Rob Coyte's Blog
Recent Blogs
- How Will Income Streams Increase From Shares? 27-Jul-2010
- The Importance of Income from Shares 26-Jul-2010
- Why Has The Income For My Investments Fallen? 20-Jul-2010
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How Will Income Streams Increase From Shares?
In the last two blogs we have discussed the fact that income has decreased from our investments over last couple of years and we are seeing the last stage of this play out at the moment. This has happened in prior periods throughout history and the income has always recovered to where it was and then over time continued to grow.
This time it will be no different to this, it will just take time and we also need to remember that in some instances we are facing a trade off between capital gain and income. For example, if we have a business that owns $200 million worth of property as valued by sales of similar assets but you could buy a pro rata share this company for $80 million on the share market would you not do this simply because it was not currently paying a dividend?
Now going forward, how will this position rectify itself and our investments return to paying income?
The answer is quite simple and relies on the fact that the impediments to why companies (or managed funds) were not paying dividends have now been in the main removed.
Also, companies are now looking to expand their profitability given the difficulty of the last couple of years. As of last week US companies are beating profit forecasts, and according to a survey from Bloomberg, analysts see the biggest two year earnings increase for companies since 1995. The consensus view is that S&P 500 profits may rise 35 percent in 2010 and 17 percent in 2011. This increased profitability will result in increased dividends, other things being equal.
Remember when we are talking about the life cycle of companies and economic fortunes of financial markets 3-4 years is considered a short period of time. We need to be asking what is going to happen on a “normalised” basis for the next 20 – 30 years.
This time it will be no different to this, it will just take time and we also need to remember that in some instances we are facing a trade off between capital gain and income. For example, if we have a business that owns $200 million worth of property as valued by sales of similar assets but you could buy a pro rata share this company for $80 million on the share market would you not do this simply because it was not currently paying a dividend?
Now going forward, how will this position rectify itself and our investments return to paying income?
The answer is quite simple and relies on the fact that the impediments to why companies (or managed funds) were not paying dividends have now been in the main removed.
Also, companies are now looking to expand their profitability given the difficulty of the last couple of years. As of last week US companies are beating profit forecasts, and according to a survey from Bloomberg, analysts see the biggest two year earnings increase for companies since 1995. The consensus view is that S&P 500 profits may rise 35 percent in 2010 and 17 percent in 2011. This increased profitability will result in increased dividends, other things being equal.
Remember when we are talking about the life cycle of companies and economic fortunes of financial markets 3-4 years is considered a short period of time. We need to be asking what is going to happen on a “normalised” basis for the next 20 – 30 years.
The Importance of Income from Shares
We have discussed previously the importance of having access to a growing income stream to provide financial security. Whilst over the long term assets like shares and property provide, the only way for this growing income stream to be achieved there are periods when income will actually decrease. The crisis that will be known as The Credit Crisis in decades to come was one such period of time. Investors have noticed this effect and the attached article explains the events of the last few years but make no mistake over the next 10-20 years this strategy is still the only viable strategy for us to achieve what we need to.
We just need to ride it out.
We just need to ride it out.
Why Has The Income For My Investments Fallen?
The nature of this crisis was a “Credit Crisis”. This meant that banks and lenders of money were calling in loans and not lending money to every day businesses.
Direct Shares
Direct Shares
- Companies choose to keep cash rather than payout to shareholders as they were uncertain about whether or not they would need to repay debt to their bankers or indeed if they needed cash to fund their own development and business as credit markets dried up.
- Most companies have raised capital from investors where necessary and “solved” this dilemma so in general most shares have now returned to paying “normal” level of dividends. This will take some time as dividends are paid every 6 months at best.
- Managed Funds own shares and these investments made substantial capital losses over the last 2 years and the amount of dividend income from these investments was quite low (for above reason).
- Managed funds only pay distributions based on taxable income (very simply). As there was no taxable income distributions were very low.
- They have now started to see capital gains however these gains are only offsetting previous losses. Therefore form a taxable income perspective they nullify each other out so once again the distributions will be down. However, in saying this now that the “losses” have been utilised going forward they will have no choice but to distribute income as it is earned.
- With dividends from the underlying shares returning to normal the level of distributions is higher than it had been previously (virtually nil).
- Property investments involve debt and have therefore been hit hard by this crisis.
- Banks have increased the cost of this debt which is taking all available cash out of the structure. They are also demanding that these vehicles repay debt which once again is utilising cash reserves making it unavailable for distribution to investors.
- Slowly but surely as these property vehicles address the issues they can go back to paying distributions but this will take some time.
What Do We Do Now? – Part 2
Last week we discussed the need to 'sit' in regards to gyrating markets. As Winston Churchill said “If you are going through hell, keep going”. Well guess what, the theme of this week was the complete opposite to last week, with concerns over the global economic recovery and European debt issues fading and investors saying the market had been “oversold” and provided cheap buying opportunities. The Stoxx Europe 600 Index rallied 5.4% this week with the MSCI Asia Pacific Index rising 4 percent this week which included a 3.7% rise for the S&P ASX 200.
The morale of this story is let’s not get to infatuated with short term movements and focus on the big picture. Short term sometimes can be a matter of years not days or weeks.
Continuing on from last week, we are going to look at how the share market is not a gauge of how the underlying investments performing, it is merely a gauge of investor sentiment. This being the case the share market will simply show if we are getting good value for assets, be it as a buyer or seller. History has been littered with examples that demonstrate that the share market is not an efficient mechanism, furthermore, it cannot be as its influenced purely by human behaviour.
There is arguably plenty of opportunities to buy businesses at the moment on the share market where the current price of the associated share grossly underestimates the future profitability of that business. However, the old adage “something is only worth what someone is willing to pay for it” is totally correct, only if you must sell. If you can be more patient this is definitely not the right way to value these assets. However, there are more straight forward examples currently of where the “actual” value of the assets, as determined by a market, this itself is then severely discounted and this is the price reflected in the share price. Here are a couple of examples.
We have exposure to a listed investment company, a company thats business is to invest in shares of other listed businesses. In theory this company on any given day could sell all its shares on the share market and then have cash left over and pay this out to the share holders. One such investment company is trading on the ASX at about 25% discount to what this cash value would be if they sold all their assets. Therefore what this investment company is doing is buying its own shares back from those that want to sell because they are making a riskless return of 25% on the transaction immediately the benefit of which flows to its shareholders...ie us.
We have exposure to a number of property assets through the share market. One company has properties worth $400 million as valued by valuations and transactions of similar buildings. They have debt of roughly $200 million which means there is equity in the business of $200 million. By purchasing the shares on the share market today you are effectively buying a pro-rata share of the $200 million equity for $80 million, a sizeable discount. During the lows of the GFC the value of the $200 million was as a low as $25-$30 million as measured by the “efficient” share market. In regards to the biggest opportunities they are usually where there is blood on the floor - can I interest someone in a retail shopping centre portfolio in Europe? There are other issues with banks etc, however of importance they are still supportive and the gearing involved is less than a lot of the Australian piers facing similar issues. As of December they had assets of $966 million with debt of $672 million leaving equity of $294 million. We can purchase this equity in these assets today on the ASX for $15 million. Even if worst case scenario is factored in there is plenty of “safety margin”.
The morale of this story is let’s not get to infatuated with short term movements and focus on the big picture. Short term sometimes can be a matter of years not days or weeks.
Continuing on from last week, we are going to look at how the share market is not a gauge of how the underlying investments performing, it is merely a gauge of investor sentiment. This being the case the share market will simply show if we are getting good value for assets, be it as a buyer or seller. History has been littered with examples that demonstrate that the share market is not an efficient mechanism, furthermore, it cannot be as its influenced purely by human behaviour.
There is arguably plenty of opportunities to buy businesses at the moment on the share market where the current price of the associated share grossly underestimates the future profitability of that business. However, the old adage “something is only worth what someone is willing to pay for it” is totally correct, only if you must sell. If you can be more patient this is definitely not the right way to value these assets. However, there are more straight forward examples currently of where the “actual” value of the assets, as determined by a market, this itself is then severely discounted and this is the price reflected in the share price. Here are a couple of examples.
We have exposure to a listed investment company, a company thats business is to invest in shares of other listed businesses. In theory this company on any given day could sell all its shares on the share market and then have cash left over and pay this out to the share holders. One such investment company is trading on the ASX at about 25% discount to what this cash value would be if they sold all their assets. Therefore what this investment company is doing is buying its own shares back from those that want to sell because they are making a riskless return of 25% on the transaction immediately the benefit of which flows to its shareholders...ie us.
We have exposure to a number of property assets through the share market. One company has properties worth $400 million as valued by valuations and transactions of similar buildings. They have debt of roughly $200 million which means there is equity in the business of $200 million. By purchasing the shares on the share market today you are effectively buying a pro-rata share of the $200 million equity for $80 million, a sizeable discount. During the lows of the GFC the value of the $200 million was as a low as $25-$30 million as measured by the “efficient” share market. In regards to the biggest opportunities they are usually where there is blood on the floor - can I interest someone in a retail shopping centre portfolio in Europe? There are other issues with banks etc, however of importance they are still supportive and the gearing involved is less than a lot of the Australian piers facing similar issues. As of December they had assets of $966 million with debt of $672 million leaving equity of $294 million. We can purchase this equity in these assets today on the ASX for $15 million. Even if worst case scenario is factored in there is plenty of “safety margin”.
What Do We Do Now?
Investing is a battle of emotions, mainly fear and greed. To be a successful investor you need to control these emotions as well as understand the basic principles of what you are investing in. You are buying assets, be they businesses that generate profits or commercial property that earns rent for years to come. It’s important not to lose sight of these basics when making financial decisions. The share market is not a gauge of how these underlying assets are performing just simply a gauge of whether you can buy or sell these assets for a good price or stupid price depending on what side of the transaction you are on. For some reason when everyone is selling on the share market and things are cheap then people want to sell. I am pretty sure this is the opposite concept to the boxing day shopping sales where everyone lines up for a bargain why is the share market different?
We have recently been fielding queries from clients saying they have heard terms like 'double dip recessions' and that the world economy is not going as well as initially thought. They have therefore been asking should they sell up. Well quite simply, the share markets have fallen since mid-April, the S&P 500 has fallen 16%, so all this information is already factored into the share price. Therefore, to sell to avoid this situation would be pointless. We need to focus on the bigger picture and that is to own assets over the next 20-30 years that will generate growing income streams for us over that time be it rising profits or rent (refer to diagram below). Importantly, the last few years have pretty much been a couple of times in a hundred year event given the magnitude of the market falls. The S&P 500 index which is a broad index for US shares fell some 56% from its highest point to its lowest point over a couple of years and the US economy lost 8.4 million jobs over this period. Also given the nature of the credit crisis or GFC a lot of income from investments was effected as companies sought to hang on to cash rather than pay it out to investors. For most assets this situation has now passed and they will return to paying “normal” levels of income to their investors the same way as it did the early 90’s in the diagram below. For successful investors the principles remain the same we need to keep eye on bigger picture and ride this out. Alternatively how can we benefit from the situation?
Markets by their nature react to every bit of information and do what I term “look busy”. They are taking actions which are purely reacting to short term information which could be reversed the very next day. I witness this every day as I look at my Bloomberg and digest the information released and the market movements that are associated with that information. It is absurd to say the least. One day investors are concerned about European debt problems, the next they are not, this could go on for weeks at a time. The fact of the matter is that Stoxx Europe 600 Index is trading at 11 times earnings which is well below the average. This indicates that these stocks are cheap when you compare them to the S&P 500 index which measures US stocks is trading at 15 times earnings. If Europe were to revert to the average of 15 times earnings, which it will sooner or later, this will result in a share price rally of those stocks of 35% cetris paribus. Why waste your time worrying about 1% here or 2% there, as it is impossible to know what path it will take, however you can say that it will revert to average eventually. Imagine standing on the top of a rocky granite mountain with a bucket of water and tipping it out. The only thing you know is that it will eventually get to the bottom if you try and predict the path it will take along the way you will send yourself crazy. So if it hits a sharp edge and the water flows to the right and you then extrapolate that and say well it will keep going right all the way down so it will go this way just to then hit another jagged edge and then be redirected left. Only concern yourself with things you actually know. For example people need to buy groceries, gamble, drink alcohol or basically enjoy themselves, have water and electricity, planes need to land at airports, people get sick and go to hospital, governments and businesses will pay rents for their buildings for their staff and their staff will get there by driving a car and paying tolls on toll roads.
This recovery has a while to go and it will take some time but lets not lose sight on what we need to be doing in regards to the big picture. We have done the hard yards, let’s not lose our nerve at this point. The S&P 500 index needs to rally 53% to get back to its 2007 high.
Next week's blog I will look at some specific examples of how the share market can at times be so far off with how it values businesses both on the high and low side. I will also look at a number of present situations and you can judge for yourself whether or not this makes any sense.
We have recently been fielding queries from clients saying they have heard terms like 'double dip recessions' and that the world economy is not going as well as initially thought. They have therefore been asking should they sell up. Well quite simply, the share markets have fallen since mid-April, the S&P 500 has fallen 16%, so all this information is already factored into the share price. Therefore, to sell to avoid this situation would be pointless. We need to focus on the bigger picture and that is to own assets over the next 20-30 years that will generate growing income streams for us over that time be it rising profits or rent (refer to diagram below). Importantly, the last few years have pretty much been a couple of times in a hundred year event given the magnitude of the market falls. The S&P 500 index which is a broad index for US shares fell some 56% from its highest point to its lowest point over a couple of years and the US economy lost 8.4 million jobs over this period. Also given the nature of the credit crisis or GFC a lot of income from investments was effected as companies sought to hang on to cash rather than pay it out to investors. For most assets this situation has now passed and they will return to paying “normal” levels of income to their investors the same way as it did the early 90’s in the diagram below. For successful investors the principles remain the same we need to keep eye on bigger picture and ride this out. Alternatively how can we benefit from the situation?
Markets by their nature react to every bit of information and do what I term “look busy”. They are taking actions which are purely reacting to short term information which could be reversed the very next day. I witness this every day as I look at my Bloomberg and digest the information released and the market movements that are associated with that information. It is absurd to say the least. One day investors are concerned about European debt problems, the next they are not, this could go on for weeks at a time. The fact of the matter is that Stoxx Europe 600 Index is trading at 11 times earnings which is well below the average. This indicates that these stocks are cheap when you compare them to the S&P 500 index which measures US stocks is trading at 15 times earnings. If Europe were to revert to the average of 15 times earnings, which it will sooner or later, this will result in a share price rally of those stocks of 35% cetris paribus. Why waste your time worrying about 1% here or 2% there, as it is impossible to know what path it will take, however you can say that it will revert to average eventually. Imagine standing on the top of a rocky granite mountain with a bucket of water and tipping it out. The only thing you know is that it will eventually get to the bottom if you try and predict the path it will take along the way you will send yourself crazy. So if it hits a sharp edge and the water flows to the right and you then extrapolate that and say well it will keep going right all the way down so it will go this way just to then hit another jagged edge and then be redirected left. Only concern yourself with things you actually know. For example people need to buy groceries, gamble, drink alcohol or basically enjoy themselves, have water and electricity, planes need to land at airports, people get sick and go to hospital, governments and businesses will pay rents for their buildings for their staff and their staff will get there by driving a car and paying tolls on toll roads.
This recovery has a while to go and it will take some time but lets not lose sight on what we need to be doing in regards to the big picture. We have done the hard yards, let’s not lose our nerve at this point. The S&P 500 index needs to rally 53% to get back to its 2007 high.
Next week's blog I will look at some specific examples of how the share market can at times be so far off with how it values businesses both on the high and low side. I will also look at a number of present situations and you can judge for yourself whether or not this makes any sense.
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