract wins in the past 12 months, management are clearly expressing some bullishness. To grow revenue by 20% to $224 million, and putting aside timing differences, Matrix will need to win at least $114 million of new work, on top of the current order book of $110 million. Remember this book has declined $70 million in the past six months, not grown.”

      “Sell-side analysts last month were forecasting earnings of 66¢ a share for 2012 and, using these numbers, the share price valuation is over $10. Those analyst expectations, however, are now 61¢ a share for 2012 and my own number is closer to 51¢. In the absence of any announcements of contract wins, expect further downgrades. If Matrix can achieve 52¢ of earnings per share, my intrinsic value becomes $6.80 – which is still significantly higher than the current price. And remember, it has to win some contracts because at the moment the declining order book is just 58% of last year’s revenue.”

      • Thank you Roger for reply in details.

        David, for those of us big lesson learned.

        1. No matter what happens do your own research (even if it is Roger’s or W. Buffet’s most favorite stock of 2011)

        2. A1 does not mean there is no risk and nor A2!

        3. Diversify

        4. When price significantly goes up in short time, sell it or (sell few) or prepare risk the gain.

        Roger, I think it will be good to understand if you could write sometimes about, if something goes bad then, how and when to react.

      • I was thinking the same thing. A summary of the Getting Out chapter in Value.able perhaps with some recent examples…There have been many more C5 that have stumbled than the odd A1. Diversification is key. Some investors may simply want to say, I will only invest in companies that have been A1 for at least three years in a row or those that have never rated lower than an A2 in the last decade. Thats what we are able to do. Such rules would, of course rule out new floats but also help to avoid flash-in-the pan situations and companies with lumpy economics.

      • Roger,

        Mistakes happen and it is cathartic that you can discuss MCE.

        I just reread you Eureka article titled ‘Something Special’ in Feb this year when you thought value was $10.21. Do you still think it is extraordinary with bright prospects?

        Could you explain why you thought it was an A1? The business performance doesn’t seem to support that, particularly cashflow.


      • Hi Paul,

        When the facts change you have to be prepared to change your view. What is the intrinsic value of a business that loses money? It matters not whether the intrinsic value was $10 or $100 before the year of a loss. In the year of a loss the valuation will change dramatically. We previously expected ROE to rise but now expect it to fall dramatically.

        Asking whether I still think it’s extraordinary is disingenuous because there have been posts and columns warning of its problems since that Feb column. At the start of February the stock was at $6.95 and in March 2011 the shares were at $9.72. But the problems described relate to the level of profit the company will make and its cash flow in a year where new orders are not flowing thick and fast, not whether it will go broke. An A1 rating is useful in predicting the chance of a major liquidity event. We don’t currently believe the company is going broke. Do you? Our data suggests there is ‘CURRENTLY’ a very low risk of that event. Any new announcements the company makes however could change that too.

        We expect a diversified portfolio of A1 rated companies to outperform – over the long run – a portfolio of lower rated companies. And that is the wonderful advantage the A1-C5 quality ratings have given us. There is over 40 years of academic research supporting the way we have developed the quality ratings (Centro was a C5 and guess what…). Those losses are permanent. Losses related to Matrix may not be. Time will tell. Interestingly the extreme level of negative sentiment towards Matrix suggests to me possible capitulation and a very close watch needs to be kept on the company – something we are doing.

        I liked MCE for myself at $3.00 in 2010 and continued to like it until we didn’t any more. As the stock rallied threefold, many seemed to agree (were they taking their queues from price?) and some fund managers I know, still own Matrix. You have to conduct your own investigations and make your own conclusions. I am happy to continue to share my thoughts but you must remember, as I have said many times, that because I cannot be expected to keep my thoughts on every stock up to date here, you need to do your own research and always seek and take personal professional advice.

      • How do you predict a low chance of MCE having a liquidity event – the cashflow is negative? Yet you have it rated as an A2. Cashflow should be the most important factor when determining likelihood of a liquidity event.

        I suppose the expectation is that when you where the most prominent supporter of MCE, which you pushed hard as your pick of the year, the best pick for super fund and the list goes on. Yet once the tide turned and the business didn’t perform you simply stopped commenting on it.

      • Hi Brent
        When the tide turned, Roger simply unloaded MCE, which he has explained here several times and shows me that he is on top of his game and a big lesson that all of us have to learn if we’re going to be successful in investing. There is no reward blaming Roger for our own shortcomings, after all he is giving everyone here a leg up not a hand out. I personally think there would be more to be gained discussing and learning to recognise the signals that affect any stocks that we may hold. I remember thinking when Roger first raised the concerns about MCE’s cashflow what effect that would have and not knowing didn’t do anything about it, but I’m not about to blame Roger as I’m in charge of my own destiny and if we don.t make mistakes on the way we won.t learn. Besides it’s not over yet if Mce gets a few orders in their order book it’ll be all on again.
        Looking forward to skaffold Roger

      • Hi Brent,

        I also wrote about it and commented about it here. “Push hard”? I don’t push anything and as I have repeatedly explained you must do your own work and seek and take personal professional advice because I am under no obligation here to keep every stock mentioned up to date. Other fund managers own MCE – have larger stakes than I ever did – and still own it. Arguably bigger supporters of it than me. It’s worth remembering in investing that when the facts change, so should your conclusions.

    • A said the future was so bright he had to where shades. He must have ditched the shades and is now carrying a torch.

      We all make mistakes. I think Buffett said if you didn’t make mistakes it wouldn’t be any fun.

    • Also interesting that MCE’s profit downgrade was included in their AGM presentation, and not released as a “Price Sensitive” announcement. Either MCE management aren’t too sharp, or they did this deliberately. I will go with the former for the time being.


  6. Roger,

    Just a simple question if I may from a beginner.

    Why were you buying COH in the $50s when you had a valuation in the $30s?


    • Thanks Paul. Its a high quality company that has ‘never’ traded below intrinsic value. Well, not my conservative estimates of value for it anyway. We average down with our eye on current valuations and forecast valuations. Cochlear is arguably the very best A1 of all the A1s. ARB is up there too. I believe I have answered the questions about the different valuations that have been published. One was a forecast valuation made before the recall and the other a more recent ‘current year’ valuation.

      I have also made references to being able to see the past and the future in terms of intrinsic values for a company, which makes the decision of when to start the process of averaging easier. The closest Cochlear has ever been to intrinsic value was in 2003 – it traded within $1 of intrinsic value. Ever since then its never traded closer, forget about a discount. We have some confidence that one day, markets will become sufficiently dislocated to see COH at a discount but our job is not to speculate about that. The plan is to take advantage of a steep sell off in the price due to a temporary issue. The position is not large because it is the start of an averaging process that will continue if and when the price declines further. COH was recently at a meaningful discount to our forecast valuation and given its quality and the long history of trading at a steep premium to our estimates intrinsic value – we believe the risk of getting this one wrong is slim or even zero.

      A friends has asked if I would like to meet with CEO Dr. Chris Roberts BE (Hons), MBA, PhD, Hon DSc (Macq), FAICD, FTSE, FIEAust, and of course I have said yes. If permitted, I will share any new thoughts here.

      • I recently came across a patient and partner in there mid 30’s who both had cochlear implants. They both had only 1 side implant operations with the previous model and were using a standard hearing aid for the other ear. The partner removed the external device and showed me. Having never seen before, I was amazed. They will both require the other ear implant in the next few years. (the original costs were totally covered by health insurance, and they get a new external device every 5- 10 years under there health fund agreement)

        It was very interesting to learn that adults are having cochlear implants to aid with hearing issues, and not just new born babies which I thought was there main target market. It would be good to know what percentage of sales are for adults vs babies and how this differs in different countries. Could you ask Dr. Roberts if you meet with him?
        Brad S

      • I would be delighted to ask that question and I believe there is an interview with Dr Roberts covering that subject on Radio National (although I heard it repeated on ABC Classic FM).

      • Thanks Roger for the reply. I am just getting the hang of things.

        So in summary do you think it is sensible to buy shares well above value if it is a high quality company.


      • I could never answer that question so broadly. It also depends on the company and on the event that the company faces. And remember we aren’t event even anything close to our desired weighting. An example where we might consider such a strategy is a legal settlement – something we know will pass and which isn’t reflective of the operational strength or franchise strength of the business.

      • It is good to flesh this out.

        I read your book and it continually says to insist on big discounts to value. That is why I was surprised you were buying at big premiums.

        I suppose as you mentioned that there are times when you think you don’t need big discounts.

        Thanks again Paul

      • Hi Paul,

        I can’t speak for Roger but here are my thoughts.

        Firstly Roger’s book is a guide and a good place to start, it is the start rather than the end of the journey. it helps us learn some fundamentals and we can then build our own criteria, style etc from that foundation as we learn more and more about being an investor.

        For me, in the case of COH it is a question of which value are you buying at a discount for and this links directly into what your investing criteria is. I think it is fair to say that COH is trading at a discount to future value, when in the future that is is the question that needs to be answered and whether you are willing (and have enough of a margin of safety) to wait that long if it takes that long for price to catch up to value. This may not be textbook but if i had the cash i would be buying a small portion of COH as i am confident that i will see a return from that investment and that it is still a quality company. I might not buy as much as i would if it was at a discount to my current value.

      • Nice post, Andrew, and by the way, I always enjoy reading your posts, both thoughtful and thought provoking.

        In my humble opinion, COH is a company whose history would suggest that future performance is likely to continue in a similar vein. The recent recall is a negative for the company in the short term (and an opportunity for some to take a position) but is not a sign that the space in which COH operates is deteriorating in any way. The fact that COH has strung together more than 10 years of shareholder enrichening performance without a hiccup like this before, suggests that it is not likely to be a regular occurrence.

        As such I repeat my observation that the recent share price drop was a rare opportunity. COH now is my largest listed investment, and one that I am very comfortable with in the longer term (though I would add that cash is still my largest holding).

      • Hi Paul,

        As Roger mentioned, being at a discount to future IV is a key component. If a company has a long history of trading at a vast premium to IV and falls to a slight premium, there is no point buying it if an acceptable discount to future IV doesn’t exist. Otherwise a considerable risk of trading sideways, a return to IV or unacceptably low returns can occur.

        Even if a discount to future IV does exist, the prospects for the business would have to be understood and be extraordinary.

      • Pat Fitzgerald


        I do not have much confidence in my IV’s and therefore I do not use them when deciding to buy, I still use the broker ‘consensus target price’ to decide if something is cheap or not. COH’s broker ‘consensus target price’ is still above $55.
        I was hoping to subscribe to Skaffold but it is out of my price bracket. So it looks like I will keep using the broker ‘consensus target price’ for a while longer.

      • Great stuff Pat. The important thing is operating rationally and consistently over a very long period of time. Don’t bet the farm on any one investment and you can’t help but beat the masses who aren’t operating that way. Now, about that price, given awarded developers who work for Nintendo, EA Games, HTC, Porsche and Nike, worked on Skaffold and given its data is supplied by arguably the world’s most reputable source, we wanted to make what we think is the world’s best value investing application as affordable as possible but reflective of its incredible quality.

      • Hi Pat,

        Only you know your own individual situation and you have to make your own decisions. None of us have yet seen the full capability of Skaffold but many of us have been following this blog for more 18 months or so and have great confidence in the Value.able approach.

        My own experience tells me that even if I only had $10,000 to invest, a subscription to Skaffold would still a profitable investment. I am not sure what your “price bracket” is but one bad “consensus target price” from brokers might cost you a lot more.

        In any case, good luck with your investing and stay tuned to this blog. I am sure you will read many comments about what other subscribers think of it.

  7. Perhaps WOW (cheapest its been since Jul 08) is starting to nag. It IV has not only caught up with its share price over the last 5 years but has gone past it and is starting to put a few lengths on it, building a nice MOS in the process. I will over the next few weeks start to accumulate parcels of shares if WOW SP lowers below $23.50

  8. Roger, this is not on topic regarding Cochlear but a few reminiscences from my past. Not necessarily for the blog unless you want to post it.

    When I was a youngster, I remember being scared witless. Nikita Kruschev was President of Russian and had placed missiles in Cuba. The third World War was about to start. Stock markets plunged. This was surely the end of the world and a young man named Warren Buffet started a partnership buying stocks.

    About a decade later the Israelis waged war against the Palestinians to claim what they considered was their rightful inheritance. Oil prices skyrocketed. There was going to be a major conflagration in the Middle East. The Arabs would control the oil supplies and the world economies would never recover. And an investor In the USA called Warren Buffet bought stocks as everyone else sold in a panic.

    At the end of the seventies runaway inflation eroded asset values. Gold prices went through the roof. Stocks would never recover and Warren Buffet kept right on buying.

    In October 1987 the stock market crashed. On Black Friday stocks were sold indiscriminately. The Dow fell 32.5% in 3 days from Friday’s high to the low on Tuesday. There had never been such mayhem. You could not get through to your broker on the phone – they weren’t taking calls or making markets. (There was no internet or online trading in those days, or any trading if the market makers would not quote a price). People would never recover from this apocalypse. Yet by August of the following year stocks had recovered all of these losses.

    There have been many other examples during my investment journey including President George Henry Bush’s declaring war on Iraq in 1991. However, the above examples suffice to make the point.

    And now the world’s media are at it again telling us it is all over. In uncertain times we need to remember the past and to cling to the story of the Eastern monarch who charged his wise men to come up with a phrase that would hold true at all times. They presented him with the following “This too shall pass.”

    Richard Branson was quizzed in Auckland last night, on the financial crisis and how this affected companies. His reply: What a fantastic time to start a business: prices are cheaper, labour is plentiful and opportunities as always abound.

    I’ll follow the “Bransons” rather than the economists or the media.

  9. Opportunities to buy into a company as established and unique as Cochlear is (or has been) in the Australia market almost inevitably seem to come at a bit of a premium. History can reveal how much of a premium. No doubt Roger can tell us when, if at all, Cochlear has traded below his IV estimates – I have made a few hindsight calculations in this regard but will not post them here just ahead of the launch of Skaffold!

    One thing I do find useful is to look is historical PE ratio. (Sorry Roger but I’ve found them to be tremendously useful as part of my investment lexicon over the years). From 2001 to 2011, Cochlear’s lowest PER is 16.8. (Using the lowest price at which the shares traded during the company’s relevant financial year). This is, purely coincidentally, both on an historical basis and a “hindsight” forward basis. Analysts’ EPS estimates for 2012 cover a very wide range but the median appears to be around $2.58. At a multiple of 16.8 this gives a value of $43 (and a bit of change) – this is a mirror image of the lowest comparable value at which Cochlear has traded over the last 10+ years if we can rely on the forecast. I appreciate that is a fairly big IF at the moment. My IV number is currently about $40 but will increase very significantly if normal EPS growth is restored in 2012. So I have an IV which is a bit below the lowest comparable price at which the shares have traded in the last ten years.

    How this information is used is largely dependent upon what I think of the company and where I think it may be in five to ten years from now. Does it still have a large moat or has someone found the plug or built a bridge over it?

  10. If I needed a hearing implant, I’d insist on a COH device and I’m not a doctor nor a shareholder.

    My (moot) decision is based on my knowledge of the company, it’s products and it’s history of innovation.

    I see the recent recall as a commitment to quality.

    In 10 years time a lot more people will be implanted with the company’s devices.

    High ROE, good growth prospects, great management and a strong competitive advantage ticks all but one box, at $52 it’s a bit too expensive for me.

    Another go at sub $45 and I write out a cheque.

    • I was happy to pick up COH at $45.99 on 4th Oct especially now its over $60 in spite of claims on IV closer to $45. Interestingly I am still stuck with MCE at over $8 when IV was being stated as over $10 by most value investors (inc my future valuations based on the talk of this community particularly) … most went quiet, not exposing their hand, as the “value” (and the price!) of MCE dropped away.

      I’ll be glad to get along to the ASX hour with Roger in Brisbane to find out when to sell MCE … I’d especially like to know when to sell MCE or is it too late to wait?? Still nothing from the exec even though the Acting CFO bought $130000 worth of MCE shares for his super fund to buy MCE at current levels. So much for no news is good news! So what’s really changed guys?

      • Hi Neil,

        If you can search this site on google for keywords matrix and cash flow you will see that at the half year results I mentioned my concerns about cash flow. It’s an important chapter in Value.able that should not be ignored – I wrote it for very good reasons. We didn’t own any significant number of shares and sold what we had at or around the full year results and I wrote about my disappointment with the fy11 results then. If you are continuing to hold or even if your arent, it must be part of your own strategy. You must do your own research and have your own approach and your own reasons for holding matrix and every other stock in your portfolio. I am delighted to share my thoughts and insights here but you must do your own work and be completely responsible or the stock market is not for you.

  11. One of the best behaviours that we would do well to emulate is to maintain a cash buffer at all times. Buffett commented recently that he wont go below 20 bill or something close to it. Not only does he state that you don’t need debt, but he goes further and has cash on hand.

    Roger has had a lot of cash recently, there are not many with such discipline.

    This is what we all need to work on rather than stock picking alone — managing our overall position.

      • I feel the same impulse Brad, but i am working very hard to force myself to maintain a certain percentage range of cash overall.

        It’s like in the early days of learning basic financial management, most people learn (one way or another) that the foundations of wealth accumulation starts when we spend less than we earn — this is saving. This discipline leads to the funds necessary to invest. I think it is an analogous but more sophisticated form of discipline, at this more advanced stage, to be able to accumulate cash within ones investable portfolio. Waiting patiently for the fat pitch, such as a high quality company going below it’s intrinsic value, is really where a lot of money can be made over the long haul. As an investor, I take a lack of cash for investment at these times as a personal failure.

        In the past I have made two mistakes based my lacking this degree of patience. Firstly, I have paid too much for high quality and my returns have consequently been modest. Secondly, I have dropped my focus on quality to get the ‘cheaper’ companies without realising the risks of big losses when earnings fall over.

        One last detail to add to this idea. One of the main reasons I don’t like to use options to fix this problem — E.g. selling out of the money put options for companies I desire, or call options on current holdings — is that it gives me another excuse to act frequently. There should be periods of time when nothing needs to be done, months that roll by where we let the cash accumulate in our (high-interest) accounts. If we can do this, our investment accumen has risen.

    • There is a perception that Buffett has never used debt, which is not correct.

      For those interested in the subject, it’s worth reading “WARREN BUFFETT AND THE ART OF STOCK ARBITRAGE”, the book by Mary Buffett & David Clark.

      This only relates to special situation deals; in general he’s right to advise that you don’t need debt.

      • I saw an interview with Bill Goss from PIMCO, he said Buffett and Munger came to him for a loan in the ’70’s and he actually turned them down!

        You’ll find Buffett uses debt conservatively and often for a specific purpose such as BNSF purchase. Also, his debt is always funded and at term – no margin loans with moving LVR’s!

    • Hello Andyc –

      Quite a topical point you raise as in mutual fund land a well known value fund-manager has just been caught out. Bruce Berkowitz’s Fairholme fund is rumored to have been a forced seller of his US financials as his 30% cash buffer (kept to pounce on bargains) was eaten up by redeeming mutual fund investors: AUM down from 18B to 9B. Pesky mutual fund investors redeeming cash is similar to a margin call and Bruce’s experience is a salutary lesson to all fund-managers near and far — once the cash buffer is exhausted you may become a forced seller into a falling market at the worst possible time.

      It was just announced yesterday that Bruce and his fellow manager split. At Fernandez’s joining in 2007 “Berkowitz joked that it took him a lifetime to find his own Charlie — a nod to Charlie Munger, Warren Buffett’s longtime partner.”

      No kisses there now.

      Kisses, LL

      • Interesting you mention Berkowitz Lindy, I have been following him recently and have watched with intrigue how he has plowed funds into the likes of Bank of America and AIG on the basis that over the long term they will rise from the ashes.

        I totally agree that this is such a quandary for fund managers since they are at the whims of investors many of which may be invested due to recent performance. Seth Klarman tackles this by only allowing certain kinds of investors and also educating them thoroughly about his approach. I believe Mohnish Pabrai also educates his clients in this manner.

        But probably the most important distinction between these guys and Berkowitz is the consistency of their performance :) Performance matters very much.

        Ultimately this is one key advantage of being a private investor, we can act independently of the crowd.


    Hi Roger
    Sometimes funds just run out.
    After last couple of years there were quite a few “bargains” which have not paid up yet and 4-5% divi return not enough to make an impact on ones portfolio.
    Roger,sometime ago you also mentioned on Sky that COH’s value was in mid $40’s, so buyers are “aware”.
    Many investors dont believe(like you) in stop losses so they have to wait for market to go up and get some decent profits.
    Offcourse when that happens “bargains” will be “bargains no more”


  13. Good and common sense article Roger, i have commented before how i have waited for something like this to happen to Cochlear for a while. Shame it happens in a time where i have no free cash to invest for a while.

    This is a great Australian company (and there are not many of those) and i don’t think the recall changes the business fundamentals in any real meaningful way in the long term.

    Although the recall will affect the company, as long as they fix the problem and it doesn’t continue to happen, than i doubt in 5-10yrs time we will be talking about the recall.

    As for value nagging, my problem is that it has been nagging me at a time when i don’t have the resources to shut it up whilst when i did have the resources, values was hard to come by and i was not clever enough to hear the faint nagging whispers that did exist albeit very softly over the trampling of bulls and irrational optimisim.

    • Not really. I didn’t know the financial impact at that stage so I sat out, anything else and to me it would be speculating. Just because your buying COH without knowing the financial impact of the recall doesn’t mean Its not having a punt.

      • I think Charlie Munger said, commenting on his and Buffett’s success, something like “we don’t do anything really different to anybody else, I guess our guess is just better than their’s”

      • No investment decision is devoid of some degree of guessing
        I think the key is in your first part when you say for you it would be a guess

        I wonder if the stock dropped to $30 whether you would say the same?

        To a broader audience, what would you have thought if the board had come out to say that profit for 2012 was expected to be zero because of recall and re-implantation costs but that they were taking every step possible to protect their patients (as they are currently already doing)? Things would have got interesting then.

        Personally I would have loved it if the profit for 2012 had been projected as zero. I’ll keep praying.

    • Hands up who thinks they should be able to pick the bottom (Me!)
      Though Cochlear DID hit $45, spent one day then headed back north all in an unusually clean V pattern…. where was I?
      The stockmarket is a very bad place for perfectionists: endless opportunites to beat oneself up.

      • Someone well known in investing but to whom I always promised would remain nameless for reasons that will be obvious momentarily said; “leave bottom picking to monkeys”

    • Not me. I was buying from $52 down to $47 and am quite pleased. I missed the day it hit $45 but everyone has to work sometimes. Providing there are no more hiccups along these lines from the company for a bit, I think this dip will have provided a rare opportunity.

      I suppose in some respects, the timing was a little unfortunate. The AGM provided an update not long after the recall announcement and if there had been an extra few weeks before an update on the financial implications there might have been more of an opportunity for the market to fret and lower prices to present.

      • Thank you Grant – great strategy. Have used it myself to ‘build a position’. I believe it’s called Averaging Down and is one great way to deal with the impossibility of picking the bottom…..with one proviso: you have to be confident it’s a great stock that will surely go back up.

  14. Dear Roger
    I know you like Cochlear – you told us so and gave us a $59 valuation however I regard this company still high risk and I am sure investors were not pleased to see their values drop by such a large margin and wiping out a whole year of profits. Despite the recent upturn in price it is not on my radar as a buy. Instead I have concentrated in oversold miners and in 2 weeks bought and sold for a average gain of 10% profit – the market is volatile – high risk and the Chinese are all smiles – well for the near future. The market wont change until the European debt is halved and wiped clean and new rules agreed to and America awakes and the greedy become less greedy – It will happen and listening always.

    • COH is less risky than I once thought: imagine you can’t hear anymore, your desire to hear again is enormous. You’re going to investigate hearing options including bionic implants.

      Cochlear reckons only 10% of prospective patients have been implanted: This is what drives their industry growth and they, despite their recent setback, are far and away the leader due to years of superiour R&D vis a vis their opposition.

  15. I must admit I was tempted to buy some COH, but the whole macro situation had me thinking ‘don’t buy anything now, you fool, a full-blown crash is just around the corner!’ . Of course I’m exaggerating and being facetious, but I obviously wasn’t ‘switched on’ to what was staring me in the face when they were sub $50.

    Speaking of the macro environment, some of you may or may not be aware of John Hussman, a fund manager who publishes regular commentary on all things investment. His latest few have been good reading (and yes, I know it is confirmation bias for us Chicken Littles), but one thing that was suitable to note on this blog was his reference to the use of P/Es when analysing stocks. Use your noodle to find his whole commentary but the relevant stuff was:

    “Investors should recognize that P/E multiples are simply a crude shorthand for legitimate valuation calculations (specifically, the careful discounting of a whole stream of future cash expected to be delivered into investor’s hands over time). P/E multiples subsume a whole set of assumptions regarding the entire future path of growth rates, profit margins, return on invested capital, and other factors. The common practice of valuing the stock market based on “forward operating earnings times arbitrary P/E multiple” is not only misguided – it’s an utterly disappointing display of Wall Street’s willingness to dumb-down the investment process.”

  16. I don’t understand how you can value COH at $59 when a few weeks ago you said it in your ‘Should you be readying yourself’ blog post that COH 2012 IV was $37.25. How can it change so rapidly?

    • Hi Ian, our definitions of recently are different. The $59 valuation is older than the more recent $37. You raise a good point. Where I refer to previous valuations, I should date them. Thank you for pointing out a source of confusion that I will do my best to avoid. I should also refer back to posts from a year and a half ago where I explained that we use multiple valuations that describe a range and also that once thevfull year results are in we switch from 2011 to 2012 valuation. A column may also refer to future valuations too. Dating with work.

      • I made the same observation as Ian. It does beg the question of what rationale was used to purchase COH at $51.30 using value.able principles while believing its value to be $37.25.

      • When you can see the history of a company’s intrinsic value relative to its share price and at the same time see it’s future prospects, it all becomes much clearer. Having said that our hope was that it would become much cheaper and fall below $37, which would have seen us buy our total intended weighting but alas, the impact appears to be about $30 mln on this years NPAT. Perhaps the paragraph in the blog that helps is: “What I do know is that in 2021 we aren’t likely to be thinking about this recall, just as nobody now talks about the Wembley Stadium delays that dogged Multiplex back in 2006.”. I hope that helps. Value changes over the years. Read about the relationship between changes in valuation and book value in Value.able.

      • Thanks Roger. “When you can see the history of a company’s intrinsic value relative to its share price and at the same time see it’s future prospects, it all becomes much clearer.” Ah…Skaffold, yes?!

      • David Sinclair


        Shouldn’t current estimates of the value of a company reflect what is expected to happen in the future? I can understand valuations needing to change as new information becomes available, but if a ‘future valuation’ concept is needed to account for changes that are already expected then I would suggest that the current valuation is flawed. Either that or expected growth is being counted twice: once in the calculation of value (current or future) and a second time when the current price is compared with future valuations.

        David S.

      • Hi David. Thanks for your post.

        I appreciate the sentiment however intrinsic value does change. If your supposition were correct, there would be justification for rising prices only when those prices were below intrinsic value. It is reasonable to assume that the percentage change in book value in any given year, is likely to be reasonably close to that year’s change in intrinsic value and and you need company’s whose intrinsic value is increasing at a satisfactory rate. Time value of money and inflation ensures the current valuation isn’t flawed, even in the presence of projections of what future valuations might be.

      • Perhaps, but if I already know (or have a reasonable expectation) that a company’s earnings are going to fall temporarily but recover in a reasonably short period of time, then my current valuation should take that into account. If I buy at a price above my current valuation and justify the decision by saying that future valuations will be higher because earnings will recover then I am effectively admiting that my current valuation does not take the expected recovery into account, so the valuation method itself is flawed.

        Treatment of (presumably) one-off events like the Cochlear is the more obvious flaw, but the way the method is applied can also be flawed. Of course the value of a business can be higher in the future due to the time value of money, but I am not buying the business in the future, I am buying it now. If my method gives higher current valuations to growing businesses then expected future growth has already been built into the price I am willing to pay. If I then use my formula (which already builds expected growth into the valuation) to calculate a “future value” based on the expected increase in earnings then I am building the growth into my valuation twice, which increases the risk of me paying too much for the business. Growth in value over time is a good reason to keep owning a business as the price increases over time, but I am suspicious about using it to justify decisions to purchase now without a decent discount to the current value of the business.

        David S.

      • Hi Avito,

        As Roger alludes to, dollar cost averaging in unison with Value.Able principles allows investors to begin a position at a premium to IV, with a view to fulfilling their desired portfolio weighting at a discount to IV. In this manner, the average price can be at or preferably below IV. I would be very surprised if the Montgomery Fund had purchased a significant proportion at the $51.30 level. Conducting the DCA strategy from a discounted initial position is ideal; however, for companies such as COH & ARP, opportunities to begin DCA from a discount of say ten to twenty percent are rare to say the least. Value.able principles place greater emphasis on understanding the business than on IV’s and in understanding COH it may be that this is a company with a very bright future. Further, if future IV represents a significant premium to the current price, one could be forgiven for beginning a position at a premium. Personally, I would be very happy to see COH drop to $30 or below, however if it continues to rise I won’t be complaining either.

        Please forgive me if some of this sounds convoluted, I am still refining my understanding of value investing.

        As a side note, I would add that Value has been nagging extraordinarily often over the past few months. Examples would include; COH, ARB, AAPL, GOOG & ORL.

      • I did the reverse dca buying mce in the spp / insto raising at $8.50 with a view to flicking them once issued ….

        Errrrr, that “trade” is now a long term investment!

    • I noticed this also and was trying to get an explanation in a previous post.

      It seems there is justification to buying without a MOS.

      Unfortunately this seems a bit like “watching the market” and expecting that the price will fall even lower. If you fail to get your dollar cost averaging…you’ve overpaid.

      If the company is super high quality, it’s ok to pay more than IV. That’s what I’m learning from this. Or mabe I should ignore how Roger invests in his fund as he is professional…and I should stick to the normal principles?

      I did not buy COH because my current IVs on 10% RR are: 2012 – $45.07 and 2013 – $48.50. If I bought at $50…I would be expecting to wait a number of years to see IV climb above that.

      Those IV’s are based on analyst forecasts NPAT of: 2012 – $162m and 2013 – $175m.

      • Hi Darren,

        You have to develop your own method and stick to it. No method will capture every opportunity and I can feel the angst when my method captures an opportunity that others miss, or worse, an opportunity that others also capture but one that fails to immediately reward, or doesn’t! Consistency is the hallmark of all great investors.

      • I guess because I’ve been in the market less than a year, I don’t have my own method yet. At least not one that is profitable!

        That’s why when I see you investing in something that doesn’t make sense to me (according to what I’ve learned from your book and this blog), I feel like I’m isolated and lacking information.

        I also feel like I’ve made some mistakes since starting on the value investing strategy (such as not buying with large enough MOS).

        I think I need to come to terms with there being no exact “right” or “wrong” way to implement value investing and that alot of it still depends on trial and error and gaining experience.

      • Hi Darren,

        Experience has played a significant part in formulating our process. That experience all tells me to worry less about another investor’s claim of ‘inconsistency’ than I do about returns. Think Buffett’s investments in Coke versus his investment in PetroChina. Our approach is designed to take into account many things, including the possibility that a A1 amongst A1s stumbles without falling 20% below an estimate of intrinsic value that we built to be conservative and which has never been breached by that A1 company.

        Regarding profitability within a year, our own process expects to lose or underperform perhaps three years out of every ten. Indeed if we are true to the value investing principles as presented in Value.able, we should indeed hope for underperformance. That would mean our holdings are not rallying with the market or it could mean they are falling further than the market. Either way, that should mean more time to accumulate at even cheaper prices. We are likely to always have some cash in the account to take advantage of the Cochlear type events.

    • I’ve now had a chance to look back at how the differences transpired. $59 represents a forecast valuation that precedes the downgrades. While also being referred to as recent, it predates the $37 valuation, which is a current valuation. Everyone needs to have their own process and I can’t be responding to gripes by those whose own process dont produce the same result. There are thousands of different stocks purchased by those who all learnt under Ben Graham. I hope Valuable will give birth to a similarly diverse range of processes.

      • Kent Bermingham

        Let the buyer beware, Intrinsic Value changes daily, there are so many variables that can change overnight.

        Roger what happens when a great company like VOC continually produces great results with a low POR thus banking Franking Credits, if they are not anticipating a near future loss when do they pay the credits back to stakeholders?

      • Great questions Kent. There has been some lively debate about this very subject here at the blog. There are several options open to the company. One is to pay all the earnings/franking credits out and replace funds with renounceable rights issues. Another is accumulate until the ROE stabilises or matures…the list goes on. Whether VOC is or remains “great” remains to be seen.

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