As investors, one enters into a disagreement every time one buys a share. Indeed the seller of those shares disagrees with the buyer 100% and this is reflected in the fact they have taken the opposite position in the trade. So it’s important therefore to never feel threatened or personally offended when someone disagrees with your assessment. After all that is what makes a market. Allowing emotional immaturity to pervade any discussions about stocks only reveals that one is emotionally immature.
Investors shouldn’t mind conjecture and disagreement.
Add BI to the list
This week Peter and his team invited me, several times, to respond to a BHP “insider” who disagrees with us about our view on BHP – a view we have held now for some time. Add this “insider” to the list of everyone who has ever traded shares with us. They all disagreed.
In the time we have been articulating our dislike for BHP shares, their price has fallen from circa $40 to a low of circa $30 and very close to our estimated intrinsic value. But it is over the longer-run that share prices reflect business performance and BHP shares have produced no capital gain for investors since 2007. I’ll talk about why in a moment.
Stocks rise and fall daily and in the short run BHP’s share price could rise as the Australian dollar falls or as Andrew Mackenzie cuts costs. But in the long-run Andrew Mackenzie must confront the same fact that his predecessors all faced; that BHP and its peers are price-takers in an industry that cannot escape cyclical oversupply and excess capacity.
In any event, we aren’t employed to correctly pick the short-term direction of prices of stocks we do not intend to own. We are required to preserve our clients funds first and grow them second.
If the outlook is sufficiently unclear for a company, we’ll simply avoid that company and not pretend we have some unique insight that the other 50 analysts covering BHP for Australia’s biggest brokers and fund managers don’t have.
If you think BHP is a great business, we won’t be standing in your way. You would however have made significantly more money investing in any number of other businesses since 2007 and our view at Montgomery is that remains the case in the future.
What we don’t like
We are also less enamored with BHP’s $110 million improvement in earnings from every one-cent decline in the Australian dollar, than we are concerned by the company’s capacity to record “exceptional”, or so-called “one-off” losses of $1.4 billion in a six-month period, as occurred most recently. It will take a lot of one-cent declines in the Australian dollar to make up for all the one-off losses and write downs.
The company is currently forecast to earn $16.5 billion in 2014. Leaving aside the fact that analysts producing these forecasts have absolutely no idea what commodity prices will be tomorrow, let alone in 2014, the current forecast is the same as the reported earnings of the company seven years ago.
Despite no growth in profit in seven years, $28 billion dollars of additional equity has been retained and raised to fund this “growth” and borrowings have increased from $15 billion to $27.6 billion. If your analysis of the economics of this business is that this is high quality, well, you have reached a different conclusion to us because we don’t believe the very long-term economics of this business can dramatically change. I will however change my view the moment Warren Buffett turns up on our shores and bids for BHP.
Given the deceleration in the mining boom is playing out precisely as we have expected, given the dramatic decline in Australian resource company capital and maintenance expenditure and given China needs to ‘adjust’ to its massive overcapacity in everything “from ships to solar” we are delighted for others to buy BHP for its yield and we wish them every success.
Other mining plays and road kill
We have never purchased BHP, but we did have exposure to the mining boom through an almost 20% exposure to mining services companies. We did however take profits and we sold out of all of our Montgomery [Private] Fund exposure to mining services in April 2012 – more than a year ago, thus recording gains, while saving our investors from subsequent declines of 40%-60% and more. We already feel as though we got it right and have moved on. Studying the road kill after running it over is not something we have had the time or the inclination to do. Investing in the road kill is even less likely to employ our resources.
Most importantly, we don’t expect to get every zig and zag right on every stock and indeed we don’t even bother to try. But watch out for those who point out our errors and savour schadenfreude. Such responses reveal a great deal about their emotional intelligence, something successful investors must have a high dose of. It is only when asked that we posit an answer to where things might go, but in reality we simply don’t know.
Internally we aren’t even thinking about BHP because we cannot be sufficiently confident that BHP will be worth more in 2020 than it is today and so we will invest elsewhere – somewhere where we are confident, like Cochlear and CSL. There are simply businesses with clearer prospects we should be devoting our attention to.
The investor and media obsession with BHP is simply because it is big, and also because BHP is one of the most inherited stocks owned by the baby boomer generation. But if Google, Yum Brands, Johnson and Johnson, Nestle, eBay, Apple and Microsoft were Australian-listed companies, BHP would be receiving far less attention.
Sadly this week I was not able to devote this column to a stock opportunity that we believe has emerged from the rising US bond yields and declining Australia dollar. Perhaps if we can accept that investors and traders will always disagree, we can free up our time to write about much more useful issues.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
Read what Peter wrote on Monday here, and watch Roger’s BHP view on Super TV here.
Also in the Switzer Super Report
- Graham Richardson: My SMSF – Graham “Richo” Richardson
- James Dunn: iSelect set to become market darling
- JP Goldman: How low can the Aussie Dollar go?
- Gavin Madson: Where to now for fixed income investors?
- Jo Heighway: Make the most of SMSF tax deductions
- Paul Rickard: Question of the week – how can I invest in infrastructure
