Analysts Top Picks

I am frequently critical of the funds management industry, as I pointed out in my post, routinely, when you factor fees into the equation, over 80% of managers fail to beat the most suitable benchmark.  The key reason for this is fees & charges, of course, but it at least warrants consideration of how useful the advice of brokers/analysts in general is.

I found this article on the US version of the MSN-Money website.  It ably demonstrates the issue I have with broker recommendations, which in-turn reflects on the fund management industry.  It points out that the 10 stocks analysts hated most routinely beat the 10 stocks analysts loved best.  In thinking about this article, you may decide a contrarian position is likely to be more profitable.  I tend to often agree, but my opinion is most ably captured in the quotation from A. A. Milne (Author of Winnie the Pooh):

 

"The third-rate mind is only happy when it is thinking with the majority. The second-rate mind is only happy when it is thinking with the minority. The first-rate mind is only happy when it is thinking.”

Rather than trying to think with the majority, or the minority, I try hard to be completely objective when examining an individual stock for investment purposes.  This can be hard to do with very popular stocks that get a lot of coverage, but it can definitely be done.  By far, however, the easiest way to ensure your analysis of a stock is not ‘coloured’ by others opinions, is to spend much of your time examining stocks in the area of the market that analysts and the financial press virtually ignore.  The very best discoveries are there and await the inquiring mind.  I thought it might be worth having a look at some highly regarded analysts selections for 2011 in Australia. To have Goldman Sachs Picks for 2011 are attached.

For those of you who couldn’t bother opening the link, the picks were (same order as the article, I’m not sure if it was a preference order):

1. AMC – Amcor.  Amcor over the last 5 years have reported earnings per share (EPS) of $2.04.  Over the 5 years prior to that, they reported $1.96.  To my way of thinking, for a company to justify a P/E multiple 17.17, which is about 20% above the market, they must show better historical performance, or brighter future prospects.
2. BHP – BHP Billiton.  It’s hard not to expect, barring a major collapse in the world economy, that BHP will do better than the broader market over the next few years.  But it must be remembered that BHP are the 4^th biggest company in the world (By Market Cap) and as well as they do, many smaller, more nimble companies will do better.
3. JHX – James Hardie.  I am agnostic here; lumpy sales and earnings, in a difficult business make analysis difficult.
4. NWS – News Corporation.  I have been a long-time bear on NWS, however, they have migrated their business substantially away from newspapers and can probably be expected to marginally outperform the market over the coming years now they are trading on a more sensible P/E multiple.
5. QAN – Qantas.  I say no to airlines as a general stance.  Qantas are one of the best in the world, but as a long-term investor, best avoided.  If they ever divest their frequent flyer program, then the rest of the business should be strongly avoided.
6. AIO – Asciano.  Trade on too high a multiple due to ambitious forward earnings expectations.  Hard too imagine them beating the market over the next few years.
7. CPU – Computershare.  At $10.10, there is probably a lot more upside than downside in the longer term with CPU.  If the next couple of years (as generally expected) turns out to be strong for M & A, they will do better than the broader market.
8. LLC – Lend Lease.  $10,000 invested 5 years ago here would now be worth $7861.  LLC have been a huge disappointment, nothing tells me they are likely to do much better than the broader market over the next few years.  I don’t think they will under-perform as badly as they have historically either.
9. OST – Onesteel.  I like OST, they have been an historically excellent performer, with management that acts generally in shareholders best interests.  I do not like their industry. Chinese, Korean and Indian steelmakers have considerable competitive advantages & input prices will squeeze margins.  Still, likely to out-perform over the medium term.
10. WPL – Woodside.  Hard to bet against the energy industry.  I think over the medium to longer term, WPL will do well.

 The 10 selections are not terrible, and depending on how well the best 2 or 3 go, could even slightly outperform the market.  But going back to my earlier point, the safest route for anyone who can ably analyse the future prospects and financial reports of a company is to look where less people have already looked (i.e. outside the top 150 or so companies). You are less likely to find a gem looking under a rock where dozens have already looked; you need to find the rocks that haven’t been looked under.

The most important thing is to deeply and critically analyse any potential investments regardless of popular opinion, or invest with someone who is properly incentivised to do just that.  To do anything else would be to risk being known by another A.A. Milne quotation as “A Bear of Very Little Brain” – Tony Hansen 31/01/11.

The Importance of Benchmarking

The S&P/ASX200 TR index (my preferred benchmark) finished calendar 2010 at 34,518.53 points.  If you are a market follower, you will have heard many commentators saying the market was down in 2010.  This is a mistake often perpetrated on an unsuspecting market by an (in my opinion) uninformed ‘commentariat’.

The S&P ASX 200 did finish calendar 2010 down 2.57% on its 2009 finish, however the S&P/ASX200 TR index finished up 1.57%.  How is this? Well this simply means that dividends accounted for 4.14% of the total return for the ASX200 in calendar 2010.  This is not a new phenomenon, Australia is, and has been for some time one of the highest dividend paying share markets in the world.  The difference between the Price (S&P/ASX200) & Total Return (S&P/ASX200 TR) index over the last 3 years was 4.19%, over the last 5 years, it was 4.40%.  By way of comparison, US markets return less than 2% annually on average to investors as dividends.

Given the comparatively high Australian dividend returns, it is all the more important we consider them when deciding how our market has performed.  I consider the ASX200 (and the All Ordinaries and other ‘price’ indices) to be completely invalid measures when it comes to benchmarking, because when it comes to measuring returns, if dividends aren’t part of your ‘return on investment’, then what are they? Whether you choose to reinvest the dividends or not is your choice, but they must make up a part of your performance measure.

In my opinion in the area of performance measurement, there is no more important concept than benchmarking.  Imagine I were a pretty fast 100 metre runner (I’m not), had I beaten everyone I’d ever raced, and my best time was an extremely impressive 10.3 seconds, were it not for benchmarking, I’d possibly consider myself one of the fastest men alive.  Based on all recent evidence, this would be a reasonable conclusion.  Benchmarking, however tells me that my best time, a 10.3 second 100m dash would not be fast enough to have qualified for the most recent Olympics and therefore, there must be many who are faster than I.  Benchmarking myself against, for example the Australian 100m girls under 14’s record would also be unsuitable.  To be a valid performance measure, a benchmark must be 2 key things. Firstly, a valid measure of performance and secondly, nominated in advance of the performance occurring.

When it comes to benchmarking performance for Australian Equity fund managers, unless they are operating in a specific sector, such as listed property, or resources, the only suitable benchmarks will be the accumulation indices, either ASX200/ASX300 or All Ordinaries.

A quote I like that demonstrates the importance of benchmarking is made by Warren Buffett: “one must avoid the error of the preening duck that quacks boastfully after a torrential rainstorm, thinking that its paddling skills have caused it to rise in the world. A right-thinking duck would instead compare its position after the downpour to that of the other ducks on the pond”.

Believe it or not, since 1980, on a dividend-reinvested basis (over calendar years), the total return indices have exceeded 20% on 11 occasions (greater than 1 in 3 years). They have exceeded 40% on 5 occasions (nearly 1 in 6 years – though the last time was 1993). In these years, it is possible for investors to be substantially duped if their fund manager does not benchmark to an appropriate index.  An uninformed investor whose fund manager has grown his portfolio by say 38% could be compared to Buffett’s duck if the market has advanced by say 44%.

Believe it or not, some funds (though not many) use the ASX200 (rather than the TR index) as their benchmark.  This immediately gives them over a 4% advantage, so they could take a hefty annual management fee, track the benchmark closely and still report above benchmark performance.  Worse still are the ‘absolute return’ funds, without naming names, I have seen examples of these that charge 2.5% p.a. management fees, have a benchmark of 0% (they don’t even give you CPI) and charge 25% ‘out-performance’ (is beating 0% really outperformance?) fees, they comfort you by not charging fees until any capital losses (in years they decline) have been recouped. Given that the Australian market has advanced about 12.5% p.a. over the last 30 or so years, such a fund, had it exactly matched the benchmark returns would have left you with a return of about 7.5% over time. Over 30 years, $1 invested at 12.5% p.a. will become $34.24, whereas invested at 7.5% p.a. it would become $8.75, the difference would be in your fund managers pocket, so take care when investing in managed funds (or super for that matter). Now the weekly readership is growing, anyone with anything they would like me to address specifically is welcome to contact me by e-mail: tony@eternalgrowthpartners.com - Tony Hansen - 24/01/2011.

The Importance of Buy & Hold

In mid-March 2008, when the market was down 25.85%, I was quietly confident that there shouldn’t be a huge amount of downside left after such a substantial decline.

Now, you will note from the above statement, I don’t rate much in the forecasting stakes – the market went on to fall roughly as far again over the ensuing 12 months.  What I can lay claim to is some solid results in the stock-selection stakes.  I found Credit Corp Group (ticker - CCP), they seemed to tick a lot of the boxes I seek, reasonably long and consistently profitable trading history, high return on equity, averaging over 25%.  Their only issue would seem to have been that they were far too heavily leveraged at a time when such leverage was frowned upon due to seizing credit markets.  A quick perusal of their business and their cash flows, however, indicated that if they committed seriously to paying down their debts, they could do so in pretty short order – they did and they have (cut by roughly 2/3 in the next 2 years).

So I bought a small parcel of CCP @ 66 cents 14/03/2008 (it is not a big holding, today they make up less than 4% of the family portfolio).  In pretty short order, they hit 99 cents (up 50% on purchase price), and then they bottomed at 39 cents on 28^th January 2009 (down 40.91% on my purchase price).  All this indicates is that it was a volatile period; those of you in the market then will already know this.

In any case – as at the time of first drafting this post (20/12/10), CCP is priced at $4.05 and they have returned me 14 cents in dividends since purchase.  So they represent $4.19 of value to me today, which equates to an annualised return of 95.83%.  I don’t point this out to gloat; I have made a couple of purchases that worked out better & a great many that did not nearly so well (doing not nearly so well as 95.83% can actually be quite satisfactory).

In truth, the point I want to make regards the ‘buy & hold’ ethos.  I make the point as follows – In order to maintain my annualised growth of 95.83% on my original 66-cent purchase price, CCP will need to grow my investment by 63.25 cents per year (.9583 x 0.66).  This means that to get to 20/12/2011 still carrying my return of 95.83% pa (on original purchase price), I need CCP to finish the year at about $4.68 (including dividends).  Now this only represents a return of 15.62% from their current position. This is only a little more than 3% above the historic market (S&P/ASX200 TR) return, and entirely possible from this company.

Year	Price	Growth
20/12/10	$    4.05
20/12/11	$    4.68	15.62%
20/12/12	$    5.31	13.51%
20/12/13	$    5.95	11.90%
20/12/14	$    6.58	10.63%
20/12/15	$    7.21	9.61%
20/12/16	$    7.84	8.77%
20/12/17	$    8.48	8.06%
20/12/18	$    9.11	7.46%
20/12/19	$    9.74	6.94%
20/12/20	$   10.37	6.49%

The table set out to the left further demonstrates this proposition stretched out for the next 10 years.  You will see that by the 10^th year, the required return (assuming a smooth return of 95.83% per annum on my original investment) is only 6.49%.  I can go out today and get a 6.5% return from any number of places, so that will be eminently achievable.

Though I haven’t included the next 10 years of the table, I can assure you it gets more impressive, by the 20^th year all I need in order to continue to grow my starting capital by 95.83% annually on its original value is to grow my holding by only 3.94%.  Clearly, if 3.94% is all the return I expect, I may start to move some of this capital elsewhere, but you see the power of the notion.  This is a demonstration of one of the most powerful parts of share investing, the power of the ‘free leverage’ afforded by uncrystallised capital gains. Tony Hansen - 17/01/2011.