Sharenet Blog

At Seed we have an investment process that is both simple and robust. By not overly complicating the process we attempt to consistently make investment decisions that will more often than not result in investment returns in excess of the targeted benchmark. We want to get the odds in our favour as often as possible and focus on the process rather than the outcome.

Before making any investment we ask ourselves three important questions:
1. Are we making this investment with a long term (i.e. at least 3 – 5 years) mindset?
2. Is there intrinsic value in this investment?
3. Is there a risk of permanent capital destruction in this investment?
An investment will only make its way into our portfolios if the answer is ‘Yes’ to the first two questions and ‘No’ to the third question.

Our portfolios are generally managed within strategic and tactical asset allocation frameworks, i.e. each portfolio has a stated benchmark and then mandated weighting limits for each asset class (e.g. benchmark local equity weighting of 50% with a maximum of 70% and a minimum of 30% in local equity, etc). We then make tactical decisions away from our benchmark (underweight or overweight) based on our research.

During a recent report back we were asked what our time horizon is for making these tactical asset allocation decisions. Referring back to the three questions we ask when making any decision it was quite simple to point out that we make all investments on a 3 – 5 year horizon. A key aspect that we had to point out was that while we make our decisions with a 3 – 5 year outlook, very few of our investments go unchanged over this period. On a monthly basis we update the valuations of each asset class, i.e. determine whether there is still intrinsic value in the investment, to determine whether we need to change the asset allocation of the underlying portfolios.

When valuing an asset class our assumption is that fair value will be reached in a straight line over 3 – 5 years. Markets naturally don’t move in a smoothed fashion and it is interesting to note how much the expected return from each of the asset classes can change over periods less than 12 months based on market movements. We take advantage of these opportunities to increase and decrease the weightings to the various asset classes.

The chart below is an extract of our equity valuation tool. The horizontal axis is the ALSI’s starting PE with the vertical axis the subsequent 5 year annual return. It is apparent that lower starting PE ratios equate to higher expected returns and vice versa. The red spot corresponds to the ALSI’s level in December 2010, and the yellow spot is at 30 September 2011. In the space of 9 months the market moved from being in overvalued territory to a level that was showing good signs of value.

By updating our valuation chart on a monthly basis we were able to take advantage of the opportunity presented in early October by increasing the allocation to local equities across all of our portfolios and in the Seed Flexible Fund in particular.

We trust that this gives some insight into the process followed at Seed. As has been discussed we also take a long term view, but ensure that we perform regular reviews.

Take care,

Mike Browne
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

In nominal terms on the first trading day in May, the market moved up to a new high, closing at 34,482. New highs make many investors nervous, but typically they are bullish indicators. It is also interesting to note that this market high was made despite the fact that a large portion of the market – the resource sector – is still down over 35% from their 2008 recent highs. In other words the new market high has been driven by the financial and industrial sectors.

Ultimately business value is dependent on earnings growth, and as a sub sector certain of the general retailers have been exceptionally good at growing their earnings over the last 10 years. The sub-category of general retailer includes well known retail stores such as Cashbuild, Mr Price, Massmart, The Foschini Group, Truworths, Woolies, and Holdsport etc.

The chart below reflects the General Retail index relative to the earnings of this sub sector from 2000, both indexed to 100. Over this period, these companies have managed to grow their earnings by over 13.2% pa compounded. This compares reasonably well to the earnings on the overall market, which over the same time period have grown by a compounded 15%. From this starting point, the share prices have actually lagged earnings growth. However the starting valuations in January 2000 for this sector were expensive with the average PE at around 20.

At times investors become very enthusiastic about certain businesses and are willing to place higher and higher multiples on earnings. This was the case in January 2000 with these shares, and again from around March 2010 as prices relative to historical earnings moved through the 18 time level (i.e. PE above 18). Continuing growth in underlying earnings have, however, been supportive of the higher prices and the February official retail sales growth rate moved up firmly to an annual 7.2%.

While there may be some concern that this rate of retail growth, especially when combined with the high levels of unsecured debt, is not sustainable, a cursory view of some of this sector’s recent results and trading updates, gives a sense of generally firm growth:
• Mr Price, in its trading update for the year to March expects headline EPS to increase by between 18% and 23%.
• The Foschini Group will release its annual results to March at the end of May. It is expecting headline earnings per share to be up between 20% and 23%.
• Truworth’s interims reflected a 14% gain in headline earnings and it is planning 6% growth in trading space.
• Holdsport, the owner of Sportsman’s Warehouse and Outdoor Warehouse announced that its earnings for the year to February should be up around 20%.
• Massmart announced a 44 week sale update to the end of April with total sales growing by 14.7% and comparable store sales growth up 8.9%.

For a number of reasons, this sector continues to attract foreign investors, aided in no small measure by Wal-Mart’s acquisition of Massmart. These businesses have proven track records, good management, relatively low levels of government intervention, and a definite emerging market growth theme, making them attractive long term investments.

But as the historical PE moves back again to the 18 times level, more and more investors are pricing in strong growth over the next few years in order to justify these more steamier valuations. Investors should show some restraint.

Kind regards,

Ian de Lange
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

Anyone who has spent any time valuing a business, or its indivisible unit, a share in a business, knows that there is not one specific method, but rather a range of valuations methodologies that can be applied when formulating the valuation.

At its most basic level, the value of a share today is the discounted value of all future cash flows that will be generated from the share. While simple in theory, in order to try and determine a theoretical value, investment analysts spend a lot of time on forecasting a company’s future income stream. However, even armed with accurate information on future earnings for a specific company, because we live in a world with extensive investment choice, the investment process often comes down to making an assessment of one investment option relative to another.

This so called relative valuation methodology is widely used and in many respects is simpler than making an assessment of the value on an absolute basis. Ultimately investors have choice and so even after performing a thorough valuation, an investor will produce a ranking table in order to compare one investment option against other competing investments.

As with all investment tools there is not one method that is infallible so when adopting a relative valuation methodology, an investor is looking for certain relationship patterns that tend to hold over time.

A few examples of relative valuation techniques that investors use include the following:
• The earnings yield or dividend on shares relative to the current yield on money market or yield on property shares.
• The price of one share relative to another share – usually, but not necessarily, in the same sector.
• The price of one sector relative to another – or an index in one country relative to another country.
• The price of a share relative to its underlying book value over time to determine if relatively cheap or expensive.
• One currency relative to another currency.

Even one of the most common valuation methods used – the price to earnings – or PE method is in essence a relative valuation method, when extended to comparing a company’s PE to the market average PE. With this method, company’s actual earnings are defined as a ratio to the number of shares in issue to arrive at earnings per share (EPS). Once the common yardstick has been obtained in the form of the PE, then it becomes easy to compare one traded share price to another in a relative format.

Look at the chart below, which compares the PE ratio of Anglo American relative to the PE ratio of Massmart over a 10 year period. This so called PE relative chart is a common tool used by analysts to gauge where value is appearing. This chart does not imply that either share is attractive or unattractive in its own right, but it gives a clear sense of the relative outperformance of Massmart against Anglo American over 10 years.

PE relative of Anglo American to Massmart

Source: I-Net and Seed Investments

Ten years ago, Anglo American had a PE ratio of 18 compared to Massmart’s 8. While the PE ratios have, on average, been almost equal over the past 10 years Anglo American’s PE has declined to 8 compared to Massmart’s 34 – i.e. one quarter of Massmart’s PE and a deterioration of some 90% over this time frame.

Analysts will say things like Anglo American looks cheap relative to the market or relative to consumer shares. There may be very valid reasons why one company’s valuation has deteriorated on a relative basis over time, but this is where an analyst should do additional work in order to make an assessment of the fundamental reasons. So by all means, make use of relative valuation techniques. They can be very powerful, but in and by themselves they will not tell the full story.

Kind regards,

Ian de Lange
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

Whilst most people see Retirement Annuities (RA’s) as a vehicle to fund provision of capital for their old age, this isn’t always the case as I was recently shown an example by one of my colleagues whereby changes in the rules relating to RA’s have given certain individuals an opportunity to plan their estates a lot more effectively.

Previously, members of an RA were compelled to retire from that fund before the age of 70. This rule has now fallen away and it is now possible to join an RA after the age of 70 with no mandatory retirement age; you may ask yourself “Why on earth would anyone in retirement want to purchase an RA?” But the following example will illustrate its effectiveness as a retirement planning tool for certain individuals:

“Mr A is 80 years old and has more than enough income and capital to fund his lifestyle. He has R 3 000 000 invested in a Money Market account at a bank which he decides to invest into an RA. For ease of calculation, we will assume that none of the R 3 000 000 is allowed as a deduction in the tax year of contribution. We will also assume that the underlying portfolio in the RA is a Money Market Fund earning the same rate as what he would have earned outside the RA. Mr A dies and the growth of the RA at this point is R 300 000 (which is the same as if he had left it in the Money Market account).

“If he hadn’t used the RA, Mr A would have had to pay R 120 000 in income tax (40% on the R 300 000 income from the Money Market account) leaving a net payout of R 3 180 000. The Money Market Fund would also be an asset in Mr A’s Estate, and if we assume that his estate duty rebate has been used on other assets, estate duty of R 636 000 would be payable. Executors fees of R 126 882 would also be payable on this asset leaving a net (after income tax, estate duty, and executors fees) R 2 417 118.

“By investing into the RA the interest earned is not taxed, leaving a total value of R 3 300 000 (all growth in an RA is currently tax free). The RA is not an asset or a deemed asset in the estate and is dealt with as a taxable lump sum death benefit received from a Retirement Fund. All contributions made to a Retirement Fund, not previously allowed as a deduction, are allowed as a deduction when calculating the taxable portion of the death benefit. If we assume that Mr A has already used his R 315 000 tax free retirement benefit, then total tax of R 54 000 will need to be paid, leaving a net benefit after tax of R 3 246 000.”

One must bear in mind that by locking up capital in an RA, accessibility will be greatly reduced (only 1/3rd is available as a lump sum) so this is a tool which should only be used by individuals with a large amount of free capital which is not going to be used or required during their lifetime. Naturally this type of strategy doesn’t make sense for most investors, but for those that it does, the potential benefits should not be ignored.

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Kind regards,

Barry Hugo
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

PSG Group Ltd released its annual results for the financial year ended 29 February 2012 on Monday, once again reporting some strong numbers and hinting at promising opportunities for further growth on the horizon.

PSG Group is an investment holding company with stakes in 39 underlying investments, including three companies separately listed on the JSE. PSG has its roots in financial services and as a result has a large exposure to the financial services, retail banking, and private equity sectors, but recently also ventured into agriculture and education. The company’s market capitalisation currently stands at approximately R 9.5bn.

Recurring headline earnings per share improved by 27.6% to 308.6 cents per share, while the dividend for the year increased by 22.4% to 82 cents per share. The Sum-Of-The-Parts (SOTP) value per share, which is explained below, has increased by 19.4% to R 55.92.

By the nature of its business, which is purchasing companies and unlocking their intrinsic value, it is unlikely that PSG will ever have a massive dividend yield and more likely that it will instead aim to reinvest as much of its profits as possible into new investment opportunities. Therefore, an essential valuation tool to value PSG is the Sum-Of-The-Parts (SOTP) value per share. The SOTP value per share metric looks through to an investment company’s underlying holdings and then calculates what the share should be worth in the market, based solely on the underlying holdings.

An extract from PSG’s financial statements shows the contribution of the underlying investments to PSG’s asset value and SOTP value per share:

Source: www.psggroup.co.za

PSG has also issued an updated SOTP value per share of R 61.66 as of 4 April 2012, which amounts to a further increase of 10.26%. The share price currently hovers around the R 53 - R 55 range, indicating a discount to SOTP. From the graph below it can be seen that the share price remains relatively close to the SOTP over time, although a discount has been in place for the past three years or so:

Source: www.psggroup.co.za

We will now have a brief look at the performance of two of PSG’s underlying investments that are also listed separately on the JSE, namely Capitec Bank and Curro Holdings.

Capitec Bank (32.5% Holding)

Capitec has taken the lower income market in the retail banking sector by storm, and has grown rapidly to a point where it currently employs over 7,000 people, has 3.7m active clients and a market capitalisation in excess of R20bn.

Capitec have delivered a return of 29% on ordinary shareholder’s equity, which is slightly lower than 2011’s figure of 35%. Understandably such high RoE figures are difficult to maintain in an environment where other banks are trying their utmost to capture a share of the lower income market. Capitec achieved headline earnings of R 1.08bn for the financial year, with headline earnings per share increasing by 49% to R 11.25.

Capitec is vitally important to PSG’s future success as it comprises 50% of PSG’s asset value. PSG CEO Piet Mouton attributes much of Capitec’s phenomenal growth to their management team, which has been in place since the company’s listing. He further displays confidence in their ability to grow the business’ client basis even further and to remain profitable going forward.

Curro Holdings (63.1% Holding)

Curro Holdings comprises about 9% of PSG’s asset value, and has enjoyed a lot of media attention since listing on the JSE AltX in June 2011. The excitement among PSG enthusiasts can be attributed to the company’s interesting business model of developing, acquiring, and managing private schools in South Africa, as well as the believed upside potential waiting to be unlocked.

Curro has expanded its number of schools countrywide from 3 to 16 since 2009, while the number of learners has increased from 2,000 to over 10,500 at present. This expansion came at quite a cost, with R 142m spent on the development of four new school campuses and a further R 80m to upgrade and expand their existing schools. As a result of all this capital expenditure, Curro reported a headline loss of R 7.5m for the financial year ending 31 December 2011, compared to a profit of R 5.2m reported for the previous year.

PSG cautions that Curro is still in its capital expenditure phase, which will be costly and capital intensive over the short to medium term. However, management believes that their long term growth strategy will unfold with very favourable results once the foundations are in place.

PSG has been a brilliant performer over the years, and has a strong management team in place, but as we mentioned last week one needs to ensure that a good company remains a good investment before making a capital allocation.

To get Seed's reports emailed to you directly every week, sign up for our newsletter by clicking here.

Kind Regards,

Cor van Deventer
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

Most investors have heard the saying, generally attributed to Albert Einstein, that compounding is the eighth wonder of the world. Compounding is a fairly straightforward concept (making gains on prior gains) but it can be very difficult to completely grasp as its effects are only truly felt over the extremely long term (think 20 years and more).

At the beginning of this year the Seed Weekly Report looked at 2 investors that invested a lump sum into the SA market (via the ALSI) for a 10 year period. Investor B used the dividends paid out to enhance his lifestyle, while Investor A slavishly reinvested the dividends. At the end of the period Investor A had 33% more invested than Investor B. While it is obvious that Investor A is better off, there can be the argument that the fruits that Investor B enjoyed as a result of his withdrawals could equal the financial value that he lost out on.

Agreed. Over a 10 year period, while compounding is good for your investments, the added benefits do not obviously always outweigh the opportunities lost. Over longer periods, however, the added benefits become more and more obvious.

For the purposes of this article, let’s assume that two 25 year olds each inherit R 100 000 from a distant aunt. They both decide that it’s not enough that they are able to stop working, but it’s a sizable amount that they want to invest in the stock market (ALSI – as they are able to take on the full market risk). Here their 2 strategies diverge slightly (or at least they don’t think there’s much difference at the outset).

The first recipient decides to reinvest his dividends with the following mindset, “This money is a windfall to me, and I don’t need to look at it or use it until I retire. I therefore want all my dividends reinvested”.

The second recipient is disciplined in that he wants to invest the inheritance, but would like to have a bit of extra cash each year to splurge, “I’m being responsible by investing the inheritance, but it won’t make much difference if I just have the dividends paid out to me as they are declared rather than having them reinvested”.

In the first 5 – 10 years the second recipient boasts that he’s a) got an investment that has grown nicely in real terms, and b) has ALSO been able to go on a few nice holidays and buy some new gadgets. The first recipient just keeps his head down, knowing full well that the power of compounding will kick in down the line.

At age 65 (retirement) the difference in size between the two portfolios is mindboggling! The portfolio that had the dividends reinvested is now over 5 times larger than the one that had the dividends continuously withdrawn. Both men have been made wealthy by their investments, but the one that reinvested his dividends has created significantly more wealth than his counterpart. The chart below shows the difference between the two portfolios using ALSI data over the past 40 years.

Less than 40% of the difference between the two portfolios can be attributed to the money that was spent on the holidays and gadgets. The remainder, over 60%, is the opportunity cost of not reinvesting the dividends. In this example, nearly R50m extra is generated through returns on the reinvested dividends!

While we agree that money can’t buy happiness, each investor needs to assess the pro’s of instant gratification versus the con’s of the opportunity cost of missing out on the compounding effect. Further, both investors did well by investing their inheritance rather than immediately spending it on a new car (or other depreciating ‘assets’), or a trip around the world, but one just did a WHOLE lot better than the other!

Take care,

Mike Browne
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

As multi-managers we focus most of our research in two areas:
• Selecting the best fund managers and blending them together
• Valuing asset classes to determine expected returns and risks going forward

This week we’ll take a closer look at valuing bonds.

As mentioned in previous weekly reports, bonds are essentially loans made by investors to the issuers (governments, parastatals, corporates) who promise to repay the bond back at a predetermined date with a predetermined interest rate. The return of the bond is therefore fairly simple to calculate. The initial yield will in a large part determine the total return (on a nominal basis) if the bond is held to maturity. Factors that will affect the total return will be any default (failure to pay either coupon or principal) and the reinvestment risk.

Reinvestment risk comes about when the coupons (interest payments) are paid to investors and need to be reinvested. Should prevailing yields be below the initial yield then the total return will be lower than the initial yield to maturity, but if they are higher, then investors will be able to enhance their return by reinvesting at the higher rate.

The chart below shows the relationship between the initial 10 year spot bond yield and the subsequent 5 year annual return. As can be seen, there is a tight relationship between the two variables with the initial yield explaining over 90% of the total return.

A large part of the Monetary Policy Committee’s (MPC) mandate is to keep inflation between 3% and 6%. While there is a ‘political’ mandate to encourage strong GDP growth (which will sometimes result in inflation staying higher for longer) there is at least the framework to bring inflation back should it move significantly above 6% for any extended period.

The inflation rate that is priced into the market for the next 5 years can be approximated by taking the difference between the long (nominal) bond rate and the inflation linked bond rate. Since the turn of the millennium the implied inflation rate has been between 4.5% and 6% nearly two thirds of the time. This range is intuitive as it sits in the upper portion of the MPC’s target range.

History shows that when the implied inflation rate was above 6% the average subsequent 1 year return from bonds is 18%. When the implied inflation rate is below 6% the average subsequent 1 year return from bonds is 9%. Naturally it is therefore better (in general) to invest into bonds when the inflation outlook is poor than when it is rosy. Taking a closer look at the numbers reveals an average 1 year return of only 6% when the implied inflation rate is below 5% and 25% when it’s above 7%.

Below is a cross section of the implied inflation rate and subsequent 1 year return from bonds. Notice the trend line:

We expect that this relationship will hold as long as inflation targeting is part of the MPC mandate. With actual inflation expected to sit between 3% and 6% (but more likely closer to 6%), periods where the market expects high inflation will generally be followed by periods where expectations moderate. Falling inflation expectations are good for bonds returns as the market prices in lower interest rates, which results in capital gains on fixed income investments.

As with any valuation model, the actual outcome will most likely differ from the model’s expected outcome, but the model does give a good indication of the type of return that one should reasonably expect going forward. Periods with high starting yields AND high implied inflation rates are good periods to be investing into bonds, with the converse also being true.

Kind regards,

Mike Browne
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

9 March marked the 3rd anniversary of the bottom of the 2007/2008 bear market, where the S&P500 index declined a massive 57% to 9 March 2009 from its October 2007 high. Then in just 2 years, the same index gained 100% from the lows made! Most global stock markets followed a similar pattern.

In trying to understand valuations, let’s revisit some basics. The value of a business is the discounted value of its future earnings at an appropriate discount rate. This should be relative easy to arrive at, but we know that because we are dealing with future uncertainty, there is a range of possible outcomes, hence the ongoing price volatility.

At the core, there are only 2 variables that affect the value of a share of a business – the income that it will generate, and the discount rate applied to that future income stream in order to arrive at a net present value. Expanding on each of these:

• A 100% shareholder has a claim on all of the future earnings generated by that business. Therefore a part shareholder has a proportional share in those future earnings. Some of the earnings will be received by way of a dividend, while typically the bulk will be reinvested back into the business for future growth and hence higher future dividends.

• The discount rate applied to the future stream of income is the second main factor in valuing a company. While the discount rate is affected by the prevailing interest rates, a rational investor will want to apply a higher discount rate to a more cyclical business, while one with superior management, a strong balance sheet and better quality and higher earnings growth, will justify a lower discount rate.

Instead of quoting discount rates, use is made of the price to earnings (PE) ratio, which is more or less the inverse of the discount rate. i.e. a company with steady and growing earnings, a strong balance sheet and quality management will justify a higher PE ratio. This metric is widely used and typically easier to understand.

The effect of the multiplication of these two factors can and does cause the price volatility that we see on a daily, weekly, and monthly basis. For example look at the reported earnings per share for all the S&P500 companies. It peaked in mid-2007 at around $85. Analysts would have been forecasting various forward levels around this, but then came the global financial crisis and earnings fell dramatically to below $10 a share by mid-2009.

As reduced earnings were quickly factored into investor forecasts throughout 2008, so share prices tumbled, eventually ending down almost 60% off the peak. But the interesting thing is that just as quickly as company earnings fell, so they have reversed all the way back up again with the 12 months to the fourth quarter of 2011, with almost all companies having reported, reflecting earnings per share of $87. Forecasts from S&P expect these to rise to $100 for the full 2012.

The chart below reflects S&P500 earnings from 1970 with the massive 2008 dip and subsequent recovery.

Source: Crestmont Research

In addition to the sometimes very volatile earnings, the multiple that investors apply to those earnings has a huge impact on valuations over various periods. I.e. an investor might suffer a loss from a company, which delivers on its expected earnings, because the rating on these earnings goes down. For example earnings may move up as expected from say 23 to 35, but the rating drops from an initial 18 to 10, resulting in a price decline from 414 to 350.

The only certainty with any investment is the price paid. Other than this, an investor does not know the exact details of the future earnings stream or the future price that an investor will be willing to pay for those earnings, making forecasts difficult.

A prudent investor will look at both the level of earnings and the rating of these earnings when making an investment.

Kind regards,

Ian de Lange
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

One of the most misunderstood areas of financial planning in South Africa is how trustees of retirement funds deal with death benefits of the funds. Most people either have their own benefits or have to deal with family members or staff who are frustrated when a claim either takes too long or the benefits aren’t paid out as stipulated in the beneficiary nomination form.

The beneficiary nomination form for an approved retirement fund benefit does not carry the same weight as one for a life policy. When you nominate a beneficiary on a life policy or an unapproved group scheme, the insurer will pay the proceeds of the policy directly to your nominated beneficiary, whether it is your mistress, your brother or the SPCA. This is not the case with a beneficiary nomination on death benefits on an approved retirement fund.

Death benefits on a retirement fund are paid out in accordance with the stipulations of section 37C of the Pension Funds Act. It grants the trustees a 12 month period from the death of the member to search for dependants of the deceased member. This needs to be done despite the existence of a nominated beneficiary. The trustees are granted discretionary powers in awarding the death benefits; however, the overriding consideration is equity in distributing the death benefit. The trustees cannot merely follow the beneficiary nomination that the member placed on the policy or pay the benefit to the dependants found by them, but must exercise their discretion provided to them by section 37C in doing so. The beneficiary nomination will act as a guideline to the trustees as to the wishes of the member, but in no way diminishes their responsibility in determining who should receive the death benefit.

In a Pension Fund Adjudicator decision of S Segal v Lifestyle RA Fund, the adjudicator stated that in order for the trustees to act equitably, they should give regard to the following factors:

• The age of the parties;
• The relationship with the deceased;
• The extent of dependency;
• The financial affairs of the dependants, and
• The future earning potential and prospects of the dependants.

The adjudicator then goes on to provide a class of potential claimants, which includes:

• Those whom the deceased had or would have had a legal duty to support, namely spouses, children, parents, grandparents, and unborn children;
• Factual dependants, such as so-called common law spouses and same-sex partners;
• Customary law spouses and those married under Islamic law, Hindu, Buddhist, Confucian, or Taoist rites;
• Major children of the deceased whom the deceased had no legal duty to support; and
• Beneficiaries nominated in writing after 30 June 1989.

A nominated beneficiary, for example a brother, who is not financially dependant on the deceased, will have very little chance of receiving the benefits if the deceased had a wife and children. This is an example of where customary law and legal statue are directly in conflict with one another, because it is common practice amongst Zulus that the oldest brother / oldest son must inherit and he will then look after the remaining dependants. Unfortunately, for customary law legal statute carries more weight.

Therefore, when you are nominating beneficiaries for your retirement fund’s approved risk benefits, take note of the parameters, which the trustees must use when allocating benefits. They are not trying to be difficult if they do not follow your wishes, they are just following the law.

Kind regards,

Barry Hugo
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966

When it comes to selecting shares to construct your share portfolio, several factors can be used to evaluate shares for inclusion. At Seed our Model Portfolio has a tilt towards value shares, buying shares with dividend yields higher than the market and PE ratios lower than the market average. Our process also favours shares where earnings and dividends are expected to grow in future.

When deciding between two shares, an investor first must decide which criteria to use to provide the best indication of the return that can be achieved, and then compare the universe of shares using these criteria. There are always shares with compelling stories making headlines, but as a rational long term investor fundamental factors and ratios should be the main drivers behind your share choices. The two factors most familiar to investors are probably the Price Earnings (PE) ratio and Dividend Yield (DY).

PE ratio

The PE ratio is calculated as the current market value per share divided by the company’s earnings per share over the past twelve months. A further variation on this figure is the forward PE ratio, which uses forecast earnings over the next twelve months in the calculation. Using forecast earnings to calculate a PE ratio is not as reliable as using actual past earnings data, because forecasts can be inaccurate (especially at turning points). However, the forward PE has a prospective nature, which can sometimes be more useful to evaluate the share’s future performance.

Dividend Yield

A share’s dividend yield is calculated very simply as the annual dividend received per share divided by the share price. A healthy dividend yield is an important factor for investors that rely on dividends as an avenue of income. Although large and consistent dividend declarations are often regarded as a sign of a company’s good financial health, some companies may have very valid reasons for not declaring dividends, e.g. setting profits aside for expansion or acquisition activities. The forward DY can be calculated on a similar basis, but using an estimate of the next 12 months’ dividends to create a prospective measure of the DY.

Tiger Brands vs. Nampak

Nampak Ltd (NPK) and Tiger Brands Ltd (TBS) both form part of the Industrials super sector on the JSE, and although very different in operations and market capitalisations they can still be compared on a PE and DY basis.

Nampak was listed in 1968 and has grown to be Africa’s largest and most diversified packaging company through various acquisitions. It produces packaging products for various products from metal, paper, plastics, and glass, and also collects and recycles used packaging.

Tiger Brands was formed in 1952 with the launch of Tiger Oats, and has grown to become one of SA’s largest consumer goods companies. The company owns a wide assortment of brands including Purity, All Gold, Energade, Beacon, and Albany.

These companies’ share data as on 05/03/2012 can be summarised as follows:

Tiger Brands’ share price has increased by 46.1% over the last 12 months, pushing the PE up to 16.8 which is well in excess of the JSE ALSI PE of 13.3. The forward PE of 15.3 implies 9% earnings growth in the next year.

On the other hand, Nampak’s share price has not run as hard over the past 12 months, increasing by only 8.6% but showing strong growth over the last 30 days with a 5% increase. The PE of 13.7 compares favourably to the ALSI, and the forward PE is a further 14% lower at 11.8. This is a very reasonable price to buy into a quality company. On the dividend yield side, Nampak has the upper hand with a 4.6% yield compared to Tiger Brands’ 3.0%. Both companies have a DY in excess of the ALSI (2.8%).

Conclusion

Tiger Brands has rewarded investors with phenomenal growth over the past 3 years, but given the high current PE and modest DY we believe that there are better buying opportunities out there. Seed has recently included Nampak into our model portfolio, at the expense of Tiger Brands, as the current valuations are very favourable and we believe that further growth in earnings can be expected as SA’s manufacturing sector grows.

Kind regards,

Cor van Deventer
info@seedinvestments.co.za
021 9144 966