Update No. 10 – 05/06/11

EGP Fund No. 1 Pty Ltd. Up by 12.79%, leading the benchmark by 17.48%.  Well, the change is significant this week, it requires some explanation.  In short, our largest holding has come under a take-over offer.  The holding, when acquired made up almost 31% of the funds assets; the offer is at about a 69% premium to the price I acquired our holding (throughout April).  That is the good news; the bad news is that I believe the offer is almost ½ of the price at which the very bottom end of my valuation, and about 1/3 of a more sensible valuation.  We shall be agitating for a much, much higher price, or better yet, to just drop the offer and keep the holding as the business will trade much, much higher than the offer price within the next few years.

EGP 20.  The EGP20 index is down by 12.91%, lagging the benchmark by 8.22%. A very marginal improvement over the previous week.

S&PASX200TR    The benchmark index is down by 4.69% since April 1 launch.

There are four keys to above average success with share-market purchases.  In my view and that of most ‘value’ investors, the first and most important is a ‘bargain’ price.  The bargain price may seem obvious and absent the other factors, if you are sufficiently good at ‘bargain’ purchasing shares, you will probably achieve above average results.  But to really do well, you will need to have other factors working in your favour.  In my view an able and shareholder focused management is the second most important factor.  Operating in the smaller end of the market, I have historically found that the best businesses I’ve owned have had substantial ‘insider’, or management ownership.  Having a management that has a substantial equity interest almost always assists in having them operate the business in the most beneficial way for all shareholders (though there can be occasions where such managements will exploit this situation).

The third critical factor is a business operating with good and improving economics.  This is usually the hardest part to assess.  Almost all PDS documents you read will say words to the effect of ‘Historic performance is not indicative of likely future performance’.  Well, this may be the case, but it is certainly a valid starting point. I am very interested in a bargain priced, ably managed business that has been historically capable of reinvesting its earnings to create yet more earnings with minimal change in return on equity. A business sharing the first two characteristics, but with a less convincing financial history will need to be very strong on the other metrics to generate even a little interest.  The final factor, one that you have virtually no control over is a buyer willing to pay the full fair value for the business.  I have had occasion to buy businesses where the markets misinterpretation of value was screamingly obvious to me, and yet I have seen the price on-market go sideways for 2 or 3 years before some inane factor set a fire under the price.  Likewise, I have had occasion to commence accumulation of shares in a business I thought was deeply undervalued, only to have a corporate transaction take place 3 days after my first purchase, crystallising the most instantaneous of gains, but cutting short my opportunity to build a significant stake in the business.

What I will attempt to do is to simply work hard for my investors to find businesses that share the first 3 characteristics, and dispose of them when someone comes along offering factor four. I expect the results over time will tell the story better than I could. Tony Hansen – 05/06/11