Robusta fundamental, leveraged investments

[robusta]

Perhaps a bit of over analysis going on here.

Looking at my portfolio and trading performance (long only) over the last 12 months its very clear that buying almost anything from mid April onwards had very little chance of being successful....the general market trend was down, news was negative, sentiment was negative.

For long only punters it was near impossible to close out trades in front...up to mid April i was averaging 1 new winning trade every 3 and a half weeks, since April ive had only 1 winning (new, closed) trade, so 1 new winning trade in 8 months...IMO any entry in any stock had little to no chance of being correct over that time frame ~ 15 April 2011 to 5 Jan 2012...see All Ords chart below.
~

Yes agree exactly the point i was making too. Not many people ahead over the last 8-9 months.

I would love to take these excuses but the fact remains the purtfolio has not been managed to my satisfaction to date, the main faults IMO are imparience, too much turnover and poor position sizing.

 

[robusta]

Robusta,

Thanks for sharing your journey thus far.

It has been a very difficult period to invest - you aren't alone.

from me...

I like your current portfolio, however it is clearly very concentrated (which I personally like), however it does mean that risk management is much more important and something to be judged frequently.

This will allways be a concentrated portfolio, hopefully in the future this does not also lead to a high turnover.

I'm not sure if you have specifically stated your investment strategy, however it seems to me that it is to invest on the basis of maximising relative value whilst ensuring good quality. At the start of this thread you said something to the tune of this being a fairly boring strategy, but clearly it is not. I invest along the lines of this philosophy and it is actually a highly interesting but highly intensive strategy. It seems as though you have discovered this by having to make many changes.

Have not posted my strategy for this portfolio so here goes...

The light bulb moment for me as a investor was reading The Intelligent Investor by Benjamin Graham. The idea that you can buy a part ownership in a company when out of favour and profit from the subsequent performance of the company seems like a good strategy to me.

From here reading Warren Buffet taught me you could pay more than book value for a share particularily if the company makes good incremental returns on retained equity.

Next Philip Fischer, Roger Montgomery et al have further confirmed and refined these basics and I hope to be able to profit from these lessons.

So the things I look for in a stock/business are:

Competitive advantage
Little or no debt
Competent and honest management
High ROE
Good prospects
A ability to retain profits and earn a high rate of return on those profits.

Note there is nothing in this strategy about picking where the market will go or regarding macroeconomic factors. I notice that you use a US indicator to predict the trend but for me I will rely on portfolio management to take advantage of market movements. If we have a bear market some cash in reserve to buy cheap, if a bull market holding good quality businesses to take advantage should keep me happy either way.

I think that it is good that you have been able to change and adapt, because this makes us better investors. Unlike some people, I personally think value, or relative value, is in a constant state of flux. I believe that current price is constantly seeking fair value on the basis of future earnings and structure. Therefore what we once thought was stable value, turned out to be very volatile and changing.

I agree in the main Macros, some rare businesses however have stable and even growing value IMO.
It is a fine line between 'falling in love' with a stock (and holding to your detriment) and 'jumping at shadows' (buying and selling on short term factors when the long term is positive) IMO.

As you have stated out of your learnings, macro factors are very important and this is something that I believe in strongly (hence the avatar). Unless one is investing in stable defensive businesses (which we are short of in Aus), then it is very difficult to determine what the macro factors at play will be over a decade. However, it is much easier to guess at over a one to two year period - with constant reassessment. My philosophy is to constantly weigh the macro factors and to determine how I think they will feed through in earnings over the next couple of years.

I respect your ability to do this Macros, you are up against almost every analyst out there, for me I dont think I can beat them at their own game. I will be looking for those stable defensive businesses and also cyclicals at attractive prices.

I like your current portfolio composition, although a couple of pointers (which you probably already have an idea of):

- COH was fantastic value at $50 or below, but has now reached something close to fair value. At this stage I think that it is difficult to gauge what level of growth in value might be possible from here. In any case, it is a quality business and should pay out reliable dividends out of strong cash flows, however, the question is whether that fits in with your investment strategy (if I'm right in maximising value?)

Happy to hold for those reliable (growing) dividends, I still think there are many years of growth left in COH and one day just as the market recently offered a crazy low price it will offer a crazy high price.

- MCE has continued risks. I was a beneficiary of the big wave upwards but fortunately sold out close to the highs. It is good to see that they are working towards stable contracts, however, it is clearly not out of the woods yet. I have stayed my hand at entering again at $3 because of the lack of certainty and also I had to question whether it had better relative value than other opportunities. My point here is just that it is important to ensure that one is not focused on what they are used to at the expense of looking at better opportunities. I see the upside and understand why you are hanging in there.

Good on you I was not so smart and did not sell anywhere near the highs in my SMSF (I still hold having reduced the position size).
MCE does have continued risks but the work will come IMO.

- OKN looks to meet all criteria. However my concern is that whilst revenue has held up well, operating and free cash flow look very sickly. I haven't had an in-depth look at OKN so I don't know if there are good reasons why there will turn around soon (and they need to).

Normally I do not like turnaround stories but OKN have been investing to reposition the business to compete with the international players, I will be watching closely.

- Again, thanks for sharing. I'm sure it would be easy to stop updating this thread, however it seems to have been very useful in developing your investment strategy and understanding.

That it has, thankyou Macros

 

[Macros]

Thanks Robusta,

That gives me a better understanding of where you are coming from. My biggest problem with employing long term value plays in Australia is that there are so few companies that fit the bill. I think more Australian value investors should be widening their scope and consider companies that are not available on our market and are able to provide much greater diversification of business assets/competitive advantage. For example, Disney looks pretty good in terms of current margin of safety, stable ROE, growing dividends, a consistent growth in value and is a company type that we lack on the ASX.

In terms of exposure to a very long term business (e.g. could easily hold for 10 years without worry), the only company that you currently hold that I personally would view that would fit the longer term criteria would be COH.

It would be very easy to disagree with me, however it is my view that the other companies are better fitted to a 'swing' value type of concept, which is pretty much what I do in that I understand that prices are highly likely to move towards value, but that value is constantly changing and market/economic forces play a significant role over shorter periods of time (e.g. 2-3 years). MCE is 100% in this camp.

 

[robusta]

Thanks Robusta,

That gives me a better understanding of where you are coming from. My biggest problem with employing long term value plays in Australia is that there are so few companies that fit the bill. I think more Australian value investors should be widening their scope and consider companies that are not available on our market and are able to provide much greater diversification of business assets/competitive advantage. For example, Disney looks pretty good in terms of current margin of safety, stable ROE, growing dividends, a consistent growth in value and is a company type that we lack on the ASX.

There are a few on the ASX that fit my criteria however in the future and as my knowledge grows I may look at international shares.

In terms of exposure to a very long term business (e.g. could easily hold for 10 years without worry), the only company that you currently hold that I personally would view that would fit the longer term criteria would be COH.

I would not say I could hold any business without worry but MTU and CCP are very long term businesses as well, I would be surprised if I do not still hold at least one of my top three holdings in 10 years.

It would be very easy to disagree with me, however it is my view that the other companies are better fitted to a 'swing' value type of concept, which is pretty much what I do in that I understand that prices are highly likely to move towards value, but that value is constantly changing and market/economic forces play a significant role over shorter periods of time (e.g. 2-3 years). MCE is 100% in this camp.

I agree value is constantly changing the goal for me is to identify businisses with a growing value over a long period of time and taking advantage of the positive compounding.

 

[robusta]

Leverage changes the equation.

Leverage is a two edged sword, one day it will work in my favour.

Only if margin lending is used. Is there a margin loan involved here?

This is a line of credit on my mortgage - so no margin calls here.

It's a lot harder when you know every dollar that you've lost will also have to be paid back. Perhaps illogical but it's the reason I will never leverage equities (or any investment in a business unless I had operational control or something approaching that).

Not a worry for me, I do not lose any sleep over this issue. IMO any one of my top three holdings is likely to wipeout the current deficit - given time.

 

[robusta]

Robusta for point 3) in your selling reason, how do you decide the price is to far above value, as you see there is a problem as price can go a lot lower than value and this also goes in the other direction. How do you maximise the your time on the upwave?

The valuation technique I use is outlined in Value-able by Roger Montgomery. I know it is not exact but find it a good rule of thumb.

There is no set % of how far above 'value' the price has to be before I sell it depends on the growth prospects of the business and also on the portfolio construction.

I use no TA or trend techniques in this decision but simply try to buy at discounts to my estimate of IV and sell at a premuim to my estimate of IV.

 

[odds-on]

Thanks Robusta,

That gives me a better understanding of where you are coming from. My biggest problem with employing long term value plays in Australia is that there are so few companies that fit the bill. I think more Australian value investors should be widening their scope and consider companies that are not available on our market and are able to provide much greater diversification of business assets/competitive advantage. For example, Disney looks pretty good in terms of current margin of safety, stable ROE, growing dividends, a consistent growth in value and is a company type that we lack on the ASX.

In terms of exposure to a very long term business (e.g. could easily hold for 10 years without worry), the only company that you currently hold that I personally would view that would fit the longer term criteria would be COH.

It would be very easy to disagree with me, however it is my view that the other companies are better fitted to a 'swing' value type of concept, which is pretty much what I do in that I understand that prices are highly likely to move towards value, but that value is constantly changing and market/economic forces play a significant role over shorter periods of time (e.g. 2-3 years). MCE is 100% in this camp.

Macros,

Great post. IMO there are few companies in the ASX that have the attributes to suit long term value plays, those that do are so closely followed that any meaningful discount rarely arises.

Your ‘swing’ value type of concept has legs. GCS would be an ideal candidate to swing into late into FY12 or 13 subject to your economic indicators picking up. Price has been dropping to 52 week lows, price to sales below 1, management advise FY12 earnings will be as per FY11 earnings, the outlook for FY13 is rosy subject to contract wins. Watch out for management guidance, then wait for the economic indicators to pick up, then only buy at a price to sales ratio that compensates for the risk.

Cheers

Oddson

 

[odds-on]

The valuation technique I use is outlined in Value-able by Roger Montgomery. I know it is not exact but find it a good rule of thumb.

Expected value. The investors friend.

http://www.investopedia.com/terms/e/expected-value.asp#axzz1iv3RXwjv

Cheers

Oddson

 

[Macros]

Macros,

Great post. IMO there are few companies in the ASX that have the attributes to suit long term value plays, those that do are so closely followed that any meaningful discount rarely arises.

Your ‘swing’ value type of concept has legs. GCS would be an ideal candidate to swing into late into FY12 or 13 subject to your economic indicators picking up. Price has been dropping to 52 week lows, price to sales below 1, management advise FY12 earnings will be as per FY11 earnings, the outlook for FY13 is rosy subject to contract wins. Watch out for management guidance, then wait for the economic indicators to pick up, then only buy at a price to sales ratio that compensates for the risk.

Cheers

Oddson

Exactly.

Expected value. The investors friend.

I like it. I think intrinsic value is way overused because one can only assess intrinsic value if all factors are known with a very high certainty and low risk of error. In reality, this isn't practicable. I tend to think of 'fair value' in line with the definition of expected value.

 

[Macros]

Leverage is a two edged sword, one day it will work in my favour.

I think there is a good probability that it will do so this year.

 

[robusta]

Macros,

Great post. IMO there are few companies in the ASX that have the attributes to suit long term value plays, those that do are so closely followed that any meaningful discount rarely arises.

Your ‘swing’ value type of concept has legs. GCS would be an ideal candidate to swing into late into FY12 or 13 subject to your economic indicators picking up. Price has been dropping to 52 week lows, price to sales below 1, management advise FY12 earnings will be as per FY11 earnings, the outlook for FY13 is rosy subject to contract wins. Watch out for management guidance, then wait for the economic indicators to pick up, then only buy at a price to sales ratio that compensates for the risk.

Cheers

Oddson

Hard to argue against that, GCS does seem a very attractive company. I would normally like to see a higher ROE and a lower Debt/Equity but the opportunity to buy below book value is very attractive, cash flow in recent times also looks excellent.

Expected value. The investors friend.

http://www.investopedia.com/terms/e/expected-value.asp#axzz1iv3RXwjv

Cheers

Oddson

Exactly.



I like it. I think intrinsic value is way overused because one can only assess intrinsic value if all factors are known with a very high certainty and low risk of error. In reality, this isn't practicable. I tend to think of 'fair value' in line with the definition of expected value.

You are right the term intrinsic value implies a exact, correct figure when in reality it is more of a range eg MTU $3.60-$4.40 hence the need to apply a margin of safety - another term that implies extra meaning that is misleading if you get the IV wrong.

http://www.investopedia.com/terms/m/marginofsafety.asp#axzz1ivVbPMQl

 

[skc]

Leverage is a two edged sword, one day it will work in my favour.

But what one edge has killed, the other edge couldn't revive.

 

[odds-on]

Hard to argue against that, GCS does seem a very attractive company. I would normally like to see a higher ROE and a lower Debt/Equity but the opportunity to buy below book value is very attractive, cash flow in recent times also looks excellent.





You are right the term intrinsic value implies a exact, correct figure when in reality it is more of a range eg MTU $3.60-$4.40 hence the need to apply a margin of safety - another term that implies extra meaning that is misleading if you get the IV wrong.

http://www.investopedia.com/terms/m/marginofsafety.asp#axzz1ivVbPMQl

IMO the market prices any business by considering the probability of both long term survival and short term success. Long term survival is different to short term success and should not be confused. These two probabilities need to be considered properly when valuing a business and the appropriate valuation tools used.

 

[robusta]

But what one edge has killed, the other edge couldn't revive.

True but in my case just a cflesh wound, not terminal.

IMO the market prices any business by considering the probability of both long term survival and short term success. Long term survival is different to short term success and should not be confused. These two probabilities need to be considered properly when valuing a business and the appropriate valuation tools used.

Sorry I do not understand. Are you saying the market is efficent in pricing short term success (or lack of) along with long term survival?

What sort of different valuation tools would you use for each?

Surely it is not enough for a business to survive long term as a part owner you would want it to thrive IMO. The historical difference between QAN and BHP come to mind as a example.

 

[odds-on]

True but in my case just a cflesh wound, not terminal.




Sorry I do not understand. Are you saying the market is efficent in pricing short term success (or lack of) along with long term survival?

What sort of different valuation tools would you use for each?

Surely it is not enough for a business to survive long term as a part owner you would want it to thrive IMO. The historical difference between QAN and BHP come to mind as a example.

Robusta,

IMO I believe the market is broadly efficient in pricing the probability of both long term survival and short term success of any business. Long term survival is different to short term success and should not be confused. For the sake of simplicity I class all businesses as either having Low, Medium or High probability with respect to long term survival (5-10 years). To aid me I use some rules of thumb; research data suggests that once a business has been operating for a few years then the probability of it surviving the long term is more or less the same irrespective of the business size. However until it has been operating for a few years there is a high probability of failure.

Any business without a few years worth of profitable operating history I class as Low. My valuation is done using liquidation value (search the internet for Benjamin Graham type formulas) as the odds are likely that it will fail. I want a discount to liquidation value and the business to be wound up in a timely manner to ensure my return.

How do I differentiate between Medium and High?

A high probability means an established company with many years of operating history working in a industry where it is either a monopoly or part of duopoly/oligopoly and provides a product that human society needs to function such as banks/electricity/supermarkets/water/insurance/gas/Microsoft and so on. How difficult is it for society to change from the product? Thinking about the scale of the change required usually helps me the most when thinking about the probability, if the scale of change is large then it is unlikely. I value this types of business using earnings yield and comparing it to long term government bonds. Now any company with a high probability of long term survival will typically trade around a PE range of 12-15 and will be closely followed with rare opportunities for a large discount. It is therefore advantageous to purchase when they are trading at lower of the range and take a long term buy and hold for an economic cycle. The number of companies that can treated like this is small.

If I do not think the business can be classed as Low nor High then it can only be Medium, that is to say that it is a 50/50 or 60/40 chance whether it will survive the next 5 to 10 years. There will be some operating history but it may not have been not always be profitable, no recurring revenues, no monopoly, I cannot see a real need to human society for the product and so on. I value these types of businesses using the price to sales ratio. Why Price to Sales Ratio? 1. It is a proven value indicator 2. It makes me focus on the not paying for too much for revenue and possible future revenue over the next couple of years.

That is the long term survival what about short term success. I define short term success as an earnings surprise within a 12 month period, obviously it depends on the business model to what could trigger this earning surprise. Investors want to make a quick buck so they want a business to have some short term success such as an earnings surprise or contract win etc. The market reacts positively to these surprises so an investor can make a tidy profit. But the probability of short term success is different, a business like a gas utility has a high probability of long term survival yet could have the same probability of a short term success as a business with low probability of long term survival. However the effect on the share price following some short term success will be different between the two businesses, in the case of a company trading at liquidation value it could double in price in a year, I doubt the price of a gas utility will. This difference in effect on the share price due to short term success affects the expected value of the investment. When assessing the possibility of short term success I merely adjust the liquidation value or price to sales ratio or PE ratio to what it could be if the short term success happened.

Expected value is the investors friend. Trust me I do not use spreadsheets or complicated maths, I just try evaluate how the market is pricing the business and what needs to happen for me to make a nice return. The market is broadly efficient not a 100% so sometimes opportunities present themselves.

Cheers

Oddson

 

[robusta]

Thankyou for your reply odds-on.

IMO I believe the market is broadly efficient in pricing the probability of both long term survival and short term success of any business. Long term survival is different to short term success and should not be confused. For the sake of simplicity I class all businesses as either having Low, Medium or High probability with respect to long term survival (5-10 years). To aid me I use some rules of thumb; research data suggests that once a business has been operating for a few years then the probability of it surviving the long term is more or less the same irrespective of the business size. However until it has been operating for a few years there is a high probability of failure.

Any business without a few years worth of profitable operating history I class as Low. My valuation is done using liquidation value (search the internet for Benjamin Graham type formulas) as the odds are likely that it will fail. I want a discount to liquidation value and the business to be wound up in a timely manner to ensure my return.

A good way to reduce risk IMO

How do I differentiate between Medium and High?

A high probability means an established company with many years of operating history working in a industry where it is either a monopoly or part of duopoly/oligopoly and provides a product that human society needs to function such as banks/electricity/supermarkets/water/insurance/gas/Microsoft and so on. How difficult is it for society to change from the product? Thinking about the scale of the change required usually helps me the most when thinking about the probability, if the scale of change is large then it is unlikely. I value this types of business using earnings yield and comparing it to long term government bonds. Now any company with a high probability of long term survival will typically trade around a PE range of 12-15 and will be closely followed with rare opportunities for a large discount. It is therefore advantageous to purchase when they are trading at lower of the range and take a long term buy and hold for an economic cycle. The number of companies that can treated like this is small.

Looks to me like the 'high' businesses are where the competitive advantages would be found. That is a very good search criteria IMO.
When you use this valuation technique do you take into account ROE, payout ratio and the capital intensity of the business? I would think variations in these numbers would make a vast difference to your returns.

If I do not think the business can be classed as Low nor High then it can only be Medium, that is to say that it is a 50/50 or 60/40 chance whether it will survive the next 5 to 10 years. There will be some operating history but it may not have been not always be profitable, no recurring revenues, no monopoly, I cannot see a real need to human society for the product and so on. I value these types of businesses using the price to sales ratio. Why Price to Sales Ratio? 1. It is a proven value indicator 2. It makes me focus on the not paying for too much for revenue and possible future revenue over the next couple of years.

Price to Sales Ratio is not a indicator I use. I view it as a variant of P/E ratio and neither take into account ROE.

That is the long term survival what about short term success. I define short term success as an earnings surprise within a 12 month period, obviously it depends on the business model to what could trigger this earning surprise. Investors want to make a quick buck so they want a business to have some short term success such as an earnings surprise or contract win etc. The market reacts positively to these surprises so an investor can make a tidy profit. But the probability of short term success is different, a business like a gas utility has a high probability of long term survival yet could have the same probability of a short term success as a business with low probability of long term survival. However the effect on the share price following some short term success will be different between the two businesses, in the case of a company trading at liquidation value it could double in price in a year, I doubt the price of a gas utility will. This difference in effect on the share price due to short term success affects the expected value of the investment. When assessing the possibility of short term success I merely adjust the liquidation value or price to sales ratio or PE ratio to what it could be if the short term success happened.

I have a lot to learn before I can predict the short term success of a business.

Expected value is the investors friend. Trust me I do not use spreadsheets or complicated maths, I just try evaluate how the market is pricing the business and what needs to happen for me to make a nice return. The market is broadly efficient not a 100% so sometimes opportunities present themselves.

I do like this approach, I do the same thing but in a slightly different way by:

1) Looking for those competitive advantages

2) Looking for a high or rising ROE.

3) Comparing the dividend yield to my required return

4) Paying a premium for retained capital in the business that will in all probability earn a high rate of return

5) Trying to buy at a discount.

 

[Macros]

The market is broadly efficient not a 100% so sometimes opportunities present themselves.

I agree the the market is broadly efficient based on aggregate expectations and I have been able to determine this through my research. However, it is frequently inefficient in components. Therefore I think there are always opportunities.

 

[McLovin]

I do like this approach, I do the same thing but in a slightly different way by:

1) Looking for those competitive advantages

2) Looking for a high or rising ROE.

3) Comparing the dividend yield to my required return

4) Paying a premium for retained capital in the business that will in all probability earn a high rate of return

5) Trying to buy at a discount.

I think sometimes one can overfocus on RoE as though it is some sort magic ratio. Yes, it can identify low capital intesity businesses and yes, it can sometimes indicate competitive advantage but in some businesses (esp service driven businesses) it is not really that great a metric and paying attention to margins will probably reveal more about competitive advantage than RoE. Just my .

 

[robusta]

I think sometimes one can overfocus on RoE as though it is some sort magic ratio. Yes, it can identify low capital intesity businesses and yes, it can sometimes indicate competitive advantage but in some businesses (esp service driven businesses) it is not really that great a metric and paying attention to margins will probably reveal more about competitive advantage than RoE. Just my .

The way I look at it is to treat stocks as buying part of a business or to put it another way buying equity in a business. It is paramount to me to get the largest return I can for every $1.00 of equity I purchase.

If I had the choice between two businesses with the same assets, one earning 10% on those assets the other earning 30% all things being equal I would be happy to pay significantly more for the higher earner. The second business has either higher revenue of margins or both.

Margins and ROE often go hand in hand IMO.

 

[McLovin]

If I had the choice between two businesses with the same assets, one earning 10% on those assets the other earning 30% all things being equal I would be happy to pay significantly more for the higher earner. The second business has either higher revenue of margins or both.

Of course. But how often are you in such an easy position to be comparing two companies with identical assets, or even significantly similar assets where there is such a large variation?

I'm not saying ignore RoE but realise that making sweeping inferences based on it can be a trap. A company with a genuine competitive advantage will have a high RoE and high margins. A company with no competitive advantage may have a high RoE (because of the business it is in) but will probably not have high margins.

Of course there are no hard and fast rules.