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by Roger Montgomery Posted in In the Press.

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Nothing beats living on an island and nothing beats living on an island and owning the only bank. The cozy banking oligopoly that exists on the island of Australia as well as high switching costs for customers has produced all the benefits associated with a wide competitive advantage.

Are you going to bother moving if your bank charges you a few cents more for each ATM withdrawal, EFTPOS transaction or EFTPOS cash-out? With 70 million ATM transactions per month, 150 million EFTPOS and EFTPOS cash out transactions per month and 30 million debit card accounts, a few extra cents charged per transaction and account is a valuable revenue generator for banks with very little additional work or cost and virtually no risk of customer loss.

In the past the banks were all the same from an investors perspective too, but there’s a change in the air. The recent capital raisings have done significant damage to the value of three of the major four banks in Australia.

When ANZ, NAB and WBC were raising capital to shore up their balance sheets, CBA was raising capital to take advantage of opportunities in a distressed market, and acquired BankWest. It shored up its profitability in the process and now has the highest ROE of all the banks at 19% and based on consensus estimates will return 21% on its equity for the next 2 years. This compares favourably with the ANZ (11%), NAB (12%) and WBC (13%).

After two decades, a clear leader for investors has emerged in Australian banking.

By Roger Montgomery, 9 September 2009

by rogermontgomeryinsights Posted in Financial Services.

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The retailer has competitive advantage, high return on equity and no debt, all of which leads to the enviable “profit loop”.

by Roger Montgomery Posted in On the Internet.

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It seems the profits to be made by TPG on the re-listing of Myer will be outsized beyond what has been reported thus far. When a TPG-led consortium purchased Myer and the Bourke Street store, they paid $1.4 billion. Of that total, just shy of $450 million was equity – the contribution by the new owners and $1 billion was debt. Here’s the interesting part… in the first year of ownership, the owners held what you might recall was a massive clearance sale. They also sold the Bourke street store. The sale of the store netted around $600 million and the clearance sale, about $160 million. With the excess cash generated by these activities, the owners received a dividend of almost $200 million and a capital return of $360 million and hey presto, the owners bought Myer and got all their money back in the first year effectively buying Myer for nothing! Whatever the company lists for, subtract a billion to pay down the debt (assuming Myer is listed debt free) and the rest goes straight to the vendors – an infinite return on equity. What will be even more intriguing is whether the company is IPO’d with any debt. The more debt left on the balance sheet, the more of the float proceeds go to the vendors and remember they bought Myer for free.

By Roger Montgomery, 9 September 2009

by rogermontgomeryinsights Posted in Consumer discretionary.

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Roger Montgomery reveals his top picks in the Australian market, with CNBC’s Oriel Morrison. Watch the interview.

by Roger Montgomery Posted in Media Room, TV Appearances.

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Cash in the bank offers better returns than iSoft, which is still trading well above its intrinsic value.

by Roger Montgomery Posted in On the Internet.

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While most buyers and sellers of shares focus on earnings and earnings growth, ‘investors’ take a wide berth around the Profit and Loss Statement and focus instead on the business’ cash flow.

Why? Cash is not the same as profits. I recall the completion of my first year in business and the accountants handed me my first annual report.  Smiling, they said that I should be proud because I had ‘made’ a substantial profit.  Pulling my trouser pockets inside out, I declared “well where is it?”

For many businesses, profits are an accounting construct.  They are the accountants ‘best guess’ about what the true picture of the business is. But business cannot spend accounting profits, it can only spend cash. When a customer buys a product on June 28 the accounts record it as sales revenue. But if the sale was made on 14 days terms, the cash will not be received until the next tax year and even then, only if the debtor doesn’t skip town. So don’t be tricked by a business reporting accounting profits – it can be losing cash at the same time.

If you own shares in a business that reports a profit but does not generate cash on a continual basis, the only thing you need to understand is that you should be concerned.

Take the recently collapsed Timbercorp (ASX:TIM) as an example. Despite the business reporting accounting profits year on year, it was actually losing money for four years in a row.

Many years ago I received a recommendation from a broking-firm’s analyst to buy shares in Southern Dental at around $2.60. The report went on to say that it represented one of the best value plays in the market at the time. Unfortunately, its cash flow materially less than its reported profits so I passed up the opportunity to buy the shares which proceeded to fall below 90 cents.

To avoid these types of businesses compare a business’ reported profits to the Cash Flow Statement. A business that continually pays out more cash than it receives will have negative operating cash flows. If this situation occurs over a number of financial periods then, depending on the cash balance, the cash outflow will need to be supported by borrowings or raising fresh capital. The first increases the risk of the business and the latter dilutes your ownership. Rarely are either positive developments.

Without continued support from bankers or shareholders, a business that continually spends more than it earns cannot survive.

To ensure the ongoing health of your portfolio and avoid companies with an elevated level of risk, seek out businesses that generate positive cash from their operations equal to or greater than the profits being reported.

By Roger Montgomery, 2 September 2009

by rogermontgomeryinsights Posted in Insightful Insights.

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One of the most common questions asked by investors, aside from what stock to buy, is; “is the market cheap or expensive?”

So how can investors estimate what the true value of the market is today and where it might be heading in the future?

Who you ask will determine the answer you receive. Some market commentators, experts, advisers and other ‘helpers’ use the P/E Ratio as their measure of fair value, some use charts to show support and resistance levels and some just make an ‘educated’ guess. It is easy to see why many investors become confused and lose confidence in the views of financial professionals, particularly since the aforementioned approaches have such a poor track record of reliability.

Just as I estimate the values of businesses, you can estimate the value of the All Ordinaries Index. That’s because an index is simply a collection of businesses weighted by their market capitalisation.

Applying the same methodology that I consistently use to value individual businesses to the All Ordinaries Index, I get a fair value for the market of around 4,100 points. At the current market price of around 4,510 points, I conclude that the market is not extremely expensive at 10 percent above fair value but nor is it a bargain.

Knowing this doesn’t help me predict where the market is going to go.  Placing a value on the market or any business for that matter is not the same as predicting its price but without a valuation you’re flying blind and merely hoping the shares you buy don’t go down.  That’s not investing, that’s speculating.

Knowledge of what the All Ordinaries might reasonably be worth today provides confidence about how to act.  If the news is plastered with stories of losses in the stock market and all looks like doom and gloom, and if the price of the All Ordinaries index is substantially lower than its estimated value, its probably time to buy.

By Roger Montgomery, 1 September 2009

by rogermontgomeryinsights Posted in Market Valuation.

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Massive windfalls have indeed been doled out to the institutional shareholders of almost half of the top 200 companies in the last act of a scripted and predictable pattern of debt fuelled overpriced acquisitions, followed by rising interest rates, tightening credit conditions and inevitable asset writedowns. Its our very own cash for clunkers scheme!

The next act however is one that shareholders should watch carefully, lest they fall into the trap of paying too high a price themselves.

Giving a company more money irrespective of whether it is through a rights issue, a placement or most other forms of capital raising is akin to putting more money in a bank account; the end result should be more earnings. And so a company that is the recipient of a billion dollars should – if it is going to beat a bank account – deliver an increase in its earnings of at least 5 percent. If the risks associated with businesses and the stock market as well as the dilution that occurs from issuing additional shares are taken into account the increase should be greater still.

Failure to increase earnings means shareholders have gone backwards.

Of course at next year’s beauty pageant (earnings reporting season), companies that boast about record earnings or otherwise substantial increases, should be reminded by reporters, journalists, shareholders and analysts of the vast sums of additional funds they were given. They should also be told that earnings can increase substantially with little more than a bank account, a generous benefactor and a rocking chair.

By Roger Montgomery, 1 September 2009

by rogermontgomeryinsights Posted in Market Valuation.

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According to Richard Puntillo, in theory, publicly traded corporations have shareholders as their kings, boards of directors as the sword-wielding knights who protect the shareholders and managers as the vassals who carry out orders. In practice, in the past decade, managers have become kings who lavish gold upon themselves, boards of directors have become fawning courtiers who take coin in return for an uncritical yes-man function and shareholders have become peasants whose property may be seized at management’s whim.

When a listed company announces an acquisition, commerciality is often cited as the reason for failure to disclose the purchase price.  But with Australia’s corporate graveyard littered with the write downs of overpriced acquisitions past (think Fosters, Paperlinx,AMP, Lend Lease, RIO and Valad) it is about time that companies treated their shareholders like kings.

By Roger Montgomery, 1 September 2009

by rogermontgomeryinsights Posted in Insightful Insights.

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