Update No. 5 – 01/05/11

EGP Fund No. 1 Pty Ltd. Up by 2.02%, leading the benchmark by 2.31%.

EGP 20.  The EGP20 index is down by 5.73%, lagging the benchmark by 5.44%.

S&PASX200TR    The benchmark index is down by 0.29% since April 1 launch.

So endeth our first month of operation.  As I have previously declared, we will seldom disclose any of our holdings, excepting when we have eliminated a position, I will then tell you what it was and why we held it (and why we disposed).  Given that we will historically buy with a very long-term view, disposals often come in the form of a corporate event such as a take-over; I expect I have participated in a disproportionately large number of these.  I like to attribute this to recognition of my assessment that the companies that were taken over were under-priced.  The consequence of this is has historically been a significant premium to my entry price, but comes with 2 unwanted side-effects.  The first is that a capital gain is crystallised, thereby triggering a taxation obligation, in truth, there are worse things than paying tax on your earnings (just doesn’t feel like it at the time).  The second side-effect is that you need to re-allocate your capital. If I am extremely confident about the undervaluation I have assessed, I would ordinarily be happier to let the value come to the surface over the course of years than take an immediate 30 or 40% takeover premium.

 Now, having talked about an historic high strike rate in having stocks I own taken over, I would say that in my view, only two of our seven holdings are realistic targets at present.  Three are far more likely to be acquirers in my view; the other two will likely focus on growing their businesses organically. So don’t expect to hear much about our holdings for a while.

 Because I will not reveal holdings, I will instead give some comparisons of our holdings with those in the benchmark:

 These workings were done 20/04/11.  On the pricing metrics, our portfolio is markedly lower-priced than the broader market.  Basically, with our P/E of 7.1x compared to a market P/E of 13.3x implies our companies are discounted 46.66% more heavily than the broader market.  The lower P/E is generally indicative of the markets assessment of our holdings weaker future prospects, however, the forward P/E ratios would seem to dispute this, now these are analysts forecasts (which must naturally be viewed with scepticism), but the comparison shows that our holdings are expected to grow their FY2012 earnings by 132% compared to those over the last 12 months, and the ASX200 is expected to grow its earnings by 35.4% (from $85.96b over the last 12 months to $116.4b in FY2012). In my view, you can’t have it both ways, assessing weaker future prospects, yet forecasting stronger future growth; it is from such discrepancies we expect to generate above average performance.

The average size of companies in the ASX200 was about $5,695m, the (weighted) average sizes of the companies we hold are $281m.  Our holdings are more than 20 times smaller on average; we hope they are consequently more nimble in their use of our capital.

The only area where we lag is in dividend payout ratio, with our holdings returning a much smaller proportion of profits as dividends.  I will take growth anyway I can get it (capital or dividends), but I generally prefer to invest in businesses with good prospects for re-investing their earnings at high rates of return, I believe we are invested in such businesses.  You can see how cautiously we assess the use of debt, 4/7 of our holdings are in a net cash position, the other 3 use only cautious debt levels, leading to our low average.  I have not used net debt (Debt minus cash holdings) in the calculations, but total debt/equity.  If I added all cash our companies hold back in, our holdings would be in a net cash position. In our view, if you are not carrying significant levels of debt, the likelihood of having a minor event turn into a major problem is very low.  Very low is our default risk preference.

 I keep an ASX200 sheet I update myself for the various ratio used, as I often find significant variations in the data across even reputable sources, I suspect many indices fail to account for the losses some constituents make, nor to accurately reflect the most recent 12 months performance in the ratios, I account for such things.  The exception is the gearing ratio, which I derived from the recent Reserve Bank Financial Stability Review (March 2011) an excerpt from this stated:

 “gearing for listed non-financial corporates fell to 49 per cent in the second half of 2010 from a peak of 84 per cent in 2008”

 The remainder of the report is well worth reading also.  The market is obviously being much more conservative with its use of debt, and given the nature of the recent GFC, understandably so – Tony Hansen 01/05/2011