Update No. 45 – 03/02/12

I thought I’d consider catalysts this week.  Most investors, private or institutional spend a lot of time thinking about the sort of catalysts that might trigger the market to move the underlying price of a share.  Catalysts are things like take-over bids, private equity offers and the like which are the catalyst for a significant price movement in the underlying stock.  There are a variety of other catalysts.  In any case, they are important in helping you realise the value of your investment.  Individuals who engage in day-trading are the ultimate example of catalyst seekers.  They are hovering around speculative stocks such as oil, mining and biotech companies, waiting for an announcement which will put a rocket under the share price.  The catalyst in this case is very rapid, you are trying to read and digest a (often substantial) set of drilling results, or medical test results or the like and to make a buy or sell decision before the market has properly valued the information.  This game is played by some with great success, but it is not a type of investing I’m interested in.

I am to the bone, a value investor.  When it comes to most value investors, generally there is less focus on catalysts than with other investors, but it still bears some consideration because a good value stock with an appropriate catalyst can trigger a very sharp re-rating in a share price.  A catalyst usually comes suddenly and fairly unexpectedly, but often for the value investor the market will simply re-rate the prospects of a company based on consistent sound performance.  If you find a business earning good ROE and steadily growing earnings, it will eventually trade on or near a price multiple that fairly values the business performance.

To use a recent example of a sudden catalyst, I noticed in the Australian Financial Review over the weekend after Australia Day that Ludowici (a manufacturer of mining equipment, screeners and the like) had been made a substantial offer that ranked as one of the all-time highest takeover premiums in Australian corporate history (106% – more than double).  This caused me to go back to my most recent assessment of them, to see what I’d missed because businesses like this (small, thinly traded, under analysed) that fly under the radar are absolutely the bread and butter of EGP.  In October 2011, after reporting season, I saw that I had developed a valuation range, based chiefly off a DCF (Discounted Cashflow) model of $7.24 to $10.50 (they were trading between $3.50 & $3.80 at this time).  Six months earlier (April 2011), I had ranged them at $7.78 to $11.50 (the mining market was stronger & AU$ weaker at this time, leading to the higher intrinsic value), they were trading at about $4.75 at this time.  In any case, I did not invest our money in this business (unfortunately in hindsight) because in my view, there were comparatively cheaper businesses available (and no obvious catalyst!), though Ludowici was in the top quartile of assessed businesses as at my most recent assessment (based on that old chestnut – Margin of Safety).

In any case, a business which was trading for $3.50 per share received a $7.20 offer and the discrepancy between price and value was pretty quickly eliminated, shareholders will get a fair price, the Danish acquirers will get a good business and we did not profit in it because there were ‘superior capital applications’, that could yet be true! – Tony Hansen 03/02/12.

EGP Fund No. 1 Pty Ltd. Up by 3.31%, lagging the benchmark by 1.49% since January 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Down by 0.56%, leading the benchmark by 8.62% all-time (April 1^st 2011).