Update No. 26 – 25/09/11

Full website: www.eternalgrowthpartners.com

We start this week with a quote from the greatest literary work of the 20^th century:

The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances. He should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored. – Benjamin Graham, “The Intelligent Investor”

Aside from the sexist assumption that an investor is a man (over 78% of EGP shares are owned by women – though many of those are my wife’s holding), this statement is every bit as correct now as when it was written, over 50 years ago.

As for ‘a portfolio of sound stocks’, after the recent reporting season, in the 12 months ended 30 June 2011, our holdings (as you can tell below) have declined in price, though not as severely as the benchmark.  In order to give fellow owners a sense of the type and strength of businesses we hold, I will give an update to some financial metrics, for a comparison you may wish to look back to Update No. 5 where I first mentioned a comparison of the metrics of the stocks we owned in comparison to the ASX200.

Now the second half of Financial Year 2011 was quite successful for our 8 holdings.  In particular our 3 largest holdings posted significant profit improvements compared to the second half of FY2010.  The end result of this is that in aggregate, because their prices have remained relatively static, and earnings have risen is that our portfolio, which had a P/E of 7x in May, now has a (weighted average) P/E 4.36x.  Because we have added a little to some of our smaller holdings, our (weighted average) Market Capitalisation is $219.75m, and the weighted average NPAT for FY2011 was $50.35m.  This NPAT is not some freaky number caused by some ‘one-off’ items, revaluations or any such thing, but a true reflection of the earning capacity of the ‘portfolio of sound stocks’ you own a share of, if anything, there were more negative ‘one-off’ items than positives, I truly expect our holdings in aggregate to grow their earnings in FY2012, even if the global economy remains weak.  In Update No. 5 I reported that our average gearing was 22.1%, but this was all debt included, without subtracting cash holdings (i.e. not net debt).  In order to give you a better picture of our holdings’ true balance sheet position, I have calculated the ‘Net Position’, the sum of all cash & cash equivalents less any long or short term debts. You should be impressed to know that your companies as a weighted average hold $45.3m of net cash on their balance sheets, which represents over 20% of their weighted average Market Capitalisation.

Now to put this in terms that might mean something more tangible to fellow investors.  Imagine instead I owned a smaller business; say a coffee shop, for arguments sake.  Imagine I offered to sell this coffee shop to you for $500,000, coming with the business is a sound management (so you won’t have to do any work!), included in the sale price is the $103,071 in cash that sits in the bank and best of all the shop returned (after taxation) in FY2011 $114,679 in profits, which have grown consistently over the last 10 years and appear likely to at the very least continue at approximately a similar rate (or even grow).  I would hazard that given such an opportunity, you would probably knock me over on your way out the door to get to the bank and sort the finances (at least I would if you offered it to me).  Well, for fellow EGP shareholders, there is no need; you already own a portion of such a business in aggregate, there is no coffee shop, but a diverse range of businesses that include two miners, a mining services provider, a property developer, manufacturers of industrial and consumer goods etcetera, in my view, much better than the coffee shop presented above.  All we need to do is remember Ben Grahams advice and be patient – Tony Hansen 25/09/11

	April 1st 2011	July 1st 2011	Current Price	Current Period	Since Inception
EGP Fund No. 1	1.00000	1.08396	0.99890	(-7.85%)	(-0.11%)
S&PASX200TR	35632.05	34200.68	29426.26	(-13.96%)	(-17.42%)
EGP 20	1000.00	883.67	749.69	(-15.16%)	(-25.03%)

EGP Fund No. 1 Pty Ltd. Down by 7.85%, leading the benchmark by 6.11% since July 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Down by 0.11%, leading the benchmark by 16.31% all-time (April 1^st 2011).

EGP 20.  The EGP20 index is Down by 15.16%, lagging the benchmark by 1.2% since July 1^st.  Since inception the EGP20 is Down by 25.03%, lagging the benchmark by 7.61% all-time (since April 1^st 2011).

S&PASX200TR  The benchmark index is Down by 13.96% since July 1^st. The benchmark is Down 17.42% all-time (since April 1^st 2011).

Full website: www.eternalgrowthpartners.com

Update No. 25 – 18/09/11

Full website: www.eternalgrowthpartners.com

I’ll be relatively brief this week; for there are a great many valuations I need to focus my efforts on at this time of year.  Wednesday evening (14^th), the time the first draft of this post being written, the S&PASX200 TR index (our benchmark) is down 15.3% since our April 1^st inception, our fund at this time is a few percentage points above it’s $1 foundation price, but is well down since July 1.  This is undoubtedly a difficult time to be an equity investor, for every bit of positive economic news we hear; I reckon we are hearing 6 or 7 negative pieces.  I have heard it described before that when all the financial commentators and talking heads are talking the market’s down, then that’s when you want to back the truck up and load up.  Though not universally bearish, there are not a lot of positive commentators around, so perhaps we’re getting close to the bottom?

The only thing that piqued my interest was the changes to the component stocks of the S&P indices.  Specifically, I thought it was an interesting reflection on the state of our economy that a newly enlarged Iluka Resources (ILU – a mineral sands miner) is replacing a newly shrunken Bluescope Steel (BSL).  It’s a shame that Australia appears destined not to be able to maintain a strong (read – profitable) domestic steel industry, but if we’re honest in our assessment, it’s been coming for a long time.  The industry may like to look at the high $AUD and the carbon-tax for scape-goats, but the fact remains, we are uncompetitive in these areas and unfortunately, if the market forces that drive the rise of ILU decide the demise of our domestic steel industry, then we must accept that and focus on those areas where we (as a nation) have a competitive advantage.

Reasons such as national security are cited when commentators discuss the need to maintain a domestic steel industry; these are invalid reasons to maintain an uncompetitive industry.  We will never be at war all at once with every other steel manufacturing nation in the world, so we shall always be able to buy from someone, if the asking price rises high enough, a domestic industry will likely sprout, that’s capitalism – Tony Hansen 18/09/11

	April 1st 2011	July 1st 2011	Current Price	Current Period	Since Inception
EGP Fund No. 1	1.00000	1.08396	1.04017	(-4.06%)	4.02%
S&PASX200TR	35632.05	34200.68	31270.96	(-8.57%)	(-12.24%)
EGP 20	1000.00	883.67	817.19	(-7.52%)	(-18.28%)

EGP Fund No. 1 Pty Ltd. Down by 4.06%, leading the benchmark by 4.51% since July 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 4.02%, leading the benchmark by 16.26% all-time (April 1^st 2011).

EGP 20.  The EGP20 index is Down by 7.52%, leading the benchmark by 1.05% since July 1^st.  Since inception the EGP20 is Down by 18.28%, lagging the benchmark by 6.04% all-time (since April 1^st 2011).

S&PASX200TR  The benchmark index is Down by 8.57% since July 1^st. The benchmark is Down 12.24% all-time (since April 1^st 2011).

Full website: www.eternalgrowthpartners.com

Update No. 24 – 11/09/11

Full website: www.eternalgrowthpartners.com

The Fund NTA dipped a bit this week (more than the market) as our largest holding which is the subject of a corporate action declined in price, as the bidder games the target.  If the takeover falls over at current prices, I truly believe it will serve our fund-holders better, though it may hurt short-term performance.

It has been a little while since I passed comment on the managed fund industry.  For a starting point, in order to find funds operating in a similar area to ours, I went to the Comsec website.  I filtered for ‘Equity Region Australia mid/small value’ as I feel this sector most closely resembles the area I focus our capital on.  I thought I’d display the performance of some of the better ranked funds, since April 1 which was our inception date.  The top 3 (by last 12 months performance) were:

1. Perpetual Smaller Companies Fund.  This fund has fallen 14.3% since April 1.  From $3.063 to $2.625 (as retrieved here Thursday)
2. Invesco Australian Smaller Companies Fund. This fund has fallen 11.4% since April 1.  From $1.125 to $0.99652 (as retrieved here Thursday)
3. Sandhurst Future Leaders Fund. This fund has fallen 7.9% since July 1 (I couldn’t find an April 1 price).  From $0.7216 to $0.6649 (as retrieved here Thursday)

I don’t point this out to gloat, despite our performance over 5 months being as much as about 20% better than the funds above.  More it is to harp on (again) about one of my favourite topics, the alignment of interests between fundholders and money managers.  Each of these funds have handsomely beaten their benchmarks over the medium to longer term (over 5 years or more), but each are trailing, or at least cutting very close to their respective benchmarks in the period examined.  Despite this period of weakness, each of the above funds is charging an MER (Management Expense Ratio) of between 1.95% and 2.14%, which is eating into fundholders capital despite weak performance.  When a client lodges their funds with a money manager, they do so in the hope (or dare I say expectation) of the performance of their investment being better than the benchmark their fund competes against.  While I think most investors will understand the odd period of underperformance (no fund ever will out-perform a benchmark in every period), what I can’t understand is people tolerating payment of fees for such underperformance.  As I have pointed out many times before, there are a variety of exchange traded funds that closely track a variety of benchmarks for negligible fees.

In my view a confident money manager should have no problem working as EGP Fund No. 1 Pty Ltd does on a performance fee only basis.  If you truly believe you can beat the indices in 70 or 80% of periods, a performance fee only manager still knows they will get paid; they just need to budget for the odd period when you miss the mark – budgeting is something a competent money manager should know how to do!

With each passing day, there is more and more information suggesting we are in for a period of relatively poor global financial health.  Australia still seems to be holding up pretty well, though a case could be made either way.  For example, there were solid GDP figures for the June quarter on Wednesday, followed Thursday by an unexpected rise in August unemployment.  I still maintain the best protection we can have against a weak period is a concentrated portfolio of superior stocks, to my view, that is what we hold – Tony Hansen 11/09/2011

	April 1st 2011	July 1st 2011	Current Price	Current Period	Since Inception
EGP Fund No. 1	1.00000	1.08396	1.05408	(-2.76%)	5.41%
S&PASX200TR	35632.05	34200.68	31567.35	(-7.7%)	(-11.41%)
EGP 20	1000.00	883.67	823.15	(-6.85%)	(-17.68%)

EGP Fund No. 1 Pty Ltd. Down by 2.76%, leading the benchmark by 4.94% since July 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 5.41%, leading the benchmark by 16.82% all-time (April 1^st 2011).

EGP 20.  The EGP20 index is Down by 6.85%, leading the benchmark by 0.85% since July 1^st.  Since inception the EGP20 is Down by 17.68%, lagging the benchmark by 6.27% all-time (since April 1^st 2011).

S&PASX200TR  The benchmark index is Down by 7.7% since July 1^st. The benchmark is Down 11.41% all-time (since April 1^st 2011).

Update No. 23 – 4/09/11

Full website: www.eternalgrowthpartners.com

The second month of the new financial year has been completed.  Wednesday saw a flood of profit results, as a lot of smaller companies released results detailing FY2011. The last day of August & the last day of February (and the first day of the next month) are the only days I look to the Small-Ordinaries index in comparison to the S&PASX200.  The reason being is that on these days, the flood of last-minute reporting from the smaller end of the market can sometimes move the Small-Ordinaries out of step with the ASX200 (which has usually substantially completed reporting beforehand).  This is not for the purpose of some ‘technical indicator’; regular readers will know I don’t care for technical analysis.  In my view, due to the disproportionate amount of late reporting from the small businesses in the Small-Ordinaries, and the way the market reacts to the results give me a feeling about how the smaller end of the market is doing (without reading every Appendix 4E).  Generally, the behemoths like the banks and the big miners are responsible for most of the movements in the indices, the only days we can notice the little guys in any significant way is when there is a flood of information.  So I generally feel that if the Small-Ordinaries is stronger than the ASX200 on these days, the little businesses as a whole are probably doing better (or giving upbeat commentary about the future) than the market was expecting.  We need to remember, however, that a lot of the businesses that report on these days are explorers and other highly speculative enterprises, profit & loss statements for these businesses are rarely a driver for share-price movements.

As for the comparison, the Small-Ordinaries was scarcely different to the ASX200 on Wednesday, up 0.8% compared to 0.6%.  So the little guys didn’t report any remarkably unexpected results as a whole.

Talking about the flood of reporting that accompanies the last day of reporting season gives me a chance to get on my soap-box over an issue that really irks me.  This is the reporting of price sensitive information during trading hours.  About 240 x 4E’s were delivered on 31 August; nearly half of these hit the market during trading hours.  Of all the market releases a company makes, probably the most important to an investor are the profit announcements, as they give investors the chance to understand how their company has performed in a given period.  In my view it is imperative these should be released out of hours, to give shareholders time to digest the information properly before acting on it.  Particularly for retail investors, who perhaps don’t have ready access to the market during market hours, it places them at a disadvantage, if the result is a good deal better or worse than the market expects, they are unable to react to the information as quickly as others.

As I mentioned last week, we had half of our holdings report this week (not part of the Wednesday flood, ours reported on Monday/Tuesday).  There was a couple of outstanding results, one about on par, and one that was a good deal weaker than I’d hoped, though the weaker than expected result can be clearly explained by revenues being delayed into FY2012, which should mean a good 12 months ahead.

The next 2 or 3 months will be very busy for me as I use the recent reporting season to refine my Intrinsic Valuations (IV’s) for those businesses I am interested in.  Five or Six months ago, I produced IV’s for 440 companies based on February reports.  I have trimmed my list down to 687 already, and by the time I get to reading some of their information, I will likely confirm that more than 200 of the 687 are still rubbish, and either can’t be valued or aren’t worth the effort – For Example, when I looked to see how many were on the list, I noticed Brisconnections (BCS) are on it.  Without reading their latest report, I can remember they have something like $3.5b of intangibles that relates to future cash-flows from toll-roads currently under construction (from memory there’s a 40 year concession to operate the roads).  I feel no capacity to place a value I could be happy with on this - which is the key asset of the company, with a couple of years traffic I could start to make an assessment, but for now, when I get to the letter ‘B’, BCS will fall off my list.  I will probably end up by late October with values on about 440 companies. Tony Hansen 04/09/2011

	April 1st 2011	July 1st 2011	Current Price	Current Period	Since Inception
EGP Fund No. 1	1.00000	1.08396	1.08396	0.00%	8.4%
S&PASX200TR	35632.05	34200.68	31846.26	(-6.88%)	(-10.62%)
EGP 20	1000.00	883.67	814.54	(-7.82%)	(-18.55%)

EGP Fund No. 1 Pty Ltd. Up by 0.00%, leading the benchmark by 6.88% since July 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 8.4%, leading the benchmark by 19.02% all-time (April 1^st 2011).

EGP 20.  The EGP20 index is Down by 7.82%, lagging the benchmark by 0.94% since July 1^st.  Since inception the EGP20 is Down by 18.55%, lagging the benchmark by 7.92% all-time (since April 1^st 2011).

S&PASX200TR  The benchmark index is Down by 6.88% since July 1^st. The benchmark is Down 10.62% all-time (since April 1^st 2011).

Full website: www.eternalgrowthpartners.com