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“What would you say about my portfolio?”

“What would you say about my portfolio?”

Its a question I have fielded innumerable times since selling my funds management businesses and leaving them as well as the investment company I listed on the ASX.  I am not in a position to answer it – having had 8 months of R&R since leaving, but I will let you know when I am.  It occurred to me however that most investors already have an established portfolio.  Those who are approaching or have entered retirement may have a large number of stocks too – although sometimes more a ‘museum’ than a portfolio.

When I am asked on air, often without notice -by Paul Turton on the ABC or Ross Greenwood at 2GB or the Peter, Richard or Nina on Sky Business – what I think about a company, I will detail the price, the intrinsic value, the ROE, the debt and whether I believe that the intrinsic value will be rising by a decent clip in coming years.  These are the things that I believe are the most important determinants of an investor’s return.

How then do investors with established portfolios respond?  What does one do, if for example, I believe a company is trading above its intrinsic value or is of an inferior quality to something else?  My concern is that an investor holding the stock may sell.  It may come to pass that this was the right decision, but there are many things to consider first.  And there is also the possibility that selling would be the wrong decision.

(Most importantly, don’t act without first speaking to an advisor who is familiar with your circumstances and needs.  You must not rely on my musings – they could change in a moment and anyway, they relate only to me. My thoughts here are “insights” into the way I think about stocks and they don’t have you in mind.)

By way of example, suppose you purchased the shares of a particular company many years ago at a significantly lower price than today’s price, rendering the yield now irreplaceable. What I mean, is that you bought the Reject Shop back in 2004 at $2.40.  The yield today is more than 25% on your purchase price.  And, what if the value is expected to rise to the current price in the next two (or three years)?  In this scenario, while it might seem a long time to wait for the value to catch up, it may be that the yield (based on the purchase price) is sufficient to warrant the wait.  Your personal circumstances are always relevant and on air, or here, I cannot know what your circumstances are.

Of course, what I can do here is take a hypothetical portfolio and detail the quality, the value and the prospects of each company – all of them companies I have received from you multiple requests to value – based on my own approach.  It is the same as the detail I provide on my own Valueline portfolio in the Eureka Report for Alan Kohler, which I have now been publishing for eight months.  From here, the hypothetical investor could approach his or her financial adviser and have a chat about their circumstances, armed with additional and relevant information about some of the topics covered in that meeting.  If the adviser suggests the sale of stocks with losses for example, the investor so armed, can propose a response that involves selling the stocks (after receiving the advisor’s approval) displaying the highest premium to intrinsic value or with the least attractive prospects for intrinsic value.  Alternatively of course the advisor may recommend a completely different approach for you to take.

So here is a theoretical portfolio:

Mr XYZ’s Portfolio(intrinsic values can change at any time as more information becomes available)
Company name Price Intrinsic Value Forecast Intrinsic Value

(above current price/above current value)

*If you believe analyst’s forecasts for sale,production and profits

2yr forecast ROE range

>20% preferred

Net Debt/Equity

<50% preferred

AMP $6.25 $4.98 no/yes (2012) 34%/36% N/A
ANZ $20.81 $17.73/$23.68## yes/yes (2012) 12%/16.4% N/A
BHP $41.50 $36.44 yes/yes (2012) 27%/32% 14.4%
Connect East $0.44 $0.00 no/no (2012) -2.2%/-5.9% N/A
Fortesque $4.76 $2.09 yes/yes (2012) 33%/46% 210%
Leightons $37.92 $32.18 yes/yes (2012) 24.6%/25.2% 34.3%
NAB $24.88 $22.12 yes/yes (2012) 11%/15.4% N/A
OZ Minerals $1.01 $0.06 no/yes (2011) 2.9%/9.4% 33.8%
RIO $69.88 $42.01 yes/yes (2012) 17.8%/20.4% 182%
Skilled Engineering $1.72 $0.66 no/yes (2012) 7.4%/11.8% 114.4%
Santos $13.31 $3.59 no/yes (2012) 4.3%/5.2% 19.3%
Suncorp $9.01 $5.18 no/yes (2012) 7.5%/8.5% N/A
Transurban $5.23 $0.25 no/yes (2012) 1.5%/3.6% 113%
Telstra $3.27 $3.12 yes/yes (2012) 31.6%/32.4% 130.7%
Uranium Ex. (UXA) $0.05 $0.00 no/no (2012) n/a net cash
Wesfarmers $28.45 $11.24 no/yes (2012) 6.3%/9.4% 14.7%
Woodside $43.03 $26.42 yes/yes (2012) 12%/20.7% 40.5%
CBA $52.84 $46.86 yes/yes (2012) 18.3%/21.2% N/A
Myer $3.32 $2.76 no/yes (2012) 20.6%/23.5% 173.8%
Bluescope $2.60 $0.53 yes/yes (2012) 2.9%/10.6% 13.3%
Alesco $4.32 $1.88 no/yes (2012) 5.6%/8.6% 29.8%

##Read the following comments about the valuations:

We’d all prefer intrinsic values that were cast in stone. Unfortunately, they’re not. The valuation depends on the input so to be safer, I always run my model using two data sets. Importantly, I only run ONE valuation formula. One valuation is based on estimates for next year’s result and the other is based on a continuation of the historical performance of the company. It gives me a ‘max’ and a ‘min’ – a kind of ‘range’ of valuations and that which Buffett has always advocated. The ‘historicals-continuing’ valuation version is useful where previous results have been volatile. The other reason for having this version is that I simply cannot get access to some companies or there are no analysts covering it – they can’t get access either or don’t want to, and so that’s when I have to use some progression or variation of past performance continuing. It’s the only way to get a valuation estimate for some companies. The idea is not to be perfect but to protect capital and do better than the market.  For example ANZ’s valuation based on a continuation of historical performance is $17.73, but based on forecasts is $23.68.  My preferred method of investing would be to buy at a discount to the most conservative valuation but if I can’t get that and valuations are rising strongly in future years I might invest a smaller proportion of my portfolio in first class business at a substantial discount to the upper valuation.

I would be interested in hearing what you prefer to see. Would you prefer to see 1) the most conservative valuation only, 2) the valuation based on next year’s earnings forecast 3) based on the continuation of the historical performance of the company, or 4) both? Feel free to vote. What I like to use myself may not be what you want to see.

Now, a couple of warnings.  Firstly, these valuations can change at any time and I may or may not update them here on the blog.  A company, for example, could announce a downgrade and the valuation would drop – potentially precipitously and I will probably busy doing something with my own portfolio(s) so do not under any circumstances rely on or expect these valuations being kept up to date here at all.  Second, my forthcoming book contains the information you need to calculate intrinsic value the way I do, so rather than ask me how I arrived at a valuation above, please wait for the book.  Third, don’t act on this information (which can and is likely to change without warning and without notifying you) – seek a professional advisor’s recommendation, preferably someone who knows you, your financial circumstances and needs.  Finally, valuing a company is not the same as predicting the direction of its shares.  Just because a company’s shares are lower than my valuation, does not mean the shares will go up. Conversely, a price that is well above my valuation doesn’t mean the share price is going to fall.

Having said all that, I hope you found the theory and exercise stimulating and thought provoking.

Posted by Roger Montgomery, 12 February 2010.



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 am new to your blog and was just reading through the comments – where can I find the following 2 courses that you’ve mentioned – “There are only two courses you need to take in order to succeed in the stock market; the first is; How to Spot a Great Business and the second is; How to Value a Great Business Complete these two courses and you will navigate your way with ease through all of the broker/analyst suggestions as well as through depressed and the euphoric markets.” ????


    • Hi Lynny,

      My apologies if the comments were taken literally. There’s no such courses but those that you must construct yourself. Its a metaphor for the the work you have to do= and the way you have to think.

  2. Roger
    I am very concerned about your comments re Oil Search as I have some of my live savings in it, bought at $5.70. The macquarie research paper has it at $8.30, yet you value it at $1.15.
    How can this be?
    We investors don’t have time to analysis all this information. On page 9 of their research is a detailed NAV by segment. It appears comprehensive.
    Can you look at it and comment on difference. I can send it if you give me your email.

    • I receive all the research so thank you for offering to send the research you have but there’s no need. I skimmed over the OSH research notes I have received in the last two weeks and Deutsche Bank research analyst John Hirjee has a USD$5.49 valuation on OSH. He might be right.

      That aside, it seems most analysts are forecasting returns on equity of low singe digits – less than the rate of return on a bank term deposit. At first glance that is not attractive. If an investor is seeking a return of, lets say 12% for $1 of equity, and that dollar of equity is producing a return of 3-5%, the only sensible price to pay for that dollar of equity is a very steep discount. Each share has $2.36 of equity so the valuation must be less than that.

      Please note that my valuation IS NOT a forecast of the share price. The share price could double or triple or halve – I don’t know. I am singularly awful at predicting share price direction in the short term. All I can tell you is what I think a company is worth based on its economics.

  3. I think valuation now, and valuation progressively 1, 2, 3, years out is good.
    If the valuation goes down inadvertantly, we generally hear about it, but, and , we understand this can happen.
    Keep up the good work.
    Sincerely Allan Barnes

    • Hi Allan,

      Thanks for the input Allan. Its great to see everyone so interested in my valuation approach – admittedly it has worked out ok.

  4. Hi Roger,

    Firstly thanks for the great site and your advice. I am eagerly awaiting the book. I might add my 2 cents worth.

    I think Dremen’s Contrarian Investment Strategies – The Next Geberation and Greenwald’s Buffet and Beyond are 2 first class books on value investing.

    A weekly online newsletter would be wonderful. Up to $1,000 per annum fee would be reasonable. As an aside, when my wife complains that I buy too many value investing books, I simply point to the profits generated by using the value approach and the simple fact that many people are still “down” when we are well in front.

    I have recently read “Wall Street Revalued” by Andrew Smithers. He discusses ways to value the market as a whole.

    My question is if I am thinking about investing in an undervalued company (say BHP for example) in the market which is overvalued (not unlike the present situation) should one consider waiting? The reason I ask is that if the market drops and institutional investors are required to sell in order to maintain their ratios, then any “blue chip” would more than likely go down in price thus presenting an even greater margin of safety.


    • Hi Steve,

      I look at BHP’s share price and given its exposure to the commodity business,would demand a much larger margin of safety. In the mid 1990’s I saw first hand a sky and horizon filled with cranes in Malaysia, Indonesia and SIngapore. In KL I remember an interpreter telling me how many offices were being built and I asked what the population of KL was. It was obvious that the entire population of the city would not fill those offices. That visit was followed by the Asian currency crisis and the fall of the ‘Asian Tigers’. In Florida in December 2007, I saw houses being marketed on billboards with the message “Make us an offer, no reasonable offer refused” and “50% off, out they go”. You know what then happened in 2008. In China there is currently 30 billion square feet of residential and commercial space under construction – thats about 22 square feet for every man, woman and child in China. Add to that the fact that based on average household incomes, an apartment in London represents 8 years, New York about 11 years but Beijing 33.9 years and you get a sense that a property bubble in China exists. You can’t help but think of all the demand for building materials that exists now, cannot last. Then you ask yourself, who in Australia sells a high proportion of their building materials (steel, cement, glass and aluminium or the commodities to make them) to China and you can be cautious enough to want a very large margin of safety.

  5. Roger

    Just as a matter of interest are the calculations of intrinsic value that you have been recently posting based upon other methods or have you come up with a different formula?

    • Hi Peter,

      I have received a few posts that promote other websites.

      To remain independent – as I am now, I cannot mention them.

      In answer to your question, I have developed an entirely new and original formula that produces very different valuations to anything else I have seen or used before. You will need to reach your own conclusions. If you read my articles here and in the Eureka report – you may click on the MEDIA ROOM tab at the top of the Home Page and select OFF THE PRESS, and you will find articles about Wesfarmers, Myer and Telstra. You may also hear about me talking about Telstra on Peter Switzer’s show.

      If you type “MYER” into the search box at the right hand side of the blog site, you can find any posts that mention Myer.

      In late August last year I wrote of Telstra (share price at the time $3.40); “…this is a business that is currently earning the same profit that is was earning at the turn of the century, whose return on equity is still not back to where it was a decade ago and whose rising return on equity is due to equity falling rather than profit growth. This latter fact stems from the policy of paying dividends far in excess of profits. Moreover, the company is a capital-intensive one – just look at the $24 billion of property, plant and equipment on the balance sheet. Further, borrowings of $17 billion are well in excess of the $12 billion in equity, which in turn is boosted by $8.4 billion of intangibles, a combination I simply prefer to avoid. Having said all that, the shares might simply go up. To those who buy or have bought the shares I hope they rise, but don’t call yourself a Buffett-style investor.”

      In September 2009 for the Myer Float I wrote for Alan Kohler: “In estimating an intrinsic value for Myer, I will leave aside the fact that the balance sheet contains $350 million of purchased goodwill and $128 million of capitalised software costs. This latter item is allowed by accounting standards but results in accounts that don’t reflect economic reality. Historical pre-tax profits have thus been inflated.
      I will also leave aside the fact that the 2009 numbers and 2010 forecasts have also been impacted by a number of adjustments, including the addition of sales made by concession operators “to provide a more appropriate reference when assessing profitability measures relative to sales”; the removal of the incentive payments to retain key staff – not regarded as ongoing costs to the business; costs associated with the gifting of shares to employees; and, most interestingly, the reversal of a write-off of $21 million in capitalised interest costs – all regarded as non-recurring. Taking a net profit after tax figure for 2010 of $160 million and assuming a 75% fully franked payout, we arrive at an owners’ return on equity of about 28% on the stated equity of $738 million, equity that could have been higher after the float if $94 million in cash wasn’t also being taken out of retained profits. Using a 13% required return, I get a valuation of $2.90. Looking at it another, albeit simplistic way, I am buying $738 million of equity that is generating 28%. If I pay the requested $2.9 billion for that equity or 3.9 times, I have to divide the return on equity by 3.9 times, which produces a simple return on “my” equity of 7.2%. For my money, it’s just not high enough for the risk of being in business.
      Importantly, the return on equity – based on the simple assumptions that three stores, each generating $40 million in sales will be opened annually over the next five years and that borrowings will decline by $60 million in each of those years – should be maintained. But the end result is that the valuation only rises by 6% per year over the next five years and delivers a value in 2015 of $3.90: the price being asked today. My piece of Myer is a bit hot for my money.”

      In the press at the time of the float I offered a current valuation of $2.90 but like Telstra there is probably not a price nearby at which I would buy it.

      Now, I don’t know what others have said about these shares or companies, nor whether they have bought them for their own investments but if they did or produce different valuations, the only conclusion must be that the valuation methodology is substantially different.

  6. Hi Roger,

    Personally i would like the following;

    1) Online access
    2) don’t need iPhone
    3) Once a week
    4) between $300 – $1000
    5) per annum for all companies

    I think you should keep it simple at first and if it proves to be popular then add extra features like iphone, alterts etc. To get a better view of what people are looking for wny don’t you conduct an online survey. There are many free websites that can help with this so its shouldn’t cost you a thing except for a bit of your time.

    I really hope this something that you pursue and that you can find enough demand to a create a viable business model from providing this service. Its definately something that Australia investors need and plus it would be a good follow up to your book.


    • Thanks Mark.

      I appreciate the effort you have put in and the suggestions. As Netj.com said in their November 1999 prospectus : I “have no plans to conduct any substantial business activity of any description…”

  7. Hi Roger,

    I’m a fairly new investor and i have been following your blog for some time now and i find your articules to be quite informative. Over the last 2 years i have tried many different strategies some with disastrous results and i came to the conclusion that share trading is not for me and that i should be investing not speculating. Since this time i have tried to educate myself by reading over 15 investing books and one of the biggest hurdles that i have come across is obtaining all the information used to calculate a companies intrinsic value. I am planning on buying your new books since i am still in learning mode but i am hoping that your books also provide references where the information can be obtained to easily perform these calculations.

    Also understanding what you are doing is one thing, the other hurdle is actually finding the time to do this on a regular basis so that you can buy stocks when they are below their true value. I’m sure that many people would love you to post your valuations say on a weekly basis and would even be willing to pay for this information. Have you thought about doing something like this?

    I have also found there here are many US web sites that provide value caclculators that can help you decide whether a company is good value but unfortunately they only value US stocks. I could not find any such calculators on australian web sites which is a pity as i thought this would be a useful tool that would benefit the time poor people like myself. Have you thought about providing your method to value companies as calcualtor or tool on your website or on the eurekareport.com.au site which you publish articles? Again i’m sure many people would like to see this.


    • Hi Mark,

      The information you seek is not hard to come by but I suspect what you are really looking for is convenience. The safest source of information at this stage is the annual reports of the company. I show you the short cuts to get the intrinsic value, returns on equity etc from the annual report. These can be downloaded free of charge from the ASX website.

      Regarding the valuation services available overseas, I have seen quite a few but when I run my calculations over the same stocks, I get very different intrinsic values and so I would rely on them. Its important that you understand the valuation mode they are using and satisfy yourself that the model is reliable and not inconsistent with a rational and logic approach.

      Your proposal for a regular intrinsic value service either via a newsletter or online is a good idea and you have piqued my curiosity. I have a bunch of questions for you:

      1) How would you use such a service? Newsletter in the mail or on line?
      2) Would you use it on your iphone?
      3) How often would you need to look at it?
      4) What do you think is an appropriate price range for it?
      5) If it was online, would you expect to pay each time you downloaded a company for review or per annum for all companies?

      There’s no agenda; it would be interesting to know what you’d like and I can do a spot of digging to see if anyone can deliver what you need. I would be curious to hear everyones’ thoughts on what they are looking for and need.

      • Hi Roger,

        My 2 cents worth.

        1) I would want online access
        2) I don’t need instant information, so access via my phone is not important
        3) Once a week would be enough (maybe a weekend wrap of anything signficant that occurred throughout the week).
        4) Appropriate price would be that which compensates you adequately while providing good value for value investors. Around the $1000 mark maybe.
        5)I would suggest per annum for all companies.

        What I would like to see is a weekly online newsletter which includes some educational material (using real-life examples) and which provides portfolio recommendations. Maybe you could include a core portfolio of ‘Stars’ which are the best of the best businesses and an alert system when any of these became undervalued or significantly overvalued. You could also have a satellite portfolio of ‘Promising Stocks’ that show potential to become ‘Stars’ but don’t yet have a long enough track record.

        I have emailed you once before about this Roger and feel there is a real gap in the market for such a newsletter based on value investing principles.

      • Hi Tim,

        Really thoughtful synopsis. Thank you. I really like the idea of a ‘best of the best’ with alerts and Promising Stocks as well.

      • Provided there is an open explanation of how intrinsic value is modelled, then it would be a good idea. If everyone uses the same model, then why should everyone go through the same routine accessing the same information to arrive at theoretically the same answer? Do it once, honestly and openly, then disseminate widely for a small fee – the price of convenience. I view calculations of intrinsic value not so much as a way of making money but as a way of not losing it.

        With that,
        1) Online
        2) iPhone unnecessary
        3) Look after price-sensitive announcements
        4) Price by hours spent on analysis, trust-based.
        E.g. short statement on irrelevance of an announcement, 5 cents (hey, if the customer already knew the announcement was irrelevant, he shouldn’t need to download the report), more lengthy week-long analysis, $10-$50 per report depending on subscriber base to that stock.
        5) As a customer, per download.

      • Great stuff John.

        I just read your thoughts again. Thank you. What did you mean by “depending on subscriber base to that stock”?

      • As mentioned, I see calculations of intrinsic value as being most useful at protecting one against (substantial) loss. It follows that I would refer to the intrinsic value whenever I am deciding whether to buy or sell a particular holding. Now with the idea of a valuation service, it makes sense to focus most of the energy (and spread the costs) on businesses that most of the crowd is already interested in. However, there will be some people (as myself) in stocks with minimal analyst coverage for which we might like a second [intrinsic value] opinion whenever a particular price-sensitive announcement crops up.

        So it follows that an hour spent on a stock that e.g. only 10 people are interested should attract a higher price per person than the same hour spent on a stock that 1000 people are interested in. Otherwise, it makes more sense to spent that precious hour on the more popular stock (for the same price/person) without giving the minority a chance.

        There will be people (like myself too) who want to hear about hidden stocks trading at prices well below magnificent intrinsic values. Same approach as above, with a suitable price/person for setting aside time otherwise spent elsewhere.

        So in referring to a “subscriber base”, I am thinking of members indicating, before actual work begins each time, whether they’d be interested in getting the intrinsic value updates on particular stocks/themes (?).

        I appreciate that bundling/package subscription is a popular preference and a simpler solution (most investor services use this model). My particular preference can co-exist with the bundling approach, and the second option will likely be the most affordable one.

      • Hi Roger,

        In answering your questions…

        1) Mail or online? Online
        2) iPhone? Deliver it in as many different formats as possible/worthwhile. People like to consume content in different ways. I’m not sure what you have in mind but I love (an not I’m not overstating it) my iPhone.
        3) Frequency? Probably weekly, on a rolling basis, with special alerts, if necessary.
        4) Price range? At top end of what’s currently available.
        5) Payment? Offer full access on a monthly renewable basis. If you are able to produce quarterly/half-yearly reports then charge (non-regular subscribers) for those as well (at a higher rate) on a download basis.

        All the best.

      • Hi MX,

        Thanks for the feedback. Interesting stuff. I like the alternative payment methods for members and non-members. Please note that I am not currently in a position to be able to assist with these suggestions but of course I will let you know when I am.

  8. Hey Roger,
    I was wondering whether you employ hedging techniques to cover downside risk?
    If you do what things do you do?

      • I will stay tuned ;) I am still new to hedging and I’m finding it difficult to be consistent and avoid speculating. I was hoping you had a nice simplified way to hedge a portfolio (apart from holding cash).

  9. Hi Roger,

    In your table on this post you have Santos as having an intrinsic value of $3.59. I recently bought Santos for around $13 and am in a mild panic.

    Is the $3.59 a typo? Should the intrinsic value say $13.59?


    • Hi Ash,

      Just because my value is so much lower, it doesn’t mean the value cannot rise. Also, my valuation is not a prediction about the price direction. Shares can remain overpriced for a very long time. It took Tesltra a decade to fall from $9.00 to my current valuation of $3.12. I do apply my valuation model across all companies without fear or favour and the value is not a typo. Santos is expected to earn between $200 million and $300 million over the next couple of years and on $5 billion of equity that amounts to a return of less than 5%. When the equity produces a return that is less than your required return, the only sensible price to pay is a discount to the equity…hence the valuation coming in at a discount to the equity per share.

  10. Hi Roger,

    Love the idea & would like to see both valuation methods in your sample portfolio.

    It may be a little too late but can you please add QBE to your portfolio, if not can you please share your thoughts on its prospects and current share price?


    • Hi Paul,

      Thank you for the feedback. I will do my best to get QBE covered. It a little down on the list at the moment but should be able to cover it in coming weeks.

  11. Dear Roger

    I am considering the ROE measure, and I was wondering whether you can comment on the following anomalies with the ROE measure:

    1. Integrity of balance sheet eg Satyam;
    2. High debt levels inflating ROE;
    3. Businesses where profits have no direct correlation with capital employed eg hedge funds (this is an idea I stole from David Einhorn).

    Your approach makes sense from a business owner perspective, and I look forward to your comments, although personally, I prefer to use operating cashflow as a measure, rather than accounting earnings.

    • Hi Peter,

      Great questions. Here are my thoughts.

      1. Integrity of balance sheet eg Satyam;

      Satyam was a special example. Cash was inflated by 50.4 billion rupees (US$1.04 billion). Accrued interest of 3.76 billion rupees didi’t exist. A liability of 12.3 billion rupees due to funds arranged by the chairman were understated. And debtors were overstated by 4.9 billion rupees. The company also inflated revenue by 6 billion rupees to 27 billion and so the operating margins of 24 per cent were actually 3 percent.

      But this occurred over several years and I understand PwC delegated its audit services. The HIH royal commission recommended the mandated rotation of audit partners every five years and Clerp 9 rotation requirements I believe commenced in July 2006.

      2. High debt levels inflating ROE;
      Yes a problem. So avoid companies with lots of debt. Very simple to do.

      3. Businesses where profits have no direct correlation with capital employed eg hedge funds. The best businesses because extremely high returns on equity. I only see a problem if you don’t like the number.

      Regarding cash flow. I agree with you and thats why its best to look at companies whose cash flow exceeds or at least matches accounting profits. ABC Learning for example, never reported positive balance sheet cash flow
      I have developed a short cut using the balance sheet to determining which companies are generating real cash and which companies aren’t. You will find out how in the book.

      I hope that helps.

  12. Roger,

    Regarding your question in the article, I’d like to see both your valuations.

    I’m not sure if it’s my data source, but I’m finding that since the GFC there are less analysts covering the stocks that I look at, so I can’t get consenus EPS growth forecasts (For example, I can’t see a consensus EPS growth forecast on MMS at the moment).

    I can still look at the consistency of the ROE and read the company announcements, but I suspect your data source may include more analysts and their growth forecasts.

    By the way, I can appreciate that the list of stocks in the article are the companies you are asked about, but to be honest, I don’t look much at these stocks.

    Since suffering a few painful losses (you tend to learn more from losses than gains!), I’m quite strict in looking for stocks with DTE less than 50% and ROE greater than 20% (eg. stocks like NVT, ARP, RKN), so these are the ones I’d be more interested to see your valuations on.

    • I bought BHP at $32.06 7/7/09 and sold at $39.10 4/8/09 to then buy back in below at around $36 – $37 after asking the broker to buy 3 times he advised to buy Myer at $3.95 17/10/09 – no one else was advising to buy Myers. I have now bought back into BHP at $40.55. I don’t understand a broker from a large broking firm where you have given the broker trust to change my decision – which he had also agreed on the buy BHP to say NO Myers. This move has created my portfolio to be in the red for 5 months and not been able to sell to change my position. This is in my super fund which I am trying to earn some capital groath and live off some of the profits. I have re-invested the profits into the fund but that is now sliding. Are you able to assist on my portfolio and maybe some possible changes – but they are in the red. Much appreciated. Ros

      • Hi Ros,

        Its important to find a good broker. A good broker is someone who listens and respectfully guides. Don’t care what a broker has to show you until he shows you he cares. I am a big believer in value investing, and knowing what the true value of a business is really helps in making sense of the various suggestions that I receive. For example, what would you do in the following situation:

        Phone rings:

        Ros: Hello?, Ros speaking

        Broker: Hello Ros, its Pauline from F1 Advisors Inc.

        Ros: Hi Pauline, What can I do for you?

        Pauline: I am looking at your portfolio and I noticed that you don’t have any telco stocks. We think the telco sector is about to take off with this NBN. The sector has been out of favour too and institutions are underweight so they are going to have to load up And because the sector is out of favour, P/E’s look unreasonably low and the icing on the cake is that our telco analyst David Fullglass has just put out a new report upgrading Telstra from Sell to Buy and reckons its really cheap.

        Ros: Right. Ok. So, Umm you think I should buy some?

        Pauline: Yes. You have got $120,000 sitting in cash earning nothing and the yield on Telstra is really attractive, so even if it goes nowhere, you are getting a better yield than you are getting on your cash…

        Now, Ros here has no idea what Telstra is really worth. She really has to just take Pauline’s word for it. If it turns out well, she will stay with Pauliner. if it turns out badly, she’ll look for a new broker and hope for the best there and the cycle starts all over again…

        Its very counter productive and an extremely inefficient deployment of intellect and resources.

        Ros would be far better off if she could respond this way:

        Ros: Gee thanks Pauline, but I have my own valuation for Telstra who’s profits today are the same as they were ten years ago. My valuation is $3.12. If you can get it for $2.50 or $2.40 give me a call.

        Ros, your answer lies not with the broker but with you. There are only two courses you need to take in order to succeed in the stock market; the first is; How to Spot a Great Business and the second is; How to Value a Great Business Complete these two courses and you will navigate your way with ease through all of the broker/analyst suggestions as well as through depressed and the euphoric markets.

    • Hi Damian,

      Yes. I have just about every analyst’s numbers. Regarding your list, I will get around to those too. I appreciate that you know what to look for but many who are visiting this blog for the first time may own shares in companies that we wouldn’t like (the Fosters and Qantas’ and the like) and so it is useful to demonstrate why.

  13. Hi Roger,

    I notice that in your portfolio only two or three stocks (BHP, LEI and maybe AMP) would be considered investment grade at the right price. Would you be happy post another hypothetical portfolio of stocks (I would be happy to mention some names) which would all be investment quality when the price was right?

  14. Hi Roger,

    juts would like to clarify. a few days ago on Your Money Your Call you mentioned that ANZ is trading around 10% discount to its intrinsic value. Now at your website is says that ANZ is actually trading above its intrinsic value. What is the correct answer.


    • Hi Victoria

      Thanks for the question. I just received an email from “Kero” who asked the same thing. We’d all love it if intrinsic values were cast in stone. Unfortunately, they’re not. The result depends on the input so to be safer, I always run my model using two data sets. Importantly, I only run ONE valuation formula. One valuation is based on estimates for next year’s result and the other is based on a continuation of the historical performance of the company. It gives me a ‘max’ and a ‘min’ – a kind of ‘range’ of valuations which Buffett has always advocated. The ‘historicals continuing’ valuation is useful where historical results have been volatile. The other reason for having this version is that some companies I simply cannot get access to or there are no analysts covering it – they can’t get access either, and so thats when I have to go off some progression or variation of past performance continuing. Its the only way to get a valuatin estimate for some companies. The idea is not to be perfect but to protect capital and do better than the market.

      I would be interested in hearing what you prefer to see. Would you prefer to see 1) the most conservative, 2) the valuation based on next year’s earnings forecast 3) based on the continuation of the historical performance of the company, or both? Feel free to vote. What I like to use myself may not be what you want to see.

      I explain how it works in my book. And it takes a book to explain it as its impossible to get it all in during a 7 or 8 minute TV slot, so Peter Switzer and I had a chat and I will cover it in more detail in a fortnight..

      The more conservative $17.73 ANZ valuation is based on the historical track record for ANZ continuing. The $23.78 ($24 rounded) is based on forecasts. I will also edit the post and add these comments so that they’re not missed by other visitors.

  15. Roger

    If a haven’t invested before and am looking at investing my cash today how should I approach the value investing issue given that most blue chip stocks are well above your calculated intrinsic values. Should I base my investment decisions on future values or wait for better opportunistic periods like substantial declines etc. All of us cannot find values in stocks like JBH like you did or should one do some research and try and find small cap stocks that could be winners in future and hence one day have values far above their intrinsic values like JBH.

    • Hi Cedric,

      I like to buy below future valuations AND below current valuations. There are three parts to the investment solution; 1) Great business 2) great prospects and 3) great price. The great business is determined by looking at the quality of the company, its competitive position, its balance sheet etc etc.. The prospects is ultimately determined by assessing how much the intrinsic value is expected to rise by in the future. Finally, the great price is based on a discount to intrinsic value and as I mentioned earlier I run my valuation model on two data sets, historical and future which provides me with a range or a ‘max’ and ‘min’. To be really conservative I want to buy when the price is at a discount to both. The other reason for doing this is that some companies I simply cannot get access to or there are no analysts covering it – they can’t get access either and so that where I have to go off some progression or variation of past performance continuing. The idea is not to be perfect but to protect capital and do better than the market. The answer to your last question is 1) how long is your investment horizon and therefore, how long are you prepared to wait and 2) how much volatility can you stomach. What you do will be determined by your temperament.

  16. Roger,

    Did you find many opportunities to buy stocks during the bull market from 2003-2007, or did you find that the market was heavily overvalued during this period?

    I’m curious because we are still over 30% from the Nov 2007 high, and yet many companies are already above their intrinsic value from your calcuations, do you have any thoughts about how this can be?

    I think the fact that property trusts haven’t recovered may be a factor.

    • Hi Damian,

      Sure, there were a large number of opportunities during those years. Its important to keep in mind however that you don’t need many. Four or five will suffice, although for diversification purposes, 10-15 is preferable. Of course, they don’t all need to be presented in any one year to have a meaningful impact, in aggregate, on your portfolio.

      An index can be well below its previous highs and many companies can simultaneously be well above their intrinsic values, if 1) those intrinsic values have declined, 2) the previous index highs were absurdly so or 3) a combination of the two. A massive dilution to intrinsic values has occurred as a result of the giant capital raisings that have taken place in the last two years, many at prices below equity per share! I hope that helps.

  17. G’day Roger,

    I’ve often pondered this sort of comment…

    “What I mean is that you bought the Reject Shop back in 2004 at $2.40. The yield today is more than 25% on your purchase price.”

    Sure, the yield is great on your initial outlay and you can sit back and be happy with that – if you’re looking at it from that perspective. Another perspective is that you have an asset that is worth a certain amount here and now, and that amount is earning a relatively paltry yield. Is it still worth holding it for the sake of that paltry yield, when looking at it from that different perspective? I suppose then you’d need to consider that against the costs of selling including CGT and what else might be on offer for the money.

    On a related issue, I also wonder about the situation where you bought a stock at a discount to intrinsic value vs buying at intrinsic value – this is the essence of the ‘Cathy’ post from your JBH thread. You own JBH having bought many dollars ago and still hold. You are happy to hold for now as that value is still increasing over time. Cathy is standing by wondering whether to buy in. Ultimately you both have $X worth, yours in JBH, Cathy’s in cash. If Cathy chooses to buy JBH, your risk of loss and margin of safety *from your current position* for both of you is the same. Yet, from what you have suggested, you would not buy a stock at intrinsic value but continue to hold the same stock at its intrinsic value having bought in lower down. The only difference that I can see compared to Cathy at the current time is that you would have CGT to think about if you were to sell. So if you wouldn’t buy at intrinsic value, if CGT the reason you would continue to hold it at intrinsic value, given the same expected rise in intrinsic value over time?

    My personal feeling is that these sort of decisions should be made based with more emphasis on the current position rather than the price of the initial purchase. I guess I haven’t so much asked a question as made a statement, but do you have any comments to make?

    • Hi Greg,

      Great stuff. Now we are really getting into some interesting material! The example I gave is where the intrinsic value of the company is rising and will rise to the current price in two years. I have to say that would be the maximum (depending on the yield of course). I agree with your sentiments in the event that the intrinsic value is not rising at a good clip. The scenario I am suggesting is superior to a high yield alternative that has no intrinsic value growth or even negative growth. Qantas for example may offer a good yield at various times but its intrinsic value has remained unchanged for more than a decade. The opportunity cost of that is far worse. And I haven’t even started to get into the transaction costs associated with heading down the path of more frequent buying and selling and then the risks associated with underestimating the rise in intrinsic value…

      The tax is indeed a significant concern. As you know unpaid CGT is an interest free loan from the ATO and something that should be maximised. I have often thought about the “if you wouldn’t buy it now you should sell it” argument, which is a variation of the one you present but each investment has to be held, sold or added to based on the circumstances of the person considering those options. The best entry opportunity of course is when you have a great company, with strongly rising intrinsic values and it can be purchased well below. Sometimes, the wait is excruciatingly long and I have at many times been tempted to ‘buy now’ and at intrinsic value, rather than below, based on the logic you succinctly describe. In a strongly rising market, this hasn’t done any harm.. the problem of course is you cannot accurately predict the market.

      While Cathy’s position and mine are rationally the same at intrinsic value, her temperament may also be very different to mine and affected by whether the funds used to buy or hold the position is seen as ‘capital’ or ‘profit’. This is behavioural rather than economical. You have to develop an approach that also fits with your temperament.

  18. Thanks for sharing Roger.
    Heres some books I like that some beginners might find useful:

    Seth Klarman’s Margin of Safety
    The.Dhandho.Investor by Monish Pabrai
    Fooled By Randomness by Nassim Nicholas Taleb
    ValueAble =) by Roger Montgomery
    The Snowball by Alice Schroeder

    • Hi Scott,

      I too have read all of them and and can commend them. I am not familiar with the websites so will have a look at them first before posting.

  19. Geoff wrote to me via email about his approachto valuation. I liked some of his comments and kindly allowed me to post his ideas here. Thanks Geoff:

    Hi Roger,

    As you know only to well you can’t overcome the principle of compounding returns over time, and the higher the better.

    In my experience valuation encompasses art, science (or financial mathematics), knowledge, investigation (research), and judgement gained through experience.

    I mostly rely on a conservative assessment of a company’s return on equity or capital, adjusted by the dividend payout ratio, by using a company’s equity adjusted for various distortions. Companies in Australia tend to have limited growth opportunities (up to 8 years), so I do not make projections beyond this period. This can lead to a conservative assessment of value, but I can compare my approach with other analysts who generally use flawed methods to reach their valuations, which I believe gives me an advantage.

    However, I believe this approach has some weaknesses. Chris Browne (now deceased) talked about some of these in his book “The Little Book of Value Investing”, and Bruce Greenwald has also espoused these as well. It appears that there are two camps here, the Buffett camp (modified Graham approach) and the modern day Grahamites (Tweedy Browne etal).

    I also use other valuation approaches, such as the knowledgeable buyer approach, and have more recently been developing a modified valuation approach, which helps me evaluate other factors.

    A number of years ago I had the privilege of meeting a money manager who invited me to Shanghai, where he lives, and I saw how he went about things. His approach was a blended Graham/Buffett approach with technical analysis and other factors. He is very successful and I think he developed this approach after going through unique experiences in his life and also over a number of years when the Shanghai market was flat or going down. His approach didn’t make sense to me, but his long-term record is exceptional.

    I am happy for this email to be placed on your blog to encourage further discussion about valuation approaches.

    Kind Regards,


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