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

Update No. 9 – 29/05/11

Full website: www.eternalgrowthpartners.com

	April 1st 2011	Current Price	Since Inception
EGP Fund No. 1	1.00000	1.02228	2.23%
S&PASX200TR	35632.05	34649.20	(2.76%)
EGP 20	1000.00	887.12	(11.29%)

EGP Fund No. 1 Pty Ltd. Up by 2.23%, leading the benchmark by 5%.

S&PASX200TR    The benchmark index is down by 2.76% since April 1 launch.

EGP 20.  The EGP20 index is down by 11.29%, lagging the benchmark by 8.53%.

I thought I’d talk about market-timing.  The market this week dipped (again) below its January 1 2010 opening price of 33985.86 (it was 33909.12 at time of writing).  So if you’d purchased the market on that date, in 17 months your return has been just short of zero.  If you own a managed fund that closely mimics the indices, you are probably 3 or 4 % short of a zero return, when factoring fees.  However, had you bought just 12 months earlier (January 1 2009 = 24801.27) you would be sitting on about a 37% gain.

So timing can greatly add to your performance, ignoring this fact is, well, ignorant.  Benjamin Grahams “Mr Market” allegory is as meaningful today as it was when written (over 60 years ago); the underlying business valuation is the most important factor.  But sensible consideration of the fairness of the overall market values could be some part of your plan, my caveat, though is it is not everything, owning the right businesses (stocks) acquired at the right prices (regardless of the market-price at the time) is far more important.  People, though, will always discuss timing, so I will give my take.  Stock-markets are enormously volatile over the short and medium term, but in the long run, will basically follow the performance (predominantly) of the underlying economy (with globalisation, obviously other factors also come into play).  If you are generally optimistic about the economic future in Australia, holding investments in Australian businesses is a sound idea.

I created this (very simple) spreadsheet from the available P/E data.  The data measures the P/E ratio of the All Ordinaries at the end of each month for the last 25 years.  It indicates the month-end high in the period was 23.29x on 30/11/99, interestingly, no ‘crash’ followed this point, but it was 43 months before the index broke above that month-end price and stayed there.  The lowest point was 8.19x on 31/01/2009, just over 1 month after this point of course, the market started a massive rise.  I would describe a general upward trend in optimism (as defined by increasing average P/E ratios) until about 2000, with a general slide in optimism since then.  We can see from this how highs and lows should be relatively recognisable.

Highs and lows are interesting, but data are most useful for ranges and averages, which tell us a historically ‘sensible’ price.  Of the 301 data points, the median is 15.72x, the mean is 15.98x, for 50-points either side of the mean is on average 15.76x & 100 points either side of the mean is on average 15.88x.  In short, I would suggest it a sensible policy would be the following:

1. If the market is between 15x and 16.9x, holding would be the best course of action.  Only add a new stock if you are very confident in its prospects.
2. Between a market P/E of 13.6x and 15x, steady/cautious accumulation should be profitable in the longer term on average, particularly when focusing on superior businesses.  Between 12.5x & 13.6x I would tend to accumulate with a fairly heavy hand, even lesser businesses should perform well from this position.  Under 12.5x, you should be very heavily invested in stocks, judicious buying at these (market) prices should result in very handsome gains over time.
3. Between a market P/E of 16.9x & 18.8x, you should be particularly careful about any type of buying, these are times to sell more often than buy.  Between market P/E’s of 18.8x & 19.7x, I would likely not even buy an outstanding business (excepting unusual valuation circumstances), I would consider selling any business close to my assessment of full value.  Over 19.7x, I would look seriously to sell anything fully valued as the market is too optimistic, a decline or an extended period of minimal index growth is more likely than not.

For those who have neither the time nor the inclination to closely follow market valuations, in order to ‘smooth’ out the entry prices, a ‘Dollar Cost Averaging’ system may be useful.  By purchasing in approximately similar amounts at regular intervals, over time you will on accumulate at prices that approximate fair value.

My second and final caveat for the week is take care in using a consistent measuring stick (for example, always take your P/E from the one place, if you use the AFR, always use the AFR, if you use Comsec, always use Comsec).  The most recent month end in the spreadsheet is 31/03/11, and points to a 15.05x ratio, now at the moment I believe the true ratio of the ASX200 is closer to 13.25x, which is about a 13.6% difference (this is why we must use the same measure consistently).  In any case, from either measure, the prices at the moment for the Australian market are, in my view, if not cheap, certainly not in ‘selling’ territory. Tony Hansen 29/05/11.
Full website: www.eternalgrowthpartners.com

Update No. 8 – 22/05/11

Full website: www.eternalgrowthpartners.com

Current Period	Apr 1 2011	Current Price	Since inception
EGP Fund No. 1	1.00000	1.04023	4.02%
EGP20	1000.00	896.84	(10.32%)
S&PASX200 (TR)	35632.05	34999.19	(1.78%)

EGP Fund No. 1 Pty Ltd. Up by 4.02%, leading the benchmark by 5.8%.

EGP 20.  The EGP20 index is Down by 10.32%, lagging the benchmark by 8.54%.

S&PASX200TR    The benchmark index is Down by 1.78% since April 1 launch.

I would like to talk about market forecasts this week.  I often keep clippings of financial forecasts from newspapers and magazines, when I come across them.  I like to look at them when the expiry date draws near; they usually serve as a vivid reminder why one should never go out into the public domain with a forecast. Now, as I pointed out in a recent update, the $1.139 trillion ASX200 indices, over the most recent 12 months (which basically captures the second half of FY2010 & the first half of FY2011) have reported total earnings of just under $86 billion according to my sums.  According to consensus analysts’ forecasts for FY2012, they are expected to earn over $116 billion in that period.  That is a 34.88% increase between now and then.  Assuming the analysts are correct, and assuming the indices trade at the same P/E ratios after reporting the results in question, then the market should have risen by about 35% by about September or October of 2012 (this is about when the proposed $116b worth of results would be reported).

Now obviously, we cannot rely on this being the case (all factors remaining constant & the analysts getting it right) or we would simply buy the market now, wait 18 months and book our 35% gain (or about 22.15% pa), we wouldn’t even need to go to the trouble of picking individual stocks.  This is due to the market being a ‘discounting machine’ and if at that point, the market takes a view that the 2013, 2014 and 2015 prospects are very dim, these prospects are what will drive the market.  So even if the market achieves the analysts forecast heights, prices may instead reflect the ‘dim’ future rather than the ‘record’ present.

This is (among the reasons) why listening to journalists and market commentator’s blather on is pointless; they are wrong approximately as often as they are right, and are often pushing their own position for selfish reasons.  Instead we must independently assess those businesses which at their current prices, regardless of the strength of the economy or the direction of the markets, we would be happy to own at current prices. Never forget that a business lies underneath your 'share price', selling should only occur when there is an obviously superior business to own at better prices, or an irresistible price is being offered, such that converting to and holding cash is viable alternative.  Tony Hansen 22/05/11

Full website: www.eternalgrowthpartners.com

Update No. 7 – 15/05/11

See the full website at: www.eternalgrowthpartners.com

Current Period	Apr 1 2011	Current Price	Since inception
EGP Fund No. 1	1.00000	1.03634	3.63%
EGP20	1000.00	904.40	(-9.56%)
S&PASX200 (TR)	35632.05	34772.72	(-2.41%)

EGP Fund No. 1 Pty Ltd. Up by 3.63%, leading the benchmark by 6.04%.

EGP 20.  The EGP20 index is Down by 9.56%, lagging the benchmark by 7.15%.

S&PASX200TR    The benchmark index is Down by 2.41% since April 1 launch.

This week, I thought I would talk about the launch of our official website.  Our www.eternalgrowthpartners.com site no longer redirects to this blog, it now has a basic structure all of its own.  Over time it will grow and evolve, but it is initially as you will observe, a very basic affair.  This is because I have defaulted to my low-cost ethos and basically developed the site with the (massive) help of Adam, my far more tech-savvy Brother.

Over time, the site will grow and evolve along two key lines.  Firstly, as I improve my understanding of developing and running a website, it should more closely reflect the appearance and functions that I have developed in my mind.  Secondly, as I have more and more feedback from those who use the site and what they would like it to do for them, I will do my best to enhance the features in keeping with user preferences, so if you have any suggestions, feel free to make contact – Tony Hansen 15/05/11

See the full website at: www.eternalgrowthpartners.com