Sharenet Blog

The next lesson that I would like to highlight from James Montier’s 10 lessons is the fact that sentiment matters in returns.

We have discussed valuation and that time and time again it’s very evident that starting valuations are critical for longer run superior returns.

But Montier goes one further and notes that while it is a cliché that markets are driven by fear and greed, this is “disturbingly close to the truth”.

Investor sentiment swings like a pendulum, from irrational exuberance to the depths of despair.

This move in investor sentiment drives prices. This price action measured over a period of time – one month, 3 months, 12 months etc is what investors receive as an “investment return”.

Some studies have been performed to try and measure investor sentiment and then having measured it, to ascertain what groups of companies perform better than others when sentiment is high or low.

Baker and Wurgler looked at various factors to measure sentiment, including:

• Discount on closed end funds. When discounts widen, sentiment is low and vice versa.
• Turnover on the New York stock exchange
• The number of and average first day returns of IPO’s (initial listings)
• The equity share in new issues
• The dividend premium (relative price of dividend paying and non dividend paying shares)

In general they found that when sentiment was low, buying young, more volatile, unprofitable companies (i.e. Junk) generated the better returns.

When sentiment is high, it is better to buy more mature, low volatility, profitable firms (i.e. quality).

This investment methodology is in itself is contrarian -

GMO’s and James Montier’s view is that at present, high quality stocks appear to be one of the few fat pitches available. I.e. with sentiment having now improved and markets closer to fair value, they say that “quality stocks continue to register as distinctly cheap on our metrics.”

Some interesting points. If you would like to discuss how this may pertain to your investment portfolio, or if you are looking for an investment manager to advise on and manage your discretionary and retirement funds, contact Vincent on telephone number below or Vincent@seedinvestments.co.za

Kind regards

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

Local markets

Industrial and basic materials had inched up by noon, while gold mining and oil and gas stocks slipped, leaving the JSE All Share up slightly by 0.2%. Investors awaited key US data to be published later this afternoon.

The rand was trading at R7.42 to the US dollar, remaining range bound but keeping alert for movements of the euro.

Oil had fallen 0.36% to $79.71 a barrel at 12:00, as investors expect OPEC to pump above quotas in the second quarter, and Chinese economic data reawakened worry over tighter monetary policy.

International markets

The Dow Jones closed up fractionally by 0.03%, while the Nasdaq lifted 0.78%. Bank and technology shares rose on hopes of better corporate profits on increased business demand.

Japan's Nikkei ended 0.96% higher this morning, as gains in machinery stocks came after better-than-expected machinery orders, serving to offset a loss in Toyota Motor Corp shares.

Asian markets closed flat as the Shanghai index inched up 0.08% and the Hang Seng finished 0.02% higher, as the latest Chinese economic data showed an inflation hike, worrying investors.

Losses in commodity and financial stocks sent the FTSE 100 down 0.1% by noon, as China’s economic data revived investor worry about the effects of tighter monetary policy.

Share price news

In the retail sector, Foschini Limited (share code: FOS) rose 2.58% to R66.68 at midday, after investors exchanged 411 388 shares.

In the clothing and footwear sector, Compagnie Fin Richemont (CFR) gained 1.78% to sell at R28 a share, after 2 756 249 shares were traded by midday.

Gold miners Simmer and Jack Mines Limited (SIM) fell to R1.22 a share, a loss of 2.40% as investors traded 889 526 shares in 45 deals.

Electronic equipment company Digicore Holdings Limited (DGC) saw the trade of 2 011 140 shares in 39 deals, sending the share price down 1.56% to R3.15.

We looked at 10 lessons that investment strategist James Montier put out in a paper issued by US fund managers, GMO. I mentioned that I would spend a bit more time on some of the lessons that he highlighted.

His lesson number 4 was – Valuation matters.

He noted that while most everyone agrees with the assertion that “value investing tells us to buy when assets are cheap and avoid purchasing expensive assets.” He has repeatedly come across investors willing to “undergo mental contortions” to avoid the valuation reality.

He highlights the Graham and Dodd methodology of calculating the price to earnings ratio by dividing the current price over the 10 year average earnings. He cites past examples when investors rejected this methodology because it is too backward looking and does not take growth into account. This was especially the case in the IT boom period when different valuation metrics were being invented.

He also cites that during the latest crisis, investors were making arguments that this methodology was overstating earnings.

However over an extended period of time, buying when the PE is low (using a 10 year smoothed earnings) generates significantly better returns than buying when markets are expensive.

The graph above reflects the compounded real return over a subsequent 10 year period, based on different starting valuations. What is clear is that when the PE ranges between 5-13, the 10 year real return is far higher than when the PE ranges from 20-48.

We have done a similar study of the real returns on the JSE at different starting valuations – modelling this, drives our basic equity asset allocation decision.

If you have any questions on your investment returns, strategy and would like to find out how Seed can assist, please don’t hesitate to give us a call.

Kind regards

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

Local markets

On Wednesday at noon, the gold mining and basic materials sectors were leading the JSE All Share into the black. The local bourse had edged up 0.57% at the time, despite a small dip in oil and gas shares.

The rand was trading within a range at midday, selling at R7.42 to the US dollar, and tracking the movements of the euro.

Gold had risen 0.26% to sell at $1124.94 an ounce, stabilizing somewhat, though traders expect that lower oil prices could spur selling.

International markets

The Dow Jones finished 0.11% higher while the Nasdaq gained 0.36% yesterday on US markets, as gains in telecommunications and industrial stocks offset losses in resources.

Japan's Nikkei slipped 0.04% this morning, following flat US markets, as losses in Toyota Motor Corp weighed on the index.

The Hang Seng finished flat, only just in positive territory as investors took profits after three straight days of gains.

Britain's FTSE 100 had inched up 0.2% by midday, tracking US and Asian markets, as gains in mining and oil shares overcoming losses in defensive shares.

Share price news

Paladin Capital Limited (share code: PLD) gained 11.11% to trade at R2 a share, as investors bought and sold 353 188 shares in 19 deals.

317 252 shares of Mondi PLC PRE (MNP) were exchanged in 195 deals, sending the share price up 6.26% to R51 at midday.

Losing ground was 1time Holdings Limited (1TM), whose shares fell 4.55% to R1.05 a share, after 14 deals traded 445 800 shares.

In the farming and fishing sector, Sovereign Food Investments Limited (SOV) fell to R8.50 a share, a loss of 3.41% after 182 840 shares were exchanges in 12 deals.

James Montier, a global financial strategist and expert in behavioural finance, put some points out in a White Paper published by US fund managers, GMO, titled “Was it all just a bad dream? Or Ten lessons not Learnt.”

He starts off by saying that the market declines of 2008 and early 2009 are being treated as nothing more than a bad dream…. The extreme brevity of financial memory is breathtaking.

He put together 10 of the top lessons he thinks investors seem to have failed to learn. I will list them and then over the next few days discuss a couple in more detail.

1. markets aren’t efficient

While many practitioners seem willing to reject the EMH (efficient market hypothesis), the academics refuse to jettison their treasured theory.

2. relative performance is a dangerous game

He quotes the late sir John Templeton, who said, “It is impossible to produce a superior performance unless you do something different from the majority.”

3. the time is never different

His conclusion on this point – “…investors get caught up in all the details and the noise, and forget to keep an eye on the big picture.”

4. valuation matters

While it is self evident that buying when cheap, he says that he has repeatedly come across investors willing to undergo mental contortions to avoid the valuation reality.

5. wait for the fat pitch

using a baseball analogy of waiting for the perfect moment when patience is rewarded as the ball meets the sweet spot.

6. sentiment matters

Investor returns are not only affected by valuation – sentiment plays a part.

7. leverage can’t make a bad investment good, but it can make a good investment bad.

Piling leverage onto an investment with a small return doesn’t transform it into a good idea.

8. over-quantification hides real risk

The obsession with overly complex mathematics hides real risks – which should ultimately be defines as the permanent loss of capital.

9. macros matters

Neither a top down view, nor a bottom up view has a monopoly on insight. He concludes that we should learn to integrate their dual perspectives.

10. look for sources of cheap insurance

His final lesson is that insurance is often a neglected asset when it comes to investing. It is the steady short term losses (premiums) that makes insurance seem unattractive to many investors. However this disliked feature often results in insurance being cheap.

Some good points, which I will expand upon.

Kind regards

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

Local markets

By noon on Tuesday, the JSE All Share had slipped 0.87% as investors took profits after the bourse’s recent rally. Losses were heaviest in the basic materials sector.

The rand was selling at R7.42 for a US dollar at midday, following in the wake of a weaker euro as traders also took profits.

Oil cost $79 a barrel, a slip of 0.05% after anticipation of an increase in US crude oil stockpiles and a slightly stronger dollar.

International markets

On US markets yesterday, the Dow Jones fell 0.13% while the Nasdaq rose 0.25%. Tech stocks climbed on gains led by Research in Motion and Cisco Systems.

Japan's Nikkei fell 0.17% this morning on profit taking, as investors reaped the benefits of the index’s six-week high reached yesterday.

The Hang Seng closed 0.05% up, recovering after initial losses as China Life gained on news that the company had predicted a sharp jump in profit.

Britain's FTSE 100 had lost 0.4% by midday, as mining shares came under pressure of lower metal prices, and banks fell on caution over the sector's funding position.

Share price news

Amalgamated Appliance Holdings Limited (share code: AMA) gained 6.25% after investors traded 3 282 509 shares in 123 deals, sending the share price up to R1.70 at midday.

Digicore Holdings Limited (DGC) gained 5% as shares rose to R3.15 each after 18 deals saw the exchange of 1 086 475 shares.

After 120 deals totaling 622 265 shares, Metorex Limited (MTX) lost 6.32% to sell at R4.45 a share.

After the company released its audited results and announced a proposed de-merger into two separate businesses, Liberty International PLC (LBT) fell 4.21% to R54.60 a share this morning, after 1 606 306 shares were traded in 1 045 deals.

Company earning for full years and interims continue to come for the period to December. The price movement post the release of the results is a good indication of what analysts have expected and what they have been factoring in. Looking at 2 of the results today, while earnings went down, the share price gained ground – clearly a case of slightly better than expected.

Today we had reports from an industrial company, a commodity related and a financial services company.

AVI
Fast moving consumer goods company, AVI, reported interims to December. Revenue was flat at R4 billion, profit down slightly, at R335m, but headline EPS from continuing operations up 9% to 112,3c.

The interim dividend was increased by 8,3% to 39c

The company has the following operations. Fashion brands portfolio, which improved operating profits by 35% to R167m.

The strong rand negatively impacted the sales of its I&J division as did some pressure on selling prices. Operating profit dropped from R125m to R59,8m.

Hot beverage brands division lifted operating profit from R129m to R167million.

On a total basis margins were up slightly from 40,3% to 40,6%.

Finance costs and debt came down.

The market liked the results and the price gained 3,76% to 2345c. Last week it traded up to R24 - a new high.

Sasol
Sasol, which converts coal and gas to fuel reported their interims to December. Turnover was down from R83 billion to R58 billion, with operating profit off from R21,5 billion to R10,5 billion.

Diluted headline EPS fell from R21,79 / share to R11,14 / share, but the interim dividend was raised by 12% to R2,80c

The lower profitability was a result of lower average crude prices of $71,42 in 2009 compared to $84,75 in 2008, as well as a 14% stronger rand to the US dollar.

The price gained 2,29% to R290,50. It fell from a high of over R500 in May 2008 to R221 in November 2008, before moving mostly sideways.

JSE

JSE reported its annual numbers to December. Revenue was up slightly to R1,1billion. Personnel expenses jumped from R238m to R318m, and other expenses from R484m to R491m. This was due to increased headcount and the acquisition of the Bond Exchange. Attributable profit fell from R374m to R367m

Diluted EPS was down slightly from 434c to 425c

The share price gained 1,1% to 6420c. It had fallen to R36 in February 2009 and has therefore rebounded in line with the strong market, especially for companies in the financial sector.

In many respects the market has been expecting firmer earnings. In some cases these have not yet come through and so there is some concerns that perhaps the JSE has rallied a bit too much – but its in line with the general risk appetite across the globe.

Kind regards

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

Local markets

At 12:10 on Monday, the JSE All Share had risen 0.69%, with shares in the oil and gas sector leading gains, though gold mining shares however had retreated.

The rand was trading at R7.42 to the US dollar at 12:38, firming in line with a stronger euro.

Gold was selling at $1134.79 an ounce, 0.22% higher as a stronger euro inspired investors to seek bargains away from unpredictable currencies.

International markets

On Friday, the Dow Jones rose 1.79% and the Nasdaq closed 1.48% higher, as unemployment statistics were better than expected and consumer spending had increased.

Japan's Nikkei gained 2.09% this morning to reach its highest level in six weeks. Exporters rose on a weaker yen and resource shares were boosted by higher commodity prices.

Hong Kong’s Hang Seng finished 1.97% higher as investors sought bargains, particularly selected blue chip stocks.

The FTSE 100 had fallen 0.18% by 12:22, eroding early gains by insurance and mining stocks.

Share price news

At 12:14, Standard Bank Group Limited (SBK) rose 2.40% to R115.35, after 2 845 866 shares were exchanged in more than 1900 deals.

Metals and minerals company Merafe Resources Limited (MRF) rose 2.52% to sell at R1.63 a share, after 2 665 910 shares were traded in over 160 deals.

Anglo American PLC (AGL) fell 0.23% to R300.10, as investors traded 353 269 132 shares in over 1 000 deals.

After 340 053 534 shares were exchanged in more than 1 200 deals, BHP Billiton PLC (BIL) lost 1.95% to sell at R249.21 at 12:15.

The construction sector has, over the course of about 5 years, experienced a full cycle. Construction companies by their very nature are quite cyclical. The reason simply is that paying someone to build roads and bridges every day isn’t as important as paying someone for drugs (medicine) on a daily basis.

The graph below that maps the share price growth of Group 5 versus the Construction sector and the ALSI since the end of 2004. They all end up fairly close to each other, but you will see how the construction sector has been much more volatile.

While demand for pharmaceutical products doesn’t change too much over the short term, demand for construction companies’ produce can and does vary quite a bit. Governments are generally a large customer of construction companies and they tend to go through phases of under development and overdevelopment. Construction can and does also get used to help growth when economies are weak (this is a case in point particularly in China at the moment). It therefore stands to reason that construction companies will be more attractive when a country is in a phase of overdevelopment and less attractive when there’s a lack of development occurring.

Remember though that the attraction, or otherwise, of a company should not overly influence your decision on whether or not to invest in the company. Price is critical in the analysis. When construction companies were experiencing booming order books at record margin they appear to be very attractive, but the price more than reflected the good news. We are now at a point where many construction shares are painting a bleak picture, and it might just be the time when they are becoming more attractive as investment propositions.

Group 5, the 5th largest construction company listed on the JSE, released interim results this morning that make for some interesting reading.

The company is mainly exposed to the construction sector (74% of profits) and has therefore been operating in a tough environment where many projects have been shelved or cancelled in the private sector, and where government hasn’t been as efficient in awarding contracts.

The tough market conditions are reflected in revenue contraction of 4% and profit growth of 12%. Profit growth in the face of declining turnover has been achieved as a result of improved margins. The dividend declared is up 9% when compared to the previous first half of the financial year.

What interests me the most about the results is that cash on the balance sheet equates to R3.24bn and the company has no debt, while its market cap on the JSE is R4.26bn. Clearly the company has a lazy balance sheet, but the market’s implying that the company (other than its cash) is worth only R1.02bn. With earnings of R 533mn for the 12 months ending 31 December 2009 the PE multiple placed on Group 5 less its cash is a lowly 1.9! The quoted PE is higher at 6.1, but these multiples are extremely low compared to the market. The company doesn’t need great earnings performance for its share price to do well as there is already a lot of bad news priced into the share.

As always the key to investment success is not the popularity of your portfolio, but rather the price you pay for each share in your portfolio.

Enjoy your weekend!

Take care,

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

Local markets

On Friday at midday, the JSE All Share had edged up by 0.02%, inspired by gains on international markets, but a stronger rand took its toll on gold mining shares.

The rand was trading at R7.46 at noon, remaining within a range and taking a lead from the euro before the publishing of US non-farm payrolls data.

Brent crude oil rose 1.70% to sell at $78.31 a barrel, after investors hoped that China would continue its economic stimulus that would encourage growth and demand for oil.

International markets

Yesterday, the Dow Jones finished 0.46% up and the Nasdaq gained 0.51% as investor confidence was boosted by better-than-expected initial unemployment statistics and productivity figures.

Japan's Nikkei index lifted 2.20% this morning, as the yen weakened after news that the Bank of Japan was considering monetary easing.

China’s Shanghai index closed 0.25% up, overcoming losses in banking and property stocks on concern that tighter monetary policy could stall domestic economic growth.

Britain’s FTSE 100 was 0.37% up at noon, following gains on US markets, but investors were cautious before the release of monthly US non-farm payrolls data.

Share price news

In the metals and minerals sector, Merafe Resources Limited (share code: MRF) climbed 3.97% to R1.57 at midday, after investors traded 4 259 415 shares in 143 deals.

After 141 deals of 668 355 shares, construction company Group Five Limited (GRF) rose 3.60% to R36.30 a share.

Digicore Holdings Limited (DGC) in the electronic equipment sector fell 6.25% to R3 a share, after 200 112 shares were traded in 20 deals.

Real estate holdings firm Redefine Properties Limited (RDF) saw the exchange of 597 030 shares in 54 deals, leading to a loss of 4.65% as shares fell to R7.58.