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    Seed Weekly - Local Equity Valuations

    From time to time we document the approach that we take with respect to our tactical asset allocation of local equities. This is not the only input into our process, but the methodology has proven to be sound, especially when taking a longer term view.

    Essentially, the thesis is one that says the more expensive the price paid for a particular share or market, the lower the expected return from that investment. Anecdotally, most investors can appreciate the advantage of buying into a good business at a cheaper valuation, in order to maximise the investment upside.

    Investment risk then is less about the daily volatility of share prices and more about the price paid relative to the underlying or intrinsic value of the business.

    At the same time – and this is what we have being seeing over the last few years – what starts off at expensive levels, continues to be pushed up to even more expensive levels as investors become more and more optimistic about the future outcome and are therefore willing to pay up. It is however at exactly the time of maximum investor optimism that risk (i.e. investment risk) is at its maximum level.

    Seed has developed a model where, on a monthly basis, we measure the market valuations in order to try and “predict” the future market returns. The chart below reflects rolling 5 year compounded returns superimposed on top of the model’s return expectations.

    The model is a multi-factor one that also learns from history and we therefore expect it to become more accurate over time. At the market bottom in February 2009, the model predicted a return of approximately 28% pa over the next five years. History has shown that, at that time when investors were extremely nervous, this proved to be an excellent entry point. The 5 year compounded return from the ALSI from that point was actually 24% pa.

    Since then, the expected return has oscillated between 10% and up to 22% in September 2011. As the market has become more and more expensive, and in fact is now at one of the most expensive levels since we started measuring, so the expected compounded return from local equities over the next 5 years has fallen to 8.5% pa.

    Because all forecasting models are fallible, we do not rely 100% on the outcome. However, as can be seen from the chart above, there is a high correlation between its expected return and the subsequent five year return and given the very low total return expectations at this time, means that we remain cautious with respect to the level of allocation to local equities.


    Ian de Lange

    Tel +27 21 914 4966
    Fax +27 21 914 4912
    Email info@seedinvestments.co.za

    Seed is hiring: Visit the Seed Analytics LinkedIn profile to view vacancies.


    Permalink2015-11-18, 17:36:53, by Mike Email , Leave a comment

    Seed Weekly - Income versus Wealth

    We live in a world of instant information, media hype and instant gratification. Advertising, movies, and television shows show lifestyles of “normal people” with hyper consumption and extravagant lifestyles, unfortunately these lifestyles are out of sync with a “normal person’s” income. Because of this people have become confused between income and wealth.

    As a financial planner I get to see the full picture of a person’s finance that includes their income, assets, and liabilities. In the last 20 years I have seen that there is often very little correlation between a person’s income and the amount of net assets “wealth” that they have managed to accumulate. I have just finished reading “The Millionaire Next Door” (Stanley and Danko) which confirms my experience. This book highlights the difference between income generation and wealth creation and I highly recommend it.

    One of the main problems with wealth creation is that it is very difficult to see how much a person is worth. People do not walk around with their balance sheet strapped to their arm or drive a balance sheet. Juxtaposed to this, consumption is shown to the world, fancy cars, fancy holidays, over mortgaged houses, expensive watches and clothes are all symbols of “wealth” and I often find that people who show the most signs of “wealth” are actually hyper consumers with high levels of income but with a much lower net asset value than what could be expected given their age and income levels.

    Whilst there are many reasons for this lack of wealth accumulation, it basically boils down to spending all, and sometimes more than, your income. No matter how high your income is, if you are spending all of your income you will never become wealthy. We need to also define wealthy, my definition is to look at your net asset value versus your annual expenditure. Once you have more than twenty times your annual expenditure in net assets, you can start considering yourself to be wealthy. If somebody’s assets are worth R 10 000 000 but spends R 5 000 000 per year, that person is not wealthy, but if somebody’s assets are worth R 5 000 000 and their annual expenditure is R 200 000 per year then you could definitely consider them to be wealthy.

    In my experience there are two major stumbling blocks to wealth creation. Firstly, and most importantly, people failing to budget. If you do not control your expenditure and you spend everything or more than you earn, you will never be able to accumulate wealth. For those of us unlucky enough not to win the lottery, we have to save and invest wisely to create wealth. Please also note that wealth is your net asset value which means that having assets with large liabilities linked to them do not create wealth.

    They say that the road to hell is paved with good intentions, unfortunately the road to financial freedom has many potholes. One of the most common “potholes” is that people (especially younger people) start off with good intentions of saving but because their income is low the amount that they are saving is not much. When they look at the growth on their investment after a year or two they become despondent with the “terrible growth” and rather just spend their money.

    This is especially so when a monthly amount is invested because people tend to forget that only one instalment has been invested for the entire investment term. So if you invested R 100 per month and achieved a 10% return it would still only be R 1 267 at the end of the year. Unfortunately people get disillusioned with the ‘low” returns in the initial stages of the investment and do not let the effect of compound interest help them grow their wealth. Psychologically 10% on R 10 000 000 is a lot more than 10% on R 1 000, we do however tend to forget that it is still 10%.

    The first port of call is to draw up a budget that sets sufficient income aside to build a portfolio that will help you reach financial independence. The second, arguably harder, part is to stick to this plan. I have generally found that writing down a budget (rather than having numbers in your head) and being accountable to someone (whether it’s your husband/wife or financial planner) helps people stick to said budget and ultimately reach their goal of financial independence.

    Kind Regards,

    Barry Hugo

    Tel +27 21 914 4966
    Fax +27 21 914 4912
    Email info@seedinvestments.co.za

    Seed is hiring: Visit the Seed Analytics LinkedIn profile to view vacancies.


    Permalink2015-11-10, 10:15:07, by Mike Email , Leave a comment

    Seed Weekly - Greatest Investment Minds - William J. O'Neil

    William O’Neil, entrepreneur, writer and growth-stock investor, was born in 1933 in Oklahoma, USA. He received his first college degree, majoring in business administration in 1951. After military service he started his career as a stockbroker in 1958.

    In 1960, he was accepted into Harvard Business School's first Program for Management Development (PMD). His research there lead him to invent the CAN SLIM strategy where O’Neil looked at all of the biggest-winning stocks of the prior decade to see if they shared common characteristics. He discovered that there were seven key traits in each big winner, and he assigned each a letter, which comprised the trademark term CANSLIM which later made him the top-performing broker in his firm.

    A young stockbroker at the time, he proceeded to take this valuable information and began applying it to his account and those of his clients. Starting out with very little cash and some borrowed money and use of margin, O’Neil had three big, back-to-back winners in his account beginning in late 1962. By autumn of 1963, his profits had skyrocketed. In 1963 at 30 years old, he became the youngest person at that time to buy a seat on the New York Stock Exchange for his own brokerage firm, the William O'Neil & Co. Inc.

    O'Neil uses a mixture of quantitative and qualitative strategies in a performance-driven investing approach. His strategy seeks out only those growth stocks that have the greatest potential for strong price rises from the moment they are purchased. This can be summarised as "buy the strong, sell the weak."

    His criteria for identifying a company to comply with his investment guidelines are summarised in his well-known acronym CANSLIM:

    C - Current quarterly earnings per share have increased sharply from the same quarter’s earnings reported in the prior year (at least 25%). "What seems too high and risky to the majority generally goes higher and what seems low and cheap generally goes lower."

    A - Annual earnings increases at a compound rate of no less than 25% (P/E is unimportant – probably in the range of 20 to 45 with these stocks) annually over the last five years.

    N - New products, new management, and new highs. Companies that have a good "story." "Since the market tends to go in the opposite direction of what the majority of people think, I would say 95% of all these people you hear on TV shows are giving you their personal opinion. And personal opinions are almost always worthless … facts and markets are far more reliable."

    S - Supply and demand. The less stock available, the more buying will drive up the price.

    L - Leaders and laggards. Stick with those stocks that outperform and shed those that under-perform.

    I - Institutional ownership. Favour companies that are "under owned" by the top professional investors.

    M - Market direction. Buy stocks on major downturns, but avoid purchases after a decline of 10% or more gets underway. "The whole secret to winning and losing in the stock market is to lose the least amount possible when you're not right."

    William O’Neill has written a few books over his lifespan and if you are at all interested in the strategy of growth investing they are highly recommended. How to Make Money in Stocks (1988); 24 Essential Lessons for Investment Success (1999) and the Successful Investor (2003).

    Keep well,

    Lourens Rabé

    Sources: Investopedia.com, Marketwatch.com, Wikipedia

    Tel +27 21 914 4966
    Fax +27 21 914 4912
    Email info@seedinvestments.co.za

    Seed is hiring: Visit the Seed Analytics LinkedIn profile to view vacancies.


    Permalink2015-11-03, 09:21:54, by Mike Email , Leave a comment