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Whose Intrinsic Values will rise the most?

Whose Intrinsic Values will rise the most?

It was as a young boy that I became enamoured with the outdoors and the unique landscape of Australia. I discovered the easiest way for me to experience it was by participating in cubs and scouts. I will never forget the motto “be prepared”. It has served me well in many ways, and while nothing is ever failsafe, it is sound advice when it comes to investing.

The market and its associated commentary is on tenterhooks. You can attribute that to the supertax’s contribution to a foreign investing exodus, nerves surrounding the property bubble in China, rising interest rates, or whatever else seems to be fashionable on the day with which to attribute the market’s conniptions to. I believe however, quite simply, that prices are generally expensive compared to my estimates of intrinsic value. That means that the performances of the underlying businesses do not justify current prices.

Of course if you are a trader of stocks valuations don’t matter. You will sell on the emergence of the Greek storm-in-a-teacup and buy the day after, when another bail-out package is revealed. Alternatively, you will buy when one newsletter says the coast is clear and sell when yet another contradicts it. The people pointing out worries about China today are those that said the banks would rise to $100 before the GFC hit. One of the easiest things to observe in the markets is that predictions of a change in direction are far more frequent than they are accurate. And anyone can explain what has happened, but few seem to be able to look far enough ahead to be positioned well.

With arguably the exception of my warnings earlier this year about the impact of a decline in infrastructure spending in China (thanks to an unsustainable commercial property and capital investment scenario) on the demand for Australian resources, I don’t try to predict the direction of markets or the macro economic determinants. I simply look at whether there are many or any good quality businesses available to purchase below intrinsic value. If there aren’t many or any great businesses to buy cheaply, the only conclusion must be that the market is not cheap.

I cannot predict what the market will do next, but its worth being prepared. When the market is expensive compared to my valuations, one of two things can happen. On the one hand, share prices can drop. That is more likeley to be the case if values don’t rise – which of course is the second scenario. Valuations could rise and make current prices represent fair values (or even cheap if values rise substantially).

In the event that prices fall (remember I am NOT making any predictions), I thought its worth looking at some of the big cap stocks (not necessarily A1’s) and how much their current intrinsic values are expected to rise over the next two years. These estimates of course can change, and its worth noting that none of the companies are trading at a discount to their current intrinsic value.

Big names and their estimated changes in intrinsic value
Company Name Current Margin of Safety Estimated change in intrinsic value 2010-2012
RIO Tinto No 8% p.a.
Commonwealth Bank No 16% p.a.
National Aust. Bank No 22% p.a.
Telstra No 2% p.a.
Woolworths No 7% p.a.
QBE No 10% p.a.
AMP No 9% p.a.
Computershare No 5% p.a.
GPT No 3% p.a.
Leightons No 13% p.a.

My estimates of intrinsic value  don’t change anywhere nearly as frequently as share prices, but they do change. I expect some adjustments to start flowing through as companies begin what is called ‘confession season’ – that period just ahead of the end of year and the release of full year results, when companies either upgrade or downgrade their guidance to analysts for revenues, market shares and profits. These adjustments could, in aggregate, make the market look cheap, but that will require 2011 valuations to rise significantly.

If prices fall (I am not predicting anything), and one is not overly concerned about quality, then one strategy (not mine) may be to buy the large cap companies expected to lead any subsequent recovery. Many investors and their advisers still subscribe to the idea that ‘blue chips’ exist and are safe. They tend to think of the largest companies as blue chips (I don’t) and if they are going to buy any after a correction, we might expect they will buy those whose values are going to rise the most. Of course, they may not know nor care about my valuations, nor do they know which companies are going to rise the most (in intrinsic value terms), but over the long term, the market is a weighing machine and prices tend to follow values. It follows on this basis then that Telstra’s value increase of just a couple of percent per year over the next two years may not put it in an as attractive a light as, say NAB.

I think you get the idea. To share your thoughts click “Leave a Comment”.

Posted by Roger Montgomery, 15 May 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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    • Hi Jesse,

      Its out of my hands and in production. Good things do come to those who wait and I am told that patience is the hallmark of the world’s best investors, so thanks for your patience.

  1. Hi Roger,

    Great blog, great work and insightful too. I am eagerly waiting for your book. I wanted to ask if your model of intrinsic value calculation is available on blog or its confedential. Can we know how you calculate the intrinsic value. I have Morning Star book – but dont know what to do with it.

    • Hi Umesh,

      You should be pleased to know that if you have Morningstar’s Shareholder book, all you need now is my book which will take you through the steps to estimate the intrinsic value for every stock listed in the book you already have. My book went to the printers on Friday so you will be able to order it and secure your copy(ies) in the next few days.

  2. MIchael Connor

    Hi Roger,

    Thank you for making available your investment information which helps to identify value.What do you think of the current market falls?I watch the US market because at the end of the day it dictates our market.I am inclined to sit on the side and watch and when the prices look attractive buy.I don’t believe markets have bottomed.On my list are the companies you mention and am waiting for JBH to hit $8 again (only joking) but who knows.I tend to agree with you that share prices are overvalued and they could come off more.


    • Hi Michael, Thank you for sharing. I do believe there is a dearth of value, which translated means; the market appears to be expensive. I however draw a line there and don’t cross over it by suggesting the market will go down. That, I don’t know. I can tell you what a company and its shares are worth but I cannot tell what the share price is going to do in the short or even medium term.

  3. Ashley Little

    This is a very thought provoking blog.
    For what it is worth the stocks I am currently looking at with the best increases in intrinsic value from 2010-2012 are the following

    JBH 47.96%
    ITX 51.78%
    TRS 51.96%
    CSL 55.68%

    My maths may be way out with csl but I don’t think people are fully factoring in the recent share buyback on ROE. Anyway I own 3 of these and am still researching ITX.

    When I read you Blog I went and looked at some of the companies in the top 50 to check the shareholder returns over a 10 year period. The results were quite surprising. The Tried to replicate the return that Buffet would look at had he purchased the businesses in its entirety. That is, the only time I looked at prices was 10 years ago when we assumes the stocks were purchased. The return is a function of the dividend compared to the price paid and the increase in book value compared to the price paid. For the stocks I looked at the results are as follows and don’t blame me if my maths are wrong. Also the stocks that are in the top 50 now are very different to 50 years ago and hence some of these stocks list below would be amounst the better performers. If we compared the stocks in the top 50 10 years ago the returns would look very different to these.

    Table of results

    The winner is Origin energy but don’t get too excited as the major part of the return came in the last year or so with the deal done with Connoco Phillips regarding the CSG assets. Taking this out it brings them back to the pack. I will note that apart from ORG the best returning stock is not included in these figures and most people should be able to guess who it . Back 10 years ago origin did have a very Ben Graham appeal to it as it was trading at a substantial discount to book value.
    The biggest loser was Computershare which was a huge surprise to me. However, when you look at the stock 10 Years ago it has a return on equity on 10% and was trading at 10 times book value. Given these figures I am sure that the Buffets and Montgomery’s of this world avoided this stock 10 years ago.
    BHP’s return does not reflect the free distribution of OST and BSL that shareholders received so its return would be higher but I have no really interest in calculating the exact return as none of these three companies really get my heart pumping.
    NAB is the worst of all the Banks which is no real surprise but what was a surprise was the fact that by and large the banks underperformed most other quality businesses.
    I have done this calculation merely for a point of interest(Yes I am a nerd) and past returns are no reflection of future performance. I hope other people find this of interest as well

    • Hi Ashley,

      Thanks for the post and for all that work. I wonder whether there is a table tool you can use or a screenshot you can send of an excel table so that the numbers are more clearly laid out? One of the issues that crops up with this kind of study and to which you have alluded is what is known as survivor bias. There are companies that don’t exist today that did a decade ago and so a complete database from ten years ago is needed to do the work. What you have done however is very useful and you are right – very surprising in parts. Thanks for teh contribution.

      • Ashley Little

        Thanks Roger,

        As a matter of Interest how do i find out what the top 50 stock in australia were 10 Years Ago

      • Hi Ashley,

        You may have to purchase or source an old copy of Shareholder from Morningstar. This is the only way to correct for survivor-bias. Give them a call and see if they still have one.

      • Ashley Little

        thanks Roger

        Being a total nerd I would love to look at the top 50 stocks 10 years ago and see the return.

        This and the current fallaing share prices is really getting me excited. I haven’t been the active since CBA stuffed their capital raising

  4. You might want to edit your post title:
    who’s = abbreviation for “who is”
    should be “Whose”

    • Hi Steve,

      Thanks for spotting the typo. Much appreciated and please feel free to let me know if you spot anything else.

  5. Hi Roger and thanks for getting me to look up “tenterhook”. I have used it in the past, but never bothered to confirm the meaning and derivation. Very appropriate right at this moment.
    I have an inkling that there are quite a few investors who feel like they are having tenterhooks removed from their skin right now. Ouch!

    I started share investing with my personal super fund about 3 years ago. At the time I was concerned that I was making stock choices in a bubble market and chose to invest about 7 % of my funds in gold as a sort of “bubble-hedge”. It turns out that this has been my best investment in the period since.

    fyi, I consider that gold is only useful as a hedge against panic and hyper-inflation economic conditions – It doesn’t generate any return on capital, etc.

    From your previous writings, I have come to the conclusion that you are always opposed to commodity trading as an investment choice.
    Is this true, or are there market environments where you have/would do it?
    If you do have any conditions that would satisfy you to buy e.g. gold, what sort of “macro value investing” conditions would you use as an exit strategy (i’m not sure myself).



    • Hi Steve,

      I am sorry that I have given you that impression. I have been an active participant in the futures markets since 1990. I don’t trade frequently. In fact I don’t “trade” at all. I do however take strategic positions on rare occasions and when I have reached a view that I can support with stats. The last long position I had was in oil at around $80 which I sold at $135. I don’t suggest commodity trading to anyone because it is very high risk. If one has come to a conclusion about the direction of a commodity (Buffett also did in silver some years back), then the commodity itself can give exposure without the execution risk, management risk, board risk and stock market risk of owning a share of a company that produces that commodity.

  6. Hi Roger, what do you think of marketing-based companies such as Photon Group (PGA) and Fairfax (FXJ). Photon seems to be a strong company who’s share price has dropped significantly over the past couple of years; seeming to be a good opportunity for the value investor. Are these your thoughts?

    • Hi James,

      I have not looked at Photon recently. I will do. Generally, I prefer organic growth than growth-by-acquisition but that does not mean buying growth cannot work. Just look at QBE. With regards to Fairfax I am cautious about the combination of a high level of intangibles and a very low level of return on equity.

  7. Michael Sheehy


    I am a very confused investor.

    Here is my problem. You have obviously adjusted the way you do your intrinsic value calculations over the years which is understandable. However it leaves the average investor like myself in somewhat of a quandry. I am looking forward to your book coming out but I am concerned it will only cloud my decision making even more. I do not have time to run intrinsic value calculations on companies. You also have access to broker reports on companies which you use to estimate future intrinsic values which are not accessible to the average investor. I hope you are able to address some of the above issues above as I have valued your insights over the years and hope this continues . What I am hoping for is a website tie in with your book where anyone who has bought your book can have some sort of access to your intrinsic value calcuations and forecasts.



    • Hi Michael,

      I have received many similar requests. The book makes it as easy as I possibly can to follow my approach. I understand that there is a lot of work in valuing every company but there is far less if you create a universe of only the best. Martin Roth’s book called Top Stocks which comes out every year in October will give you a good shortened list of companies to begin the search and if you would like to go further afield, you will find the ten years of data for 500 companies available in Morningstar’s Shareholder publication very useful. Most importantly, you need to remember that Buffett doesn’t have a computer on his desk – although his access to those that do is unsurpassable. Great investing however should be about buying businesses rather than trading stocks and happily valuations don’t change nearly as frequently as share prices. Putting a list together of the twenty or thirty best companies and their valuations and then simply waiting for prices to offer opportunities is within the reach of everyone. As I mentioned earlier however I have received many queries about something more.

      • Roger, Top Stocks is where I too start, and there are some companies there that I hold, but always some companies I say “hadn’t thought of that one – hmm….” and it is always a good read.

  8. out of curiosity what are your thoughts on Kenneth Fisher’s published work. especially about sales and margins.

    I am currently reading Super Stocks. Its quite dated, but sometimes basic investing techniques don’t change over time.

    • Fisher’s work is excellent and a must read for all investor’s. Start with Common Stocks and Uncommon Profits. Also note that Buffett once described himself as 85% Graham and 15% Fisher.

  9. I agree (for whats its worth) that there is not much ‘value’ amongst Australia’s large cap shares.

    But what about in the smaller cap range?
    I am still finding a number of companies that appear ‘good’ value in the small cap sector.
    Small caps (non-resources) seem to have ‘lost favour’ with the market over the last. This could be due to increased overall market uncertainty.

    Small caps that i still find attractively priced include:
    DWS (you have already highlighted this)
    FXL (i am still waiting for you to ‘get back to me’ on this)
    ITX (i think has been mentioned here)
    GXL (as i have highlighted only an ‘average’ company and uncomfortably high debt levels, but its in a relatively defensive area, earnings have been growing, and the market hates this type of stock after ABC Learning blew up)
    TRG (this one is harder to calculate but i think alot of attention needs to be placed on its business model and the fact that historical earnings are on ‘bottom of the cycle’).

    One large cap that is starting to attract me is Myer. Basically my target rate of return on investing is 15%. If Myer’s forecast dividend can be maintained, at current prices its approaching 10%. Now assuming constant pay out ratio’s, australia’s population is growing at 2%, average pay rises are around 3%.
    So a very simplistic assumption is that sales grow by 5% with many assumptions (constant market share, constant margins etc etc).
    I dont possess your skill level in determining accurate intrinsic value ranges, so i do the next best thing, wait for a share to be reasonable ‘value’ and then dollar average downwards into the share price so long as the reasons for buying the share in the first place still hold.

    • Hi Rici Rici,

      I wrote a post just recently about what remaining value might exist in the market. The post is entitled: “Do these three companies represent the last of good value?” I mentioned that the fact there were only three or so meant that there were nearly 1900 that were expensive and that usually means the market is expensive. I am no good at predicting markets or prices, but once again, the market has fallen in a bit of a heap again since then. I have also discussed ITX as have many of those who have posted comments on the blog. If you type ITX into the search box, you should find some of the insights.

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