The story behind these stocks is simple. We bought a underlying portfolio of wonderful companies at a 20-35% discount to their value. This portfolio was managed by three managers who have proved they can return more than the market over time.
If I said you could buy a dollar for 70c, you would be quite silly if you turned down my offer. This is exactly how I saw the discounts that PET, PMC and MFF were trading at. The market was being silly.
Most people who invest naively believe the market is always right. If something is trading at a 30% discount, then there must be a reason that so many people are selling their stock at such crazy prices. Often the market is right, but for the educated investor, these short term market inefficiencies are wonderful ways of making money. The key is to be patient and wait for the right moments.
Unfortunately there will always be a large group who just dont get the concept of buying something for less than what it is worth. You can try convince some people until you are blue in the face, but for a reason that I will never understand, they like paying more than what something is worth.
Whilst it is not guaranteed that investing in listed fund that their discount will narrow, it is comforting that you are buying the underlying companies at a discount and so your share of the earnings is effectively higher than you could purchase directly from the market.
We certainly are not recommending buying these companies now there is no discount to their assets.
Often a valuation on a company is not as simple as looking at its net assets and working out a simple discount as was in the case with the listed funds above, but there are enough opportunities that are quite obvious to allow a hard working investor to allocate capital over time.
Google was a very obvious value play when we bought it around the $580 mark. At the time, if you took out the cash from the price, it was trading at 12 times earnings. Lets invert that to an earnings yield so the property minded Australians can understand. This equates to a 8.3% earnings yield (rental yield). So if you were to compare that to a typical investment property of $500,000 in one of the major cities, it would be a rent of $800 per week. Thats right $800 bucks a week for a $500,000 apartment. There are not too many of those around. But then it gets interesting. Google is growing in the order of 23% per year. Thats right, your $800 per week for your $500,000 apartment is growing at a rate of 23% per year. It is for this reason I find it difficult to get excited about people buying apartments for $500,000 renting out for just over half this amount and likely to grow at best in the low single digits.
At Valor Private Wealth, we like to keep things simple. If we can get 4.7% in long term cash then we think it is certifiably mad to buy a risky asset that is likely to return less than this. In fact, we believe it is crazy to buy an asset which is likely to return less than a reasonable "margin of safety" over this amount. We generally use a 9% hurdle rate and a 10 year time horizon for investment. That is, if we don't believe that our asset is going to return greater than 9% per year to its owners over the next 10 years, then we much prefer the Australian government backed cash return of 4.7%.
Using this metric, we find it fascinating watching the hords of people paying high prices that will eventually equate to mid to low single digit returns on their assets. Sometimes they know something that we don't, but usually it is just human 'greed' kicking in. In Australia, most of the investments we analyse are at prices that we equate to mid to low single digit returns going forward. Globally, there are still enough opportunities to make above our 9% hurdle rate, but as the markets rise, these opportunities are becoming more scarce.
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