Update No. 13 – 26/06/11

Full website: www.eternalgrowthpartners.com

	April 1st 2011	Current Price	Since Inception
EGP Fund No. 1	1.00000	1.10123	10.12%
S&PASX200TR	35632.05	33459.54	(6.1%)
EGP 20	1000.00	867.21	(13.28%)

EGP Fund No. 1 Pty Ltd. Up by 10.12%, leading the benchmark by 16.22%.

EGP 20.  The EGP20 index is Down by 13.28%, lagging the benchmark by 7.18%.

S&PASX200TR    The benchmark index is Down by 6.1% since April 1 launch.

This week I will nominate the constituents that will make up the EGP20 between July 1^st and December 31^st 2011.  I will give a brief account of the first 10 this week and of the final 10 next week.

Now, the EGP20 has lagged the benchmark in its first 3 months of existence, such things will happen, I believe over the longer term, the constituents of this group will outperform.  Here again I give my usual caveat, that we are not licensed financial advisers and that if you are interested in any of the stocks mentioned, you should do your own research, or engage an advisor, the prospects of these stocks are identified (by my proprietary method) as having superior quantitative prospects, however, I have not undertaken the exhaustive qualitative research I undertake for the investments EGP Fund No. 1 Pty Ltd holds.  The constituents and a brief note about them:

1. OST – Onesteel.  Given the ongoing debate about the proposed Carbon Tax (again I attach my alternative carbon abatement solution, at the bottom of the 'about us' page [you must be a registered member to see it], for those who would like to see a solution, but acknowledge the fatal (anti-competitive) flaws in the current proposals), it may seem ludicrous to include this stock as a likely out-performer.  Unlike the power-generation industry, the steel industry could be driven offshore.  Onesteel will face many challenges, but I believe that the business is well positioned to withstand, time will tell, but over the medium term, I believe OST will outperform the ASX200. People overlook advantages OST has, such as owning its own sources of iron ore. 
2. OMH – This company gets marked down by the market for various things, not the least of which include mining a less well followed commodity (manganese), which is trading at well off recent higher prices, operating in countries Australian investors are wary of (such as Singapore and Malaysia), and having a huge reliance on its major customer (China).  I still think 92c makes it so cheap as to give too much weight to all the various ‘negatives’.  Although OMH has produced ‘lumpy’ results, it has been consistently profitable and even managed to maintain good production when other Northern Territory miners were closed down (see ERA below).  They seem to communicate fairly well the state of affairs to their shareholders, without the value of the business being recognised in the share price.  Unless I’m missing something, I believe they should trade much higher in the not too distant future, perhaps not testing the all-time highs of $2.87 anytime soon, but well higher than now.
3. ERA – Energy Resources Australia remain in the EGP20, despite their poor performance over recent history (including this years flooding shutdown, but particularly since Fukushima).  The company has faced myriad challenges in recent history, but I think any sensible person must acknowledge the most logical, deployment ready solution to reducing CO² emissions through energy production is a nuclear one.  ERA stand ready to produce the uranium for this solution, absent the production problems of this year.  The forward prices of uranium have dropped in expectation of reduced demand, if I was inclined to buy any commodities (I am not as it is too speculative), uranium at under US$55 per pound would be worth considering.
4. OGC – Oceanagold.  I have stated previously my distaste for gold as an investment.  The sum total of gold mined in all of man’s history would make a cube with just over 20m sides, and have almost no other use than to admire (only about 10% of gold is used for industry, and I suspect this ‘industry’ includes people with gold teeth, by contrast approximately 80% of silver/platinum mined goes to industrial uses).  That said, who am I to question people’s motivations?  If people want to buy and own a useless substance, why not own a producer with good competitive advantages.  OGC are a low cost producer of Gold, who are about to produce a lot more at a much lower cost.  If they can come even close to getting the Dipidio project in the Philippines to perform to expectations, they will go from producing at about US$600 per ounce to less than US$400 per ounce.  The copper production at Dipidio alone will be profitable (i.e. cover all mining costs); the 100,000 ounces per year gold will be a bonus.  At current prices approximately a US$150m bonus (OGC are a AU$650m company at present).  As I said, undervalued if they get it even close to right.  Like all junior miners, there are risks, but at current prices, very little of the potential rewards being considered.
5. PBG – Pacific Brands Limited. Pacific Brands have been an unmitigated disaster since listing and earn a consistently anaemic ROE (6.56% last year).  As I have pointed out before though, you aren’t paying the same price for equity as those who originally stumped up; you pay the current market price.  No, for the price of 68 cents per share, you can get earnings which are forecast by the 6 analysts covering the stock that are forecast to be about 35c over the next 3 years.  The majority of the production facilities are in low-cost countries now, debt is sensible, the key challenges in my view are rising input costs (cotton etc.) and challenging retail conditions, but the majority of their brand-stable are household brands that should hold up through the cycle.
6. RSG – Resolute Mining Limited.  Resolute produce the 3^rd most gold on the ASX, over 300,000 ounces per annum, with several good development prospects and some (potentially) even better exploration prospects.  For a relatively small company (about $500m market cap) RSG have been relatively consistent, with positive cash-flows for the last 10 years.  They would seem to have about 6 million ounces of the useless yellow-metal, marked down due to being a higher-cost producer & a good portion of the reserves being African.  The production cash-costs are forecast to decline and production to increase, on this basis, future earnings per share should be much higher, on this basis, the shares appear undervalued.
7. AGO – Atlas Iron Limited.  I have tried to find holes in the Atlas story, but they have done an outstanding job of bringing their various projects online.  They are generating an enormous and growing amount of cash each month.  To my way of thinking they have 2 key risks, firstly (obviously) a substantial slump in iron ore prices and secondly, that management gets involved carelessly in the inevitable consolidation in the sector and overpay for growth assets.
8. BOQ – Bank of Queensland.  I think BOQ has been unfairly marked down with their recent struggles.  I believe it is a case of the market over-reacting, treating a genuine one-off situation as ‘the norm’.  We need to remember that absent the flooding and cyclones Queensland had this year, that state economy (where the majority of BOQ income is generated) would be performing second only to W.A.  The big banks will be steadier, but I am confident we will look back in 5 years’ time and the TSR (total shareholder return) generated by BOQ will be better than the big banks.
9. SIP – Sigma Pharmaceuticals. The best performing of the April EGP20 nominations, up about 35% in 3 months.  Sigma looks to be one of those rare turnaround stories that are actually starting to turn.  That being the case, there is still a good amount of potential left in the price before it becomes so fully valued as to drop out of this list.
10. AIX – Australian Infrastructure Fund.  I have followed AIX for some time.  I think they seem to do things right that other infrastructure funds get wrong.  Based on the solid earnings they generate and the fact they pay dividends out of cash-flow (most infrastructure funds borrow to pay dividends higher than their ‘cash’ earnings), I think they will stably perform a couple of percentage points better than the market over the medium term.

The 10 that follow, I will go into further detail next week.

11. RIO
12. FXJ
13. BHP
14. APN
15. GNS
16. KCN
17. JBH
18. HVN
19. HIL
20. DOW

Again I must state, these are (my personal opinion) of the best of the ASX200 that we do not hold in EGP Fund No. 1 Pty Ltd, if I thought the stocks above were really outstanding opportunities, then they would not be in the EGP20, but held in our company.  I will meet with our auditor on 8 July to confirm the NTA per share as at 30 June, so until I have that confirmation, I will not make an update as to the NTA.  It is likely I will make my next update on 10/07/2011, which will outline the June 30 audited NTA and resume weekly NTA updates from that point forward.  Tony Hansen 26/06/2011
Full website: www.eternalgrowthpartners.com

Update No. 12 – 19/06/11

Full website: www.eternalgrowthpartners.com

	April 1st 2011	Current Price	Since Inception
EGP Fund No. 1	1.00000	1.08474	8.47%
S&PASX200TR	35632.05	33232.86	(6.73%)
EGP 20	1000.00	855.41	(14.46%)

EGP Fund No. 1 Pty Ltd. Up by 8.47%, leading the benchmark by 15.2%.

EGP 20.  The EGP20 index is Down by 14.46%, lagging the benchmark by 7.73%.

S&PASX200TR    The benchmark index is Down by 6.73% since April 1 launch.

A brief one this week, I found this article on the MSN Money website, which draws attention to the practice I have previously mentioned of false benchmarking.  It mentions the (unfortunately) fairly common practice of comparing performance, including dividends against a benchmark that excludes dividends.  If you saw this in a US fund manager, you should run.  If you encounter it in an Australian fund manager – run a mile. Reason being is that Australian dividends are historically close to twice US dividends, therefore the discrepancy with this type of performance measurement is twice as bad.

Next week I will post the update to the EGP 20.  The new constituents will address my most recent valuation updates and remove those companies which are no longer members of the ASX200. Tony Hansen 19/06/2011

Full website: www.eternalgrowthpartners.com

Update No. 11 – 12/06/11

Full website: www.eternalgrowthpartners.com

	April 1st 2011	Current Price	Since Inception
EGP Fund No. 1	1.00000	1.12346	12.35%
S&PASX200TR	35632.05	33712.33	(5.39%)
EGP 20	1000.00	868.33	(13.17%)

EGP Fund No. 1 Pty Ltd. Up by 12.35%, leading the benchmark by 17.74%.

EGP 20.  The EGP20 index is Down by 13.17%, lagging the benchmark by 7.78%.

S&PASX200TR    The benchmark index is Down by 5.39% since April 1 launch.

This week I would like to touch on ‘compounding’.  I come back to compounding often, because in my view, there is no more important concept for an investor to grasp.  Albert Einstein once said:

“The most powerful force in the universe is compound interest”

Warren Buffett gets attention for the power of his returns. Legitimately so, $10,000 invested in Berkshire Hathaway in 1980 would be worth about $2.45m currently, and would have grown in value by about 19.88% p.a. over that period, Buffett’s early returns were better still.  My favourite, though a less well known example of compounding assets are the returns of Leucadia National Corporation.  $10,000 invested in this company brilliantly managed by Ian Cummings and Joseph Steinberg in 1980 would now be worth about $7m - this equates to about a 24.1% p.a. return.  They have over the course of this 30 or so years split the stock 12 for 1.  A share you had purchased for the equivalent of 6 cents allowing for splits would now be worth $35.78 and you would have received about $6.16 (over 100 times your original investment) in dividends along the way.  Had you reinvested your dividends, your returns would be higher still – you see why I regularly touch on compounding, because when done well and for a long period of time, its results can be truly astonishing.  Much like Buffett’s shareholder letters, the ones from this pair are a demonstration of the correct demeanour required for success. (By the way, I believe that following a similarly ruthless investment strategy, Buffett’s return may well have been more like Leucadia’s, but he prefers to hold onto businesses, even if the returns are diminishing, Leucadia have no such preference, and are much more ruthless)

A quote from Buffett at the start of his biography “The Snowball” by Alice Schroeder says, “Life is like a snowball: the trick is finding wet snow and a long hill.”  This is how an investor should view compounding.

If I were to nominate a singular reason for Berkshire Hathaway’s (or Leucadia’s) success, it would be the efficiency with which its assets have been able to compound the cash inflows.  The return on marginal capital is the key.  A standalone business has to decide what to do with its profits.  There are 3 realistic options, return of profits in the form of dividends (or possibly buybacks), reinvestment of profits in ‘organic’ growth, or reinvestment of profits in the form of ‘acquisitive growth’.  Most businesses perform some combination of these.  The power of ‘investing businesses’ like Leucadia and Berkshire are that there have been superior capital allocators, who takes the cash thrown off by businesses (which they own) with minimal prospect of reinvesting them with high returns and finds superior applications for the capital elsewhere.  The 2010 shareholder letter from Buffett addresses this.  More important than the rate of compound of the original investment is the rate of return that can be generated from the stream of cash it generates.  If it has a lower return than the original investment, overall returns diminish.

The Australian market has on average a higher proportion of dividend return than virtually any other advanced market.  Our fairly unique dividend imputation system creates this situation.  This forces most Australian companies into a much higher payout ratio than in other markets.  This is not so bad as managements generally are poorly-skilled in capital allocation in my view.  I can stand behind that statement purely on the basis of how few companies despite rock-solid balance sheets and sound prospects initiated significant buy-backs in the 2008/2009 financial year, with stocks at once or twice in a lifetime lows.

However, in my view the recent buy-back actions undertaken by JBH, WOW & BHP are excellent ways turning the ‘handicap’ of franking credits into an advantage.  The companies have managed to use the franking credits to buy the shares back at a 14% discount (this allows a ‘margin of safety’ for management, in case the shares were more fully valued than they had thought) to the prevailing market price.  At the same time, getting the franking credits into the hands of the shareholders who can best use them.  The alternative of paying a massive dividend, with a dividend reinvestment plans, would increase outstanding shares at a higher price and dilute future compounding.  The buyback instead reduces outstanding shares and increases the remaining shareholders’ compounding effect. It does so without requiring a tax payment or an additional investment.  These buybacks are an action to be commended, dividends are lovely, but capital growth is generally the most tax effective way to take your gains.

When investors make a decision to participate in a DRP, they must think hard about the power of compounding. Even when offered at a 5% discount (as some companies do).  If we assume participation in a DRP with a 5% discount in a company with an expected return of 14% p.a., or an alternative investment in a company with an expected return of 1% more, the second investment, from the 6^th year onwards offers a superior return. Tony Hansen 12/06/11

Full website: www.eternalgrowthpartners.com

Update No. 10 – 05/06/11

Full website: www.eternalgrowthpartners.com

	April 1st 2011	Current Price	Since Inception
EGP Fund No. 1	1.00000	1.12790	12.79%
S&PASX200TR	35632.05	33959.19	(4.69%)
EGP 20	1000.00	896.84	(12.91%)

EGP Fund No. 1 Pty Ltd. Up by 12.79%, leading the benchmark by 17.48%.  Well, the change is significant this week, it requires some explanation.  In short, our largest holding has come under a take-over offer.  The holding, when acquired made up almost 31% of the funds assets; the offer is at about a 69% premium to the price I acquired our holding (throughout April).  That is the good news; the bad news is that I believe the offer is almost ½ of the price at which the very bottom end of my valuation, and about 1/3 of a more sensible valuation.  We shall be agitating for a much, much higher price, or better yet, to just drop the offer and keep the holding as the business will trade much, much higher than the offer price within the next few years.

EGP 20.  The EGP20 index is down by 12.91%, lagging the benchmark by 8.22%. A very marginal improvement over the previous week.

S&PASX200TR    The benchmark index is down by 4.69% since April 1 launch.

There are four keys to above average success with share-market purchases.  In my view and that of most ‘value’ investors, the first and most important is a ‘bargain’ price.  The bargain price may seem obvious and absent the other factors, if you are sufficiently good at ‘bargain’ purchasing shares, you will probably achieve above average results.  But to really do well, you will need to have other factors working in your favour.  In my view an able and shareholder focused management is the second most important factor.  Operating in the smaller end of the market, I have historically found that the best businesses I’ve owned have had substantial ‘insider’, or management ownership.  Having a management that has a substantial equity interest almost always assists in having them operate the business in the most beneficial way for all shareholders (though there can be occasions where such managements will exploit this situation).

The third critical factor is a business operating with good and improving economics.  This is usually the hardest part to assess.  Almost all PDS documents you read will say words to the effect of ‘Historic performance is not indicative of likely future performance’.  Well, this may be the case, but it is certainly a valid starting point. I am very interested in a bargain priced, ably managed business that has been historically capable of reinvesting its earnings to create yet more earnings with minimal change in return on equity. A business sharing the first two characteristics, but with a less convincing financial history will need to be very strong on the other metrics to generate even a little interest.  The final factor, one that you have virtually no control over is a buyer willing to pay the full fair value for the business.  I have had occasion to buy businesses where the markets misinterpretation of value was screamingly obvious to me, and yet I have seen the price on-market go sideways for 2 or 3 years before some inane factor set a fire under the price.  Likewise, I have had occasion to commence accumulation of shares in a business I thought was deeply undervalued, only to have a corporate transaction take place 3 days after my first purchase, crystallising the most instantaneous of gains, but cutting short my opportunity to build a significant stake in the business.

What I will attempt to do is to simply work hard for my investors to find businesses that share the first 3 characteristics, and dispose of them when someone comes along offering factor four. I expect the results over time will tell the story better than I could. Tony Hansen – 05/06/11

Full website: www.eternalgrowthpartners.com