I presented a webinar for Netwealth last week on value investing in small and mid cap stocks. Even after a couple of decades practising value investing, going back to basics gets me thinking about the fundamentals of what we do. And it helps, a lot.
The value of any financial security is the present value of the cashflows it is going to deliver to its owner.
That is the fundamental principle of value investing. How much am I going to get? When am I going to get it? How certain am I? Answer these three questions accurately, buy with an appropriate margin of safety and you don’t need to worry about anything else. The share price can go up down or sideways. It doesn’t even matter where the shares trade at all. The business you own is going to provide you with the return you require.
Despite knowing this, despite repeating it ad nauseam to investors and potential investors alike, I still get lured into letting share prices define our success. Sotheby’s (NYSE: BID) share price has doubled since we bought it, therefore we were right. Countrywide (LSE: CWD) is down 60% over the past few years, therefore we stuffed it up.
No, and no. The true definition of success is whether the business produces the cashflow stream we expected. It is a subtle difference, because share prices tend to be highly correlated with the underlying business performance, but it is a very important one.
The true test of value investing success
We paid $22 a share for Sotheby’s and sold it only 8 months later for $40 a share. While that sounds great, the true test is whether it delivers the anticipated cashflow stream or not. Since our purchase Sotheby’s has returned about $6 to shareholders in the form of dividends and buybacks. That’s meaningful progress but it has some proving to do yet. We won’t know for five or ten years whether our purchase price was a wonderful investment or not.
Countrywide, on the other hand, has just cut its dividend and undertaken a capital raising. Rather than paying cash out, they are asking shareholders to put more in. Further down the path than Sotheby’s, it’s pretty clear we have this one wrong. Not because the share price is down, but because the cashflows are a long way short of our expectations.
The more time that passes, the more evidence you get to assess the original investment case. Which brings me to one of our old favourites, B&C Speakers (BIT: BCE). This Italian speaker manufacturer has been in the portfolio since 2013 (and featured in the June 13 Quarterly Report).
The original purchase price was €4.10 per share. In the nearly four years since, earnings per share have grown from €0.38 to €0.58 and the dividends have kept pace. In total we have received €0.99 in dividends and last night the company declared another €1, including a €0.60 special dividend. Once paid, we will have received 49% of our original purchase price in cash. The underlying dividend represents a yield of 10% on the purchase price and it should grow from here.
The share price is up 150% since that initial purchase, closing at €10.23 last night. Would we care if it was still trading at €4.10? Of course not. We own a business that is delivering wonderful returns on our initial outlay. And that is the true test of a very successful investment.
Gareth and I were the first non-Italian visitors to B&C’s head office in Florence. The CFO, Simone Pratesi, shared a pizza with us in the company’s caffeteria. “You guys have the easiest job in the world” he told us. “All you need to do is invest in a B&C and go to the beach while I make you rich”.
Sometimes it’s worth remembering that successful investing really can be that simple.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.