Find a Masochist to Manage Your Money
Find a Masochist to Manage Your Money
Ok, masochist is taking it a touch too far. Having someone who enjoys pain managing your money could well be a recipe for disaster. But the capacity to endure pain can be very valuable.
Value investing doyen Tom Russo spoke at length on this topic at the 8th Value Investing Congress in Trani, Italy. The ‘capacity to suffer’, as he calls it, is something he looks for in listed companies. The three examples he cited were Nestle, Pernod Ricard and SABMiller. All three have been able to invest huge sums of capital in attractive opportunities, despite those investments being to the detriment of short-term profits.
Nestle spent hundreds of millions of dollars on the Nespresso concept (starting way back in 1986) before it became a runaway success. Pernod Ricard kept investing in China through a downturn in the early 2000s. Competitor Diageo packed its bags and headed home and, when the market turned, Pernod Ricard was left with the market to itself (now Diageo is paying a fortune to buy its way back in to the Chinese market). International brewer SABMiller has done the same in China and also in its home continent of Africa.
Despite civil wars, military coups and hyper inflation, SABMiller kept investing. In many African countries, the only competitor today is home brew.
The advantage of the capacity to suffer is that there are not many companies that can afford to make decisions that are in their long-term interests simply because, as is often the case, long-term prosperity is to the detriment of short-term profits. You might think of it as ‘time horizon arbitrage’. Because so few companies, managers and boards have a genuinely long-term focus, there is less competition and excess profit available for those that put genuine value creation ahead of this year’s profits.
In his 2004 letter to Berkshire Hathaway shareholders, Warren Buffett explained how crucial the concept has been to Berkshire’s insurance operations. Using the example of National Insurance (NICO), a company Berkshire bought in 1967, he said:
What we’ve had going for us is a managerial mindset that most insurers find impossible to replicate. Take a look at the facing page. Can you imagine any public company embracing a business model that would lead to the decline in revenue that we experienced from 1986 through 1999?
Here’s the table:
Between 1986 and 1999, NICO’s premiums fell 85%! Buffett went on to say that:
[the] colossal slide, it should be emphasized, did not occur because business was unobtainable. Many billions of premium dollars were readily available to NICO had we only been willing to cut prices. But we instead consistently priced to make a profit, not to match our most optimistic competitor. We never left customers – but they left us.”
Now look at the last five years of the table. NICO’s written premiums rose 10-fold in the five years following 1999, and every single one of them was highly profitable. How many management teams have the leeway, or even the discipline, to wait 13 years for their day in the sun?
The capacity to suffer helps companies, it helps fund managers and it helps you, if you have it. Companies can only have the capacity to suffer if their owners have the capacity to suffer too. Often this is means an owner manager, or a major shareholder in the mould of Warren Buffett, that enables to board to ignore the institutional imperative of meeting short-term profit targets.
Managed funds can play that role too, but only if the fund’s investors have the same capacity to suffer. Most fund managers aren’t chasing one month returns because they think it’s the best way to make long term returns. They do it because their investors judge them month to month and if they don’t deliver, they get the sack.
As a private investor, my capacity to suffer was immense. I had the good fortune to be born with a constitution that was immune to market noise. I didn’t care about daily price fluctuations. I didn’t even look.
As a fund manager, I find myself thinking about the Value Fund’s unit price more than I should. When the first question everyone asks is ‘how’s your performance?’, it’s hard not to. But I told people exactly how I was going to manage the fund when we kicked it off in late 2009. We have been very clear that we will pursue long-term prosperity at the risk of short-term underperformance.
So far, I’ve been blessed with a bunch of investors who get it.
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It's about temperament rather than talent. Or a talent for tempering temptation. All in all, best wishes for the long haul (I'm not invested in the fund yet).
Ive got a chunk of cash in the fund. I'm not sure if I'm the standard demographic but I doubt I'll need to touch the cash for another 5-10 years, so feel free to be patient! I don't care if it sits in 4% cash for the next 4 years waiting for half of Europe to default then you buy in on the over selling.
Ie I think ive read once (or on a podcast, I'm not sure) that you expected that people in the fund expected you to be picking stocks. Not true; if I remember correctly the prospectus says 0-100% Aus stocks and id be more than happy with zero% if you think everything is currently overpriced (read: crap!).
Also my accountant was a bit confused with the last distribution statement for last tax year...there was a field where he didn't know whether it had already been taxed or not. I think some managed funds send out statements where it tells you what to type In the questions on your tax e.g "H8 $10,000".
"As a fund manager, I find myself thinking about the Value Fund’s unit price more than I should. When the first question everyone asks is ‘how’s your performance?’, it’s hard not to."
That's perfectly normal Steve.
Since you post up your monthly performance on your website I'm sure it's quite difficult to escape the feeling of being judged for your short-term performance.
Look at what happened to Cochlear's share price after it announced a recall. All it takes is one incident like this to make your short-term portfolio performance look bad.
So yeah, it's perfectly understandable that you have thought about short-term performance a lot more ever since you became a fund manager.
Stick with your original plan, don't follow the crowd, shut out the noise and focus on buying undervalued stocks........that's why we are invested with you.
Hi Steve, you have just reminded me why I have money invested in the fund. I see this money as untouchable for the next 20 years or so will only care about the unit price when I go to cash some of it in. The lower the unit price in the short term the better value I get as I add to my investments on a monthly basis. Keep up the god work. Just a suggestion, could you send an email when the monthly report is available to viewto save me checking in. Take care, regards Joe
Did you guys take part in the ONT capital raising?
Yep
Hi Steve,
ONT's NPAT increased from $4.3m in 2010 to $5.1m in 2011. Where does this $800k come from? We need to know the source of the increase to know whether ONT is as good as most people think.
I'll start with this year's numbers and compare it with last year's numbers:
2011 figures:
- There is a one-off Consulting fees $389k (see note 4 in annual report)
- There is a one-off License fees $311k (see note 4)
- Insurance claim refunds $192k (note 5)
- Net Profit contribution of $367k from Bray Park acquisition (note 33)
Total of the above items' contribution to 2011 NPAT is approx. (389+311+192)*(1-30% tax rate) + 367 = $991k
2010 figures:
- There was a bargain gain of $535k
So 2010 NPAT was boosted by about 535*(1-30%) = $375k
What I want to work out is the increase in NPAT from existing operations:
exs2010 = NPAT of existing dental centres in 2010
exs2011 = NPAT of existing dental centres in 2011
OneOffContribution2010 = NPAT of one off contribution in 2010 = $375k
OneOffContribution2011 = NPAT of one off contribution in 2011 = $991k
we know the following:
exs2010 + OneOffContribution2010 + $800k = exs2011 + OneOffContribution2011
exs2010 + $375k + $800k = exs2011 + $991k
exs2011 - exs2010 = $375k + $800k - $991k
exs2011 - exs2010 = $184k
Now, we can see that the underlying businesses' growth is not as strong as the headline figures suggest.
Next question is what are these Consulting Fees & License Fees? I can't find them mentioned or explained at all in the full year result 2011. But I did find references to them in the Half Year report.
I will quote from the Half Year Report:
"We have for some time pointed to the management of practices not owned by 1300SMILES as one of several drivers for future growth of the company. We have recently granted a license to a marketing and management company, allowing it to market, manage and operate four of our southeast Queensland-based practices. We retain ownership of the practices involved."
I will make a few comments about this:
- The above quoted paragraph is inconsistent. The first sentence says that 1300SMILES will consider managing other people's practices as an avenue for growth. But the second sentence basically announced that 1300SMILES will let other people manage the Brisbane practices. Now I always thought that 1300SMILES is supposed to be the expert in managing dental centres, how can a marketing company do it better that 1300SMILES?
- This marketing company is stupid enough to pay 1300SMILES money so that they can market, manage and operate some of the dental centres. They would only do so if they can make money out of it. In other words, they must be hoping that the fees they generate during the license period, is higher than the license fees they are paying 1300SMILES for the "privilege".
- It is obvious that the marketing company has not managed to achieve this. The fact that in the annual report there is no mention of this "superb deal" by the MD, implies that the marketing company got burnt and is not going to renew the license. In other words, the above consulting fees & license fees will be a one-off thing. It won't occur again in FY2012.
- I personally saw the techniques used by this management company to market 1300SMILES. They used group buying sites, like scoopon, grabone, etc. The response that they got was quite disappointing. With these sites, it's not uncommon to see hundreds of people, even thousands, taking up the deals being offered. In 1300SMILES case, it was very low, sometimes only 5 people signed up. See the following link for yourself: http://www.grabone.com.au/brisbane/1300-smiles-1
- I believe that any companies resorting to group buying sites to generate leads, is basically "desperate". A good dental centre will not need to resort to such tactics. The customers are starting to realise this too, and soon will associate such offers to inferior services. See this article: http://www.theage.com.au/business/too-little-too-late-group-buying-sites...
In Summary:
- Business is not growing as fast as the headline numbers suggest
- Will require good acquisitions like Bray Park, Bundaberg, to continue growing at high rate
- Hasn't proved able to grow in big cities (eg. Brisbane) as fast as they have been doing in country areas (eg. Mackay, Bundaberg, etc.)
- The fact that there is no mention of license deals in full year report is, in my personal view, "misleading" or "not fortright", which basically turns me off.
- This latest capital raising is also a BIG turn off as the MD has spent the past 6 years since listing stressing the importance of keeping the number of shares to a minimum. On several occasions, he has repeated that he will only shares if vendors insist in receiving some of the consideration in ONT shares. An abrupt change like this is also a turn off.
- Having said all the above, I don't think it's going to be in a financial crisis anytime soon. It will still grow like before especially if it can secure good acquisitions.
With so many other good quality bargains available in the stock market at the moment, I just don't think ONT is that attractive. One, as explained above, the quality is not as good as being promoted by the company, and two, the price is not that cheap anyway (relative to other stocks).
On 23 August, there was a big parcel of 133,000 shares sold. I thought it was you selling, must be someone else then...
All the above are just my personal opinion.
All the best.
cp15
Hi cp15,
I won't deal with all of the points you make but a couple of the key ones:
- the licencing fees relate to one particular practice where 1300 Smiles gave someone the right to run the practice and ONT collects a licence fee and provides the dentists etc. I'm told it was successful, you can expect to see more licencing fees this year and, potentially, a growing number of 'franchised' 1300 Smiles practices.
- agree 100% on the problems with capital cities. In my view, this business is meeting previously unmet demand for rural/regional dentists by providing people with the ability to go on short-medium term assignments. Capital cities is a stupid idea, there is too much competition
- I don't think you'll see Daryl change his focus on EPS in a hurry. He has some plans for the money that I am prepared to support (this time at least), if they don't produce increased EPS I will be very disappointed.
- I don't expect rapid organic growth from this business. There are only so many hours a dentist can work in a day. The growth will come from adding new chairs to current practices and buying new ones and improving the performance. As long as he can keep generating returns on equity in excess of 20%, I'm more than happy for him to expand this way.
Cheers,
Steve
You have put your finger on the smoke and mirrors that 1300 smiles are using in their aim to grow their share price. are a terrible dental management company. They will report growth at any cost. The idea of them ever selling a franchise is laughable. As the dentists who they bought out at grossly inflated goodwill leave there imported dentists are soon gaining a name for being expensive and incompetent. This would have shown in thier figures by now if not for the CDds. They have a bulk bill policy which keeps ignorant victims coming in the front door. the guy who bought this business license In brisbane is now thier marketing guru? Smells to me I think it was some dodgy scheme to keep revenue up. I know based on the figures these places were doing there is no legit way anyone would have paid this to license them?
Before capital raising: Equity 74 cents per share, with 24 cps net profit, for 33% ROE.
postraising: Raised $8.3m on 2.37m new shares to give approx $23.7m equity
If each share can generate same ROE, then net profit for THIS year goes up by $2.7m (8.3*0.33) to $7.8m, or 33 cps (new average equity per share is about $1).
I am NOT going to be happy with 20% ROE. If you're saying you're happy with 20% return on NEW equity, then projected profit is $6.8m (ROE 28%).This would still allow them to trumpet an increased EPS by 17% (to approx 28cps), and gloss over the significant decline in ROE on new capital. If you mean happy with 20% ROE on all equity, then you're saying you're happy for next year's profit to DECLINE to below $5m (and what's that kind of decline in EPS going to do to such a thinly traded stock ?)
Having said that, I would hope that management and directors would be financially aware of the damage they might do to the company's value by acquiring businesses that can't generate same ROE as they appear to have been disciplined at in the past.
As for "plans for the money..." that implies that the appendix 3B reason that the raising is for "working capital" might be considered misleading...and of course it might be considered unethical, nay unlawful that some shareholders are given specific price-sensitive information without informing the wider market (and were these plans discussed prior to the capital raising, even as part of the reason for the capital raising???). Doesn't board have duty to inform all shareholders (and the market) or inform no-one of their plans?
Cheers,
Steve
Hey Steve,
I'm not going in to bat for management here - the capital raising may turn out to be a poor use of shareholders funds. But I have a few theoretical points to make.
In terms of what they're doing with the money, the capital raising announcement states:
'The proceeds from the Placement will be used primarily to fund a number of opportunities, along with careful and judicious use of modest bank debt, if and as required.'
That's about as much as I know.
As for the ROE comments, I'm most definitely referring to return on incremental capital, or ROIC. I don't feel expanding the existing business at very high returns on equity and buying another business are mutually exclusive. They are not going to stop adding chairs and expanding the current operations and I expect that investment to keep generating very high incremental returns. But there's a limit to how much and how quickly you can employ capital at those high rates (google Buffett's comments on See's Candy for his explanation of this problem).
If there's a separate opportunity to invest some capital and earn 20% on it, that's better than I'm getting elsewhere. Even though it will most likely lower the overall ROE, it's still a perfectly sensible use of capital, as long as it isn't detracting from the low hanging fruit available elsewhere.
Anyway, it's all theoretical until we see what he does with the cash.
Cheers,
Steve
On 5 May, ONT bought back a paltry 450 shares at $3.45. I believe this was mainly to give signals to the market that the company is going to try to stop the slide of the share price that occurred at the time (It was slipping from around $4.00 to $3.45 in relatively short period of time). About 4 months later, it's raising 2.3 million shares at $3.50, which eventual purpose is still not clear.
Although strictly speaking there is nothing "wrong" with the capital raising, I prefer if the company had announced a more detailed explanation on the planned use of the money, e.g. we are going to perform major reno on 5 sites, or we are going to buy another consolidator, or we are going to enter VIC/NSW market, etc.
The fact that they only bought back 450 shares in May, and they could have bought much more at lower prices between May and September, indicates that they are not really serious about the buyback. I feel that instead of 100% focused on running the business, management has one eye on the share price and the other eye on operation. A similar thing won't happen in a company run by top management, like ARP for example.
If ONT buys back at $3.45, then it means that ONT believes the level $3.45 is undervalued. If this is really what they believe, then they shouldn't have raised capital at $3.50. But, if they believe that $3.50 is not undervalued, to the point that it is attractive to raise capital at that level, then they shouldn't have bought back at $3.45. I know the amount bought at $3.45 is negligible, but I believe that if it's not worth doing well, it's not worth doing at all. In other words, if they are not planning to buy a reasonable amount of shares, then they shouldn't have bought at all.
Also, if the new approach of "franchising" dental centres, is so successful, I would have thought that this would have been mentioned in the annual report, but as I've stated in my earlier post, there is no mention whatsoever. Sounds and smells dodgy to me.
Another point I'd like to make: A good management won't spend a single second providing running commentaries on competitors. For example, have you ever read ARP's annual report talking about TJM/CMI? Never. But ONT is different, for some reasons which I don't really understand, the annual reports always allocate some space about its competitors, especially Dental Corp. Another example of management focusing on the wrong things.
I prefer sticking with companies with proven track record and top class & trustworthy management, which is focused on the business and not the share price, competitors, etc.
I know the Intelligent Investor likes QBE, with QBE at current level, I find this is one example of other companies providing better value and quality than ONT. With QBE giving more than 10% yield, when it eventually turns (premium rates firming + increasing investment yield), it is entirely possible that it will triple the current share price in the next few years. And if this happens, the dividend will increase as well and it is entirely possible that by that time the original investment will be yielding 20-30% yield.
Mind you, we've all got our fingers crossed on Photon.
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