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Value hunting

By Simon Angelo

October saw most markets down heavily.  It wasn't a crash - which generally constitutes a double digit fall over several days, but it was a decidedly bearish correction with the Nasdaq down 12.3% (from month start to end) and our benchmark - the MSCI World Index down almost 9%. 

Some over-diversified products such as ETFs and KiwiSaver Growth accounts for example saw balances drop more than 10%.

For the value investor, with convictions on a much smaller number of businesses and sectors you have been following for years, this should present a buying opportunity.  You back your research, back your preferred businesses, take the risk (of further correction) and top up.

The reality in this market is good businesses are holding their value which reinforces our belief in following a global but concentrated strategy.  Against wider falls of 10%+, our composite portfolio strategy was down only 3.07% from October start to end.

Dividends play a role

By definition, a good business produces excess cash flow, enough to both distribute as profit and reinvest for future growth.  When the market falls and hard times come, these sort of businesses weather the storm better than others.  Even when price declines, you can still enjoy a running yield over 5%.  This allows you to continue to hold these businesses until growth in the economy and market resumes.

A more risky type of investing is to focus on stocks that are purely growth oriented.  These are often tech or small cap businesses that reinvest all profits (if any) and don't pay a dividend.  Some investors have made big returns from these businesses - I'm thinking of one local cloud based software business for example.  These investors deserve their returns.  They've taken on a lot of risk, since such businesses can also be worth nothing, quite quickly.  

The problem for a value investor hunting for value, is that these hot, growth businesses look pretty speculative when you start reviewing the assets they own and the cash burn needed to build them.  And then you enter a territory where you're investing into something you don't fully understand or can reasonably predict the outcome of.  In other words - taking a punt, or gambling.  

When you're seeking to increase income and deliver stable return from capital, there's no place for gambling.  Moreover in the public markets, short sellers can more easily spot problems with business models based on slender assets than you can spot untapped potential.

Speaking of potential and value...

Market sogginess weighed heavily on one of our UK positions through October - the home builder Crest Nicholson.  Brexit concerns, a tough London property market, an earnings downgrade and the bearish sentiment pulled it down to a 5 year low of 274 pence.  It had been trading as high as 622 last year. 

Around 280 pence, PE (Price to Earnings) was as low as 4, asset value was well supported by land holdings in Southern England and the company had a clear plan to slow down building and maximize cash flow while waiting for the market to improve - which the market could likely do once Brexit pans out next year.  The more than healthy dividend of around 10% is also well supported.

Looking at market depth and announcements it is now clear that smart investors bought large positions, internal directors increased their holdings and in just two weeks it went from 274 back up to nearly 350.  Those investors have enjoyed a 27% return in 2 weeks while they await their next dividend payment in March - on track to yield 10% p.a. on top of the growth.

It is these sort of value spots in a bearish market that present golden opportunities for the value investor and that's why now is such a good time to enter the market to take advantage.

UK home builder Crest Nicholson is known for its quality developments in London and Southern England.  Beleaguered by bearish stock and property markets, it has recently presented great value.  There remains a housing shortage in England.
Performance update
October 2018 saw a -3.07% return for the month across the composite portfolio (comprising those accounts containing the full strategy positions).*  This was against our near 2% growth in September but was considerably less than the -8.55% decline in our benchmark, the MSCI World Index.  Our annualized return now sits at an average rate of 17.15% p.a. from inception in 2014.*  You can view the full performance chart here.
Stock take
Amit Parmar shares an interesting view and opportunity on mining giant Rio Tinto. 
Rio Tinto Ltd is an Anglo Australian mining giant with its roots dating back to 1873.  After a series of M&As and the shrewd business acumen of the Rothschild family, its scale and operations have expanded globally since 1880.  It is a constituent of two important benchmarks: the FTSE 100 (Weight: 2.45%) and the ASX 200 (Weight: 1.79%).

Key strengths of Rio Tinto include:
  1. Excellent cost management;
  2. Excellent executive leadership;
  3. Economies of scale;
  4. Outstanding capital management.
Rio Tinto has consistently demonstrated outstanding capital management. It has added value to equity holders by buying back $2.25 billion of its bond due to mature in 2024. This was completed in April 2018.

Since then it has now announced a share buyback programme and is focusing company growth through assets that offer the highest returns. The approximate buy back value is $2.7 billion in Australia and GBP 1.01 billion on the London Stock Exchange.  It has a market cap of GBP 47.3 billion with a P/E of 6.6 and debt to equity ratio of 26.56% (globally the Materials sector averages 148%).

The company offers a return on equity of 20.65% in this current environment.  The dividend yield offered is around 6.15%. There may be an arbitrage opportunity between the ASX and LSE on the stock price. The prices in NZD terms are:

ASX: NZD 80.75
LSE: NZD 72.21

The above management steps and the quantitative value offers a good stock to be added for long term investors looking to build wealth.
The month ahead
My son started his first paper round the other week.  Having helped him with the first day, I had forgotten how much hard work these are - and that you're out in all kinds of weather.  (I haven't done a paper round since I was 11).

He also received his dividend from Auckland Airport - a business I'd been investing his birthday money into.  We established that to earn this dividend via his paper round he'd need to do his run more than 7 times.

I think it was a useful lesson on the power of investing and the benefits of it.

For November we continue to look for value and the ability to generate a good level of income.  With a high degree of fear operating in the markets it's a great time to enter, although I do notice that with talks of a trade deal between the US and China, and the movement toward the Brexit deal in the UK, markets are starting to move ahead again today.
If you're a client, thanks for taking the long view with Vistafolio.  If you'd like to find out more about our innovative, managed account solutions for eligible or wholesale investors, please visit

*Past performance is not an indicator for future performance. Your actual portfolio will differ from the composite portfolio mentioned. Annualized returns are after management fees and after withholding taxes. The information contained in this document does not constitute an offer to sell or a solicitation to buy an investment, nor should it be construed as investment advice.  It is recommended that potential investors take appropriate tax and/or investment advice before making any investment.
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