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Value stocks are still out there

In the Press, Media Room | Comments (49)

Value stocks are still out there

Roger Montgomery, one of Australia’s most respected analysts says there appears to be value in certain retail and financial services businesses and in the biotech-healthcare sector. Read article

INVEST WITH MONTGOMERY

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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49 Comments

  1. Stuart S
    :

    I happened to stumble across this article the other day, which starkly highlights concerns around my previous investment portfolio – recently liquidated I’m pleased to say.

    http://www.businessspectator.com.au/bs.nsf/Article/fixed-interest-corporate-bonds-equity-returns-pd20110530-HC8N2?OpenDocument&src=kgb

    The reported comments from the unidentified fund manager are utterly appalling.  It’s hard to say whether the lack of competence or the lack of accountability is the greater cause for concern. In either case, the fund manager in question shouldn’t be managing his own money, let alone anyone else’s!

    This scenario would have surprised me a few years ago, but having suffered at the hands of fund managers of this ilk, that is sadly no longer the case. Yet countless financial advisors still recommend them as “blue chip” funds.

    I’m so grateful to have found another way!

    Stuart S

  2. Jeff
    :

    Stephen – great post that appears to be completely in-line with the investment philosophy spruiked by Roger and his disciples on this excellent blog. I agree that market sentiment is likely to be the major contributor to the recent correction but offer the following thought for consideration. Mr Market, being the voting machine that he is, pays no attention to the IV of a company. Buying in a falling market, regardless of value, can be likened to catching a falling knife. No-one is able to pick the bottom, but I would feel more comfortable waiting for evidence that the downtrend is nearing completion, rather than leaping in now and enduring the heartache that inevitably comes from watching your under-priced share drop even further. I don’t disagree with your opinion that FGE represents good value at current prices, but suggest that despite there being one of three outcomes likely from here (share price goes up,down or sideways), there is one course of action that a value investor could justifiably consider: wait and watch patiently. If the price starts to go up, you won’t pick the bottom, but you will get in as the tide lifts the boat again. If the price falls, the value on offer just gets better. If it goes sideways, there is time to get in when the direction becomes more evident.

    Preservation of capital is an important consideration and I have usually found that ‘the trend is your friend’. With that in mind, use Roger’s valuation method to identify investment grade stocks at discounts to IV, but balance short term market gyrations with some technical / trend analysis to assist with deciding when to get in or out.

    • John B
      :

      Alternatively I would say we are well in the MOS territory where it is worth adding small amounts, well aware that the price could fall further. I have added some at $5.90 and at $5.30 and feel quite comfortable about it. The upside of this approach is you don’t have to keep guessing where you might be in relation to the eventual bottom.

  3. Dan S
    :

    An issue that hasn’t been debated on this blog in relation to FGE, is their ROE trajectory in the medium term.

    In the short term, their latest guidance doesn’t suggest declining ROE.

    Given FGE is chasing larger contracts going forward, rather than acting as a sub-contractor on smaller projects, do you think they will be able to maintain 40-50% ROE?

    I believe Gavin has fantastic insight and has given a bearish view previously, but I don’t think his reasoning was explained fully.

    I think their industry leading margins are likely to come down in the medium term, so the issue for me is whether they will be able to compete against the big end of town to generate an order book of contracts large enough to compensate for a smaller clip.

    They do have great cost control, so I don’t see any issue with their ability to compete on pricing. Thus, they would have to demonstrate their ability to execute some of the larger contracts they have won recently.

    I imagine their cash pile is earmarked for fleet expansion so they can handle bigger projects. Or perhaps the growth of their West African presence.

    in relation to M&A, I note that FGE has talked extensively in the past about increasing their exposure to Electrical and Instrumentation engineering, especially in Australian coal country.

  5. fred
    :

    Hi Roger,

    Last night from America Richard O’brian the CEO of New mont Mining Corporation thought for now the gold price will move wildly but he expects for 2012 the price of Gold to be between 1575 & 1650 and maybe more.

    I watched you on Peters show last night and had a question regarding short and long term debt. Where do you find the debt of the short and long debt on both half year and full year reports.

    I dont know about that introduction you received! but the show at the end of the day was very informative and thats what counts.

    Thanks always

    I did know that you decided to buy hold sell without a mention, sorry!

  6. Bret
    :

    Good Day value investors – I was wondering if anyone had suggestions on how to track all the new shares, buy backs and other changes to equity that occurs during the year for a company. I’ve got access to yearly balance sheets but obviously things change which would drastically change your current IV…. Roger how do you track all of this?

    Hope anyone can help me so my IV’s are more accurate
    .

    • Roger Montgomery
      :

      Hi Bret,

      Stay tuned…you will like it, a lot. Don’t go taking up an annual subscription to anything else. Don’t ‘take advantage of pre June 30 deals or ‘beat the tax man’ savings that lock you in for 12 months or more. Just as in investing, patience will be rewarded.

      • Roger Montgomery
        :

        No there’s a thought! A very good thought. What if long term members (and particularly those who were fans of Jane’s Addiction!) were treated like those in demutualisations and received something to say thanks too? A very good idea to consider. Thanks for giving me something to think about Mark.

      • LukeS
        :

        Think big Roger.
        Just like the mature retailers in Australia, a RM subscription IV list will quickly expand to fill the available local market. There are lots of people in USA, UK, everywhere who need your help. They just don’t know it yet.
        Make sure your developers build plenty of flex into your system.
        Where do I send my cheque for the IPO? I want it with no scale back.

      • Robert Double
        :

        You are intriguing as always Roger. I look forward to hearing what you reveal. I am not sure I can meet the Janes Addicition requirement though; stone roses, happy mondays or some depeche mode, then I might stand a chance.

        Robert

      • Andrew
        :

        How can i prove my fan following of janes Addiction Roger.

        I can see the launch of the iPO now with Perry Farrell and Dave Navarro changing one of their songs to be titled “Roger Says”.

        I have no problems reccomending whatever it is to other investors even if i will more than likely pass on joining up. (have to put weddings, honeymoons, first home and soon to be university ahead of online subscription services)

        one thing i have noticed in my time following your podcasts, book, blog etc is that apart from being very good at what you do in funds management you are also very innovatve in your thinking and have a good grasp on how to explain things so i know that the final product will be an absolute leader in the field and will be a great resource for any investor. I wish you all the ebst in your new venture Roger.

        One question, what do you forecast the MQR of this new service you are fofering to be if it was a stand alone business? Think i know the answer but thought i would throw it out there for a bit of fun.

      • Johan van Wyk
        :

        Excellent! What a pleasant surprise to find a reference to Jane’s Addiction amongst all the talk about investments etc. Not sure what it means though – to quote one of Australia’s finest song writers: “We call upon the author to explain”!

        Anxiously but patiently awaiting the new service.

        Regards
        Johan

      • Bret
        :

        Ok…..will wait to see what you come up with. Look forward to it. Keep up the good work.

      • Howard
        :

        Being a software engineer by trade with a side hobby in investing, I am eager to see what your team will come up with, especially since I recall Roger commenting his IT team is the cream of the crop coming from Google, Nintendo etc..

  7. Andrew
    :

    I agree Roger, i think rather than being worried about the market falling it is actually starting to throw up some value. Over the last couple of weeks i have been seeing at least 4 or 5 of my companys fluctuating between being above and below their IV’s. If the fear becomes a bit more of a firend to Mr Market than i think that some of these companys will start developing a reasonable margin of safety. Some of these are big companys too.

    my problem is that my forecast Iv’s show that most have a decline in 2011 IV so i will wait for a decent discount to that IV as it is the lowest of the three i calculate and there for some of these are still above that price..

    Some companys on my watchlist that have been flicking up an element (not necessarily big) margins of safety at various points for FURTHER RESEARCH if you wish are:
    Oroton, Westpac, Vocus, Platinum and JB Hi-Fi.

    Another warning, i am not saying that these are good buys. I am only saying that at some point over the past couple of weeks some have fallen below one, two or three of my IV’s that i calcualted for each company. They may currently be above them now and i am still not happy to buy either if i was in the market as the margin of safety has not yet hit my target to give me authorisation to buy.

    Warning aside, i think this will be an interesting time for the blog as that i believe value is starting to show itself it also means that prices have fallen a great deal and will be interesting to see if people focus on the value or the drop in prices on the market. With Forge it definitley seems to be the latter.

    If the fear reamins than it will be an exciting time for Value Investors.

  8. Matt
    :

    cheers stephen,

    FGE was the first stock I bought after reading roger’s book last july and then bought more over the next month. that decision is still sound. and i sleep fine at night!

    • Andrew
      :

      Congrats Matt, this is what being an investor is all about. As you can see in other posts some others are getting a bit twitchy about the price decline for Forge but you have succeessfully seperated yourself from the market.

  9. Peter G
    :

    Hi Stephen

    First time Blog user but growing follower of Roger and the Blog after reading his book.
    I thank you for your in depth comments about FGE

    I too have topped up my holding.

  10. Grant Duggan
    :

    Nice one Stephen, to me this is just another example of when Roger has said be prepared for when those A1s are offering a reasonble discount,and your patience will be rewarded. A great article as well and very informative.

  11. fred
    :

    Hi Roger,

    I believe I have worked out your Gold pick Roger.

    1/ little or no debt

    2/ return on equity over 30%

    3/ dividend yield over 4%

    4/ fairly low trading type stock

    Am I in the ball park Roger?

    • Andrew
      :

      Hi Fred and others,

      Can we please get off the topic of Rogers gold pick, it has been going on for ever it feels and it doesn’t matter which company he is looking at or buying. Value.able teaches us to find these thing for ourselves and that is what we should be doing, not waiting to hear what Roger is interested in and then buying.

  12. Brad
    :

    Hi Stephen

    Great piece.

    I believe many market players confuse cause and effect.

    EG: Has the price of say, FGE fallen because there has been more sellers than buyers in the general stock market and FGE shares or has something adverse happened to FGE’s business?

    It’s clearly the former, all the brokers I talk to are upgrading FGE’s 2nd half numbers. Step back and listen to the media objectively rather than engage.

    As an aside, for all the China bears, there are 1.2Bn Indians 4000 kms to the west that are growing at >8% pa and only started emerging from socialism in 1991. GDP pp is $2k vs China $4k, Taiwan $20k, USA $50K and Oz $60k.

    At 8.5% growth India will have same GDP pp as China today in 2020. I can’t see either of them turning back, short of a war. They’re gonna need alot of everything.

    Cheers

    Brad

    PS Remember the maxim: “Bad news sells newspapers”

  13. LukeS
    :

    Company: My Net Phone MNF

    When a company has a ROE of 14,541% you have to at least have a look.

    I have been a happy customer of My Net Fone MNF for over 2 years and been watching them as a business since just before I got my copy of Value.able. I like the basic model. I would own this business outright at the right price.

    Things I like about MNF
    – Cash business – they get paid in advance.
    – The equipment needed to run this type of business are a few computers and some little boxes with flashing lights.
    – Subscription customers paying in advance into a growing float
    – A service that is tedious to move to another provider.
    – You have to be very bad to lose customers.
    – Showing no debt but depends how you look at it.
    – Owners have plenty of shares. Looks like they have helped it survive the ugly years by letting related party purchases remain unpaid.
    – Growing equity and earnings
    – Customer base around 88,000 has grown mainly by word of mouth as they had little money to advertise.
    – Cash is starting to flow.

    Things I don’t like about MNF
    – Lots of ugly years.
    – Lots of sales to and from related parties.
    – Tiny company. If you are only making 1 mill then easy to blow that quickly with too many staff, wrong advertising decisions or just too many lunches.
    – Main connectivity service is supplied by outside company owned by 2 directors. It is a single point of failure.
    – Increasing competition

    Some numbers (not in millions)
    – Will probably make a little over 1 million profit before tax from their operations in 2010-2011. They have past losses so not sure how all that works. They are paying no tax on their current profit. I do not understand all this well enough at this stage to comment.

    – They owe related parties about $1.5 mill. They are showing it in receivables but I don’t care what they technically call it. It looks like an unpaid bill turned into a loan with interest to me. They cannot pay it immediately. It will take a few good years to pay down. If we called it a loan then the debt to equity is very poor.

    Equity
    30 June 2010 $13,572
    31 Dec 2010 $536,447

    Prepaid Float
    30 June 2010 $1,004,588
    31 Dec 2010 $1,019,389

    What might it be worth?
    If we forget all the fancy stuff that might happen on a balance sheet with losses and adjustments and focus on the operating business profit of 1 million ish then after tax we are going to be left with 700 to 800k. We should leave some to help maintain growth and take the rest and party.
    I would like to buy that income for no more than $5 mill – around half its current market cap.

    I am not promoting this business. Shares are tightly held and price is a long way off a good margin of safety. I have not attempted a RM valuation yet. I am just getting an overall feel for the business and numbers involved. I am looking forward to seeing their end of year numbers to see if I have any future as a medium. I can feel an increasing profit announcement being channeled through me.

    • LukeS
      :

      I wrote all this before I found a previous discussion on MNF back in February. I see you have some valuations and concerns. Should have done this kind of search first.
      MNF site:http://rogermontgomery.com
      As a business owner I really like VOIP. I am a great case study for voip and the future.

      • LukeS
        :

        VOIP has a very bright future. So bright I feel it may radically affect how and where lots of us work in the future. This is not to say MNF will be the company to follow just voip offers businesses vast benefits.

        Bigger than Ben Hur
        I do internet stuff. A few years ago I setup an online retail business. We have a Sydney CBD virtual office address to give the impression of size and stability. We have a local phone number for each capital city making us look bigger than BHP. These phone numbers cost $30 per year. For $240 we instantly became a natrional business. No call charges for those numbers as they are for customers to ring.

        Work from Home
        We grew rapidly and soon needed some phone staff. VOIP means our staff can work from anywhere with an internet connection. Our shop admin is all online so staff just need some way to view web pages (computer, Ipad, smartphone) and a phone (real or virtual). We have a PABX (virtual) to mange diversions etc. Staff love working from home. We recently had someone leave to have a baby and there was a queue of her friends wanting the job. We can go away for a month or a year and run this from anywhere.
        There are some challenges with training. With technology currently available new staff could watch and listen in on live calls. We could turn those training sessions into permanent training videos. We have not done this yet however it is relatively easy and cheap to do.

        Bright Future
        This model allows us to expand without any regard for physical boundaries. No 3×3 leases, no office kitchen or amenities, no parking problems. It is only limited by our ability to manage it all. We are fortunate our staff do not really need self motivation as the work comes to them. It might be different if the job was outbpound sales calls. Anyone running inbound call centres can tap a wealth of casual and part time “work from home” talent if they put their mind to it. How many of your staff would jump at the chance to save all that travel time and just clock on at 9am from home in their best trackies and ugg boots?

        There has been discussion here before about retail commercial real estate and how online may change future demand. You might like to add the future of commercial office space to your ponderings.

    • David Sinclair
      :

      Hi Luke S,

      When you look at MNF’s ROE it is worthwhile remembering the result you get if you divide any number by zero. To explain what I mean by that, losses are subtracted from shareholders equity in the same way that retained profits are added to it. After enough years of accumulated losses shareholders equity can be eaten away until it is almost zero. At that point even a tiny profit gives an enourmous ROE simply because dividing a small return by something that is next to zero gives a big result. From my brief research, this appears to be the case with MNF. The current small profit may grow into a much bigger profit in future years, but it could just as easily turn into more losses. You have obviously done much more research into MNF than me, so your confidence in their future prospects may well be justified. I am not very good at picking which businesses will succeed in turning profits into losses, so I prefer to stick to businesses that have a history of making profits.

      David S.

      • David Sinclair
        :

        Sorry, that last sentence should have said “I am not very good at picking which businesses will succeed in turning losses into profits”, although there are a lot of businesses that do it the other way around!

        David S.

  14. Gary Burns
    :

    Hi Roger, I agree that there is still value to be found. I enjoyed your book immensely. I haven’t seen you mention Hansen (HSN) which I feel meets your selection criteria, maybe even an A1? Currency risk and the fact that the shares are tightly held seem to be the only downside to me. Can we all try and formulate an intrinsic value for this Company?

  15. Stephen
    :

    Company: Forge Group (FGE)

    I’ve watched with complete and utter fascination, the comments on this blog concerning Forge Group. There appears to be an element of fear creeping into Value Able participants as the share price has pulled back over the past eight odd weeks. It has really made me question what if any lessons some are taking from the subject of the book.

    For those that are panicky about their investment in Forge Group, it may be a good idea to revisit what it was that attracted you to the stock in the first place. I assume in suggesting this that you did a fair amount of investigation before purchasing the business.

    Lets recap:

    Forge is not strictly a business in it own right. It is a holding company consisting of three divisions.

    The first, Cimeco provides integrated construction services to the resource industry covering a range of services such as concrete, mechanical, electrical, and engineering works.

    The second, Abesque Engineering provides a wide range of services to the resource sector, utilising its own in-house resources and those of the Forge Group, covering civil, structural, mechanical, piping and electrical design and construction works.

    The third, Webb Construction (West Africa) provides integrated construction services to mining and resource companies in West Africa.

    Forge offers an integrated service though its holdings allowing them to develop projects from planning all the way through to construction. The model they have developed is called the Forge Hub and is worth looking at. It shows graphically the way the integrated model works and anyone who has subcontracted will tell you, integrated services are far more seamless than flitting between suppliers. The benefits of this are apparent to companies as they can deal with a one stop shop. MND does a very similar type of service allowing it to retain key clients over a long period of time.

    Performance:

    Forge Group has now delivered 7 consecutive halves of increased net profit before tax. Following their most recent announcement, it will be 8. The order book in Feb 2011 stood at about $275m compared to $207m 6 months earlier.

    The strategy of the board going forward is one of restraint and to organically grow the business, rather then take on hasty M&A activity not in the best interests of shareholders. This gives me some comfort as does the fact that even with strong cash reserves in the bank, the board is still not tempted to expend them without a great deal of consideration.

    In the 2011 report, the performance of each of the sectors was examined. Both Cimeco and Abesque appeared to have a strong pipeline of work in play. (I note some comments recently that Forge has failed to announce the next “big” project. I’m not uncomfortable with that given the experiences of Leightons and Downer EDI who have announced project win after project win, then been forced to write down the project and reduce profit because they priced the projects too low).

    In relation to Webb, I note it was not profitable last half as their were project run offs This needs to be monitored by investors in the coming months to indicate if there is an upturn in West African business for Forge Group.

    A look at some of the metrics over the past years shows a steady increase in revenue and net profit before tax. EPS is also growing at a linear rate. For those interested in DPS, an increasing return. ROE stands around the 34% mark with the DIV POR around the 19% mark. Being a business relying on capital expenditure the latest figures highlight the costs of extra plant and heavy equipment that needs to be factored in to the profit figures (about $9m). Potential investors should consider this when looking at the suitability of this company for their portfolio of businesses.

    The Balance Cashflow analysis I have conducted for the 2009/2010FY shows the business cash flow positive in the amount of around $17.2m.

    And the latest announcement shows a profit upgrade.

    All of the information I have written above is available from an examination of the companies reports and announcements and balance sheets. It’s what I used to determine the suitability of the business to me especially when I bought part of it some months ago.

    To me Forge has and continues to have the following outstanding attributes.

    It has:

    -A proven background of growing EPS, DPS, and Eq/share.
    -It has a conservative management team which appears to be handling my money in a responsible manner.
    -It has gearing of 7%
    -It is cash flow positive and has significant cash reserves.
    -It has a growing order book
    -It has the unique Forge Hub model
    -It is in an area that according to the latest ABARES report will see an enormous amount of expenditure take place
    -It is established and experienced, and
    -it is generating excellent returns on equity that are consistent

    Like any good investor I continue to get to know my business. I am watching the performance of Webb. I am looking forward to the appointment of a new Executive Chairman (with due respects to Mr Hutchinson), and I am looking forward to some of the implied benefits promised through Clough (a weakness, I concede).

    As an small retail investor I only have a finite number of investigative resources available to me. They consist of company reports and announcements, comments by industry participants and comments from media. I must take the time to study them all.

    From my study of the company reports, from my study of media comment, and from my consideration of recent comments made by Mr BELL (to one of our bloggers), I see no reason why the share price of FGE has dropped other than market sentiment.

    To those of you that are selling your parts of the company, just make sure you’re not panicking. If you believe truly that something smells bad, then by all means share it with us and exit your position. If you are riding in the back of market sentiment, stop, revisit the business, share your thoughts then take your action.

    To those of you who just sell because….well….the share price is going down, thank you. You provided me with an opportunity to purchase a small package the other day for about $5.49. Note that I didn’t get it the day after at $5.30 odd, because I don’t care. At $5.30 or $5.49, it’s a great discount.

    Stephen

    • Ron shamgar
      :

      Nice post Stephen. FGE has been a quality business so far. Let’s hope it stays that way in the future and it would be nice to see some major contract win sooner rather than later. Cheers

    • Craig B
      :

      Stephen,

      Thanks for that. Great effort.

      I’ve only ever owned shares in 11 businesses, but never has one of those sat on such a mountain of cash relative to their assets. I see the report at the end of this financial year as a pivotal moment in the history of Forge.

      What on earth will they do with the net $80 million cash they’ll likely have on July 1?

      That’s roughly $1.08 per share!

      The relatively small dividends the last two halves suggests they have plans for it.

      I wonder if any blog participants can shed some light on what those plans could be?

      Also, I wonder if the board/management at Forge has any form in the acquisition department at other companies?

      Particularly form in paying too much.

      • Craig B
        :

        My poor maths does not bode well for a market participant.

        96 cents per share would be more accurate.

        Still a mountain.

    • Michael H
      :

      here here Stephen. I completely agree with you and I have taken the same course of action in preceding days. These irrational movements of the market become buying opportunities. Markets do not move in straight lines and in some instances even good quality companies move with the gross market sentiment. Having a sense of the value of the business provides a basis for comparison and ultimately the confidence to block out the background noise and buy value as it becomes too compelling to ignore

    • Jonesy
      :

      Well done Stephen, although it seems we were both going for the same shares, as I topped up at $5.48 as well. Please, let us all do justice to the hard work that Roger has put in and not let him down by panic selling when the prices of our investments fall. Just remember, we must consider ourselves to be part owners of the business, in for the long term, rather than speculating on the price of stock going up. If the fundamentals of the business remain sound, then if Mr Market wants to sell you more Forge shares at $5.20 or even less, then buy them off him. In the words of WB, be greedy when others are fearful, and fearful when others are greedy.

    • Phil Harmonic
      :

      Thanks for that Stephen, great analysis. I will definitely be looking closely at this business, After seeing it drop 4.82% today, one can’t help but think that it has presented a more enticing opportunity. Also, purchased my FIRST SHARES EVER today, MCE @ 7.25 a pop. Very exciting times for this young whippersnapper!

      Also, first blog post, nice to be here.

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