QAV 538 CLUB

Cameron  00:06

Welcome back to QAV, episode 538. Recording this on Tuesday the 27th of September at 4:05pm Brisbane time for the record. How are you, TK?

Tony  00:20

Good. I was gonna say, is it welcome back?

Cameron  00:24

Commiserations.

Tony  00:26

Tough week in the market.

Cameron  00:27

Very tough.

Tony  00:29

I’m good, though.

Cameron  00:30

That’s good, that’s good. What have you been up to in the last week since we did a show, TK? Apart from selling off all your stocks.

Tony  00:38

Or at least half of them. Yeah, pretty social. Thursday was a holiday so caught up with a lot of friends; celebrated a birthday, went out for lunch. Caught up with some friends Friday night. I hadn’t been down to Macleay Street Bistro, which is down the road from us, and went there on Friday night with some friends. Really good if anyone’s lives in the area or travels to the area, I recommend it. Great place. And then as Roy and HG would say, “Festival of the Boot” over the weekend with the AFL Grand Final. We had had a mate around to watch that. And then the NRL semi final Saturday night. And a bit of horse racing in between. So, very social. You?

Cameron  01:23

Yeah, I’ve been up in Bundaberg for the last week, just got back about forty-five minutes ago. Had a great time with visiting my mom, and Chrissy and I spent a lot of time on the beach; a little bit during the day everyday with Fox, and at skate parks, and then in the night times Chrissy and I would try and sneak down there and just lay on the sand and watch the sunset and look up at the Milky Way and just chillax. Which was good, particularly with the market just collapsing around us. Take my mind off it, go and relax. Yesterday, of course, was Stanislav Petrov Da, the day that I commemorate. Sunday was the anniversary 21st anniversary of my dad’s passing, my dad’s death, so I made his favourite dish — well, his go-to dish — which is mince and beans. “Cowboy dinner” as my Scottish grandmother called it. Just minse and baked beans. That’s a bit of a tradition for me to remember him.

Tony  02:23

Oh, that’s nice.

Cameron  02:25

And then Monday was Stanislav Petrov day. Do you do you celebrate Stanislav Petrov day?

Tony  02:33

I think I missed it this year, Cam, and last year as well from memory.

Cameron  02:37

Well, you can pour one out for him. For people who don’t know Stanislav Petrov, he was a lieutenant colonel in the Soviet Air Defence Forces, September 26, 1983, three weeks after the Soviet military had shut down Korean Airlines Flight double oh seven. Petrov was the duty officer in a nuclear early warning facility in the Soviet Union, and their system reported that a missile had been launched from the United States and then five more missiles had been launched from the United States. He was given orders to launch nuclear weapons against the United States defensively, and he refused to obey orders believing that the system was malfunctioning, as it was, and consequently avoided nuclear disaster. So, there you go. So, I always try and remember him because if it wasn’t for him, who knows what the world would look like today. So, there you go: Stanislav Petrov.

Tony  03:50

I thought you’re going to talk about the Petrov affair.

Cameron  03:53

Nah, different Petrov.

Tony  03:55

Or maybe the son.

Cameron  03:56

Possibly related. Yeah, who knows? No, his father flew a fighter aircraft in World War Two. Anyway, he died in 2017, age 77. I think it’s worthwhile remembering his memory, and just to the kids out there, it’s always a good idea to disobey orders from time to time. Unless I’m giving them.

Tony  04:19

Especially if they involve Armageddon.

Cameron  04:21

Yeah. Fox must be a big fan of his, because he never listens to anything I ever say. Nor do my other kids for that matter. Anyway, on with investing news, we’ll get to the markets and everything a bit later. Some interesting stories I’ve read this week apart from all the doom and gloom: The Financial Review on September 21 had an article about the fund manager performance tables in Australia. It’s always fun to have a look at. “On a one-year basis, the best performer was Melbourne based Datt Capital, whose absolute return fund did 20.63% in the year, mostly because of bets on Whitehaven Coal and New Hope,” some of our favourite stocks in the last year as well.

Tony  05:05

Until yesterday.

Cameron  05:07

Yeah, but they must have been heavily weighted on those because we’ve had them and, you know, we certainly haven’t achieved 20.63% last year. So, congratulations to those guys. But when you go down, then there’s Lazard Select Australian Equity Fund, 20.41% for the year. They have big chunks of their portfolio in QBE — another good QAV stock — Woodside, and Whitehaven, all good QA V stocks. But of course, when you get down the ranks, Australian Eagle Growth High Conviction, 14.27%; in retrospect they weren’t as highly convicted as they thought they were at the beginning. And there’s a few others down there as well. But on a seven-year basis, they don’t all do that well when you look at them over the long term.

Tony  06:00

Sorry, excuse me, do you have a three-year basis there at all?

Cameron  06:02

No, not in this article. There’s no link, actually, in this article, to the actual performance tables, which doesn’t help. It would be nice if they actually gave me a link. But yeah, it says that on a seven-year basis, some of the more recent winners fall off the top five because they haven’t been around long enough. Some good performance on a one-year basis. Oh, sorry. We do have a three-year basis. I didn’t read enough. That Capital number one spot was 22.9% over three years, followed by our friends at Collins Street Value, 22.6%, and Samuel Terry Absolute Return, 15.82%. They’re good numbers for the last three years.

Tony  06:49

They are, yeah. And we know that Collins Street is a value fund, so that’s good. So, we will have sorted in where? The dummy portfolio, I think, was 15 odd percent over the three years.

Cameron  07:00

Something like that. Yeah. So, we’d be probably in the top three or four if we were being compared on the three-year basis. We just celebrated our three-year anniversary on the second of September, it would have been, so there you go. But they’re good numbers. And congratulations to those funds.

Tony  07:18

We forgot to celebrate our third anniversary of the dummy portfolio. But yeah, puts things in perspective, doesn’t it? I mean, it’s been horrible selling things in the last few days, but the dummy portfolio is ranked three or four in Australia. That’s pretty good.

Cameron  07:33

Yeah. So, congratulations to you, Tony.

Tony  07:36

Well, thank you. Yeah, and congratulations to the other guys, too. But I guess my comments on these kinds of tables are to look at the longer-term ones, the longer-term results. So, three years and outward at least. Whenever I look at tables like this, if they’ve got something even longer, since inception, that’s the best to look at. And certainly, if it goes back to take into account a downturn in the market. So, how long’s COVID been? Three years might just cover COVID. But you know, the longer the better to try and compare funds. I guess, you know, if you’re new to the market, and you see someone like Colin Street Value Fund, for example, do well, and you like their process, you might invest some with them. But yeah, I certainly rely on longer term performance numbers over shorter term ones.

Cameron  08:23

Well, let me see, what else have I got? Here’s another, this article was in the ABC from a couple of days ago: “Did the Reserve Bank’s money printing cause inflation? The bank says it’s complicated.”

Tony  08:37

Is that what fox says?

Cameron  08:39

Yeah. “Ah, it’s complicated.”

Tony  08:42

“Did you kick this over?” “Nah, it’s complicated.”

Cameron  08:44

It’s complicated.

Tony  08:46

Bit of gravity, bit of inertia. It’s complicated.

Cameron  08:50

Yeah, yeah, yeah. You really need to understand Einstein’s special theory of relativity for me to explain this to you, father. Well, I do. It’s a good thing that I do. So, did you read this article, Tony?

Tony  09:03

I did. I did. I learned a fair bit. I mean, it is complicated. There’s far much more going on in the Reserve Bank than I ever thought, however, I still scratch my head and say, “how did they do it, really?” There’s certainly value creation out of nothing going on somewhere.

Cameron  09:20

So, they’re basically trying to say, “look, the inflation, well, you know, it’s not really because we were printing money. It’s got to do with velocity of money, it’s got to do with the kinds of money that are out there. They’ve got all these different categories of money. Money base M1, M3, broad money.” So, I don’t know. Did you did you buy it at the end of the day? Do you think it’s more complicated or less complicated?

Tony  09:55

It’s more complicated, I mean, how the RBA works I think is more complicated. Go back to the headline; “Did the Reserve Bank’s money printing cause inflation?” It did a little bit, but like I said last week, it’s more to do with supply chain and COVID, I think, and energy, than printing money. So, the corollary, should they use rising interest rates to tame inflation, is just not going to work. It’ll work partly; or if it works, it’s because it’s crashing the economy. It’s not solving the underlying problems, which the RBA can’t solve. So, that was my key takeaway to this whole thing. But it’s almost like the tides, isn’t it? It’s like, “we may go into recession. Quick, cut interest rates, buy bonds, flood the market with money, pump prime the economy. Oops, too much. Now the tides gone the other way. Let’s take money off the table, let’s raise interest rates by by selling or buying bonds.” Yeah, it’s the tides going back and forward, but is it really having an effect? I guess it is, obviously, but is it the best way to have the effect wanted? And look, you know, I mean, all these kinds of thoughts are playing out right now. And if you look at the UK, I mean, what are they smoking over there? Their central bank is hurriedly raising interest rates, and the new government comes in and says, “well, we can solve this, we’ll just eliminate the top marginal tax rate. We’ll give or give money to rich people to spend.” It’s absurd. As one commentator said, it’s a canoe with two paddles and they’re both going in opposite directions at the moment, fiscal and monetary policy. So, that’s not going to work. That’s been happening to some extent in the US with, you know, Biden’s put a lot of money back into the economy. And my thoughts are that will probably stop after the midterm elections, he’s obviously been electioneering for votes. But whenever a government does that, your fiscal and monetary policies are at loggerheads. Interest rates are having to be raised quicker and further in the US because there’s too much money in the economy, as well as all the other problems with COVID and energy prices. It’s like you’ve got two chefs in the kitchen: one’s fiscal and one’s monetary. I remembered having a similar sort of conversation in reverse when COVID was around, that the central bank was lowering interest rates, but the government was raising taxes at the same time. So, they weren’t working together in unison. So, I don’t know the answer. If it was me, I’d put some more rules around the RBA, and limit their remit, and try and have some better link to the government to match fiscal and monetary policy. But, like I said last week, it’s not going to end well. I’m completely amazed at how uncoordinated the approach to inflation is.

Cameron  12:40

But they’re supposed to be independent from the government, right? Isn’t it sort of the point, of having the RBA at arm’s length from the government?

Tony  12:47

Yeah, it is, and I once drilled down into that because I scratched my head on why that was important. Because like, you elect the government, right? You could make a case to say they should be in charge of interest rates. The problem with putting the government in charge of the Reserve Bank is that they can print money, and they can start hyperinflation because they want to appear good to the voters and balance their budget or do away with their debt, and those kinds of things. So, I get that, but there needs to be some kind of coordinated approach between fiscal and monetary policy. It’s not being solved with one actor pulling one lever and one actor pulling another lever in different directions.

Cameron  13:28

So, the bottom line is, as you said last week, you think that all of the money printing that went on probably has had some impact on the current inflation, but there’s a lot of international factors playing here, too, that our government and the RBA really can’t do much about.

Tony  13:45

Yes, but we can do a lot about it. I mean, for a start, the raising of interest rates would have happened a lot quicker and a lot sooner, which would have been a lot healthier and helpful, if property prices were included in the inflation figures. They’re not and I think that’s a mistake. I think they were taken out, you know, for political reasons, and I think they should be put back in. So, when the RBA flooded the market with cheap money and people were stuck at home, they paid more for homes, and we had a large property increase. I could even call it a bubble. That would have been the time to start raising rates because that’s not good for the economy for all sorts of reasons, about people getting access to accommodation notwithstanding, but also the fact that you’re creating a bubble in the one asset that’s the the largest in Australia in terms of individual ownership. So, there are wrinkles in the system, and it’s working as a very blunt tool, and it needs updating.

Cameron  14:42

Well, I’m glad you understand what’s going on, because it’s all over my head.

Tony  14:47

I’m not sure I do. I’ve just seen it all before.

Cameron  14:50

All of this has happened before, and all of this will happen again, as they said in Battlestar Galactica. My last news story…

Tony  14:56

The remake.

Cameron  14:57

Yeah, the remake. Yeah. Ah, this is also from the Fin, John Kehoe the economics editor: “labour added again in surprise move on dividends. The Albanese government has shocked investors by proposing to retrospectively stop companies paying shareholders fully franked dividends that are funded by capital raisings.” I remember the last time the Labor government were talking about messing around with fully franked dividends, you weren’t very happy about it. They’re talking about it being retrospective going back to 2016. That seems a little bit dodgy.

Tony  15:34

Yeah, I agree. Gough Whitlam famously said, “I don’t agree with retrospective taxation, except for abortion in your case.” Which is a great line. And yeah, I can’t see the case for retrospectivity in this particular application, or, generally, any application, really. What’s happened has happened, and unless you’re committing murder and they retrospectively apply it, you can’t go back and change the way people have invested. They did it based on the current rules. Labor arguably lost the last election, sorry, one before last one, they won the last one and they’re in power, but the one before that they lost, among other things, because of their attack on things like franking credits. I’m surprised they’re raising this again. It’s a very narrow one, this time; what they’re seeking to stop is companies, or LIC’s or whatever, that have franking credits on their accounts that they can’t distribute because they’re either not paying dividends or not paying enough in dividends, and the franking credits get attached to those dividends. Occasionally, from time to time, investors will lobby those companies to do a capital raising and then distribute the dividend. You know, that’s fair enough, I don’t have a problem with that. I don’t see what the problem is in raising capitals and then distributing it if it takes the franking credits off the book. The people who were putting capital into the company knew that was the reason for it and agreed that was the reason for it, and put the money in. So, I don’t see a problem. Already, tax accountants are coming out saying, “hey, this may stop, you know, big companies from doing dividend reinvestment plans if they’re underwritten.” Because that’s the kind of form of capital raising to pay for a dividend reinvestment plan. So, there might be some unintended consequences. I just don’t know why they’re fighting this fight. It’s not a big deal. Jim Chalmers even came out and said it’s going to be worth $10 million of tax revenue to us, so that’s bugger all. He’s certainly got bigger issues on his desk than this one. Very strange.

Cameron  17:35

So, apparently when Scott Morrison was treasurer back in 2016, he said the Liberal Party was going to do this, but then never got around to it. He was too busy signing himself up to secret industry. and funding the Governor General’s leadership fund.

Tony  17:59

Yes, but he asked the Treasurer, turned around and asked the treasurer, and Scott Morrison said “no.”

Cameron  18:04

Looked in the mirror.

Tony  18:05

I suspect what happened back then, Cam, was that they announced it and then got feedback to say “this is dumb,” and then didn’t go ahead with it.

Cameron  18:14

Yeah, but apparently, they thought it was a good idea. So, both parties, the Coalition and the Labor Party, both seem to think this is a good idea. The explanatory material accompanying the new draft legislation says it’s “to prevent entities from manipulating the imputation system to obtain inappropriate access to franking credits.” So, they don’t think this is a legit way of distributing franking credits, apparently.

Tony  18:43

So, the Tax Office takes the view that it could be rorted, and technically, they’re correct. And it could be rorted in a large way. So, what the tax office is banking on is the fact that there are a certain percentage of companies out there who don’t distribute their franking credits, and therefore the tax office doesn’t have to… that’s like a win for the tax office. They don’t have to give people credits on their tax returns, or even pay back actual cash to people who are on low tax rates, like retirees, for example. So, that’s why the Tax Office is putting this forward. And the case is basically that if people are trying to do this in a big way, and enough companies or enough LICs borrow money to release all the franking credits, we’re going to have a big bill. So, technically that’s correct, and that might happen in the future. That’s why they’re pushing this case, but it hasn’t happened to date. And it hasn’t happened to date, because I don’t think the economics stack up that well to go to your investors and say, “hey, give us some more capital and we’ll pay a dividend and give it back to you with franking credits.” The franking credits, it’s playing around on the margin to some extent, because first of all, dividend yields are usually around, say, 4%, and then the franking credit’s a fraction of that. So, it’s, you know, it’s going to be a 1-2% improvement In the returns from the company for all that mucking around of raising money and then distributing it again. It’s not high on the agenda for most funds to seek this with companies. So, it hasn’t been a problem in the past. I just think that they’re on hiding to nothing with this one.

Cameron  20:17

And one of the impacts to us as investors, I know Jeff Wilson is not too happy about it. What are the real impacts to us if this goes ahead?

Tony  20:26

I haven’t really delved into it with Jeff’s case. I know Jeff successfully over campaign many years ago to say that an LIC… in the past, the prior law was an LIC could not pay a dividend if it didn’t make any profit. And last week I spoke about the times when LIC’s don’t make a profit because they haven’t sold anything, but they’re sitting on large paper profits. So, the LIC is still a good investment even though it’s not making a profit in an accounting sense. What Jeff lobbied for and achieved was a change in the law, to say that if there was retained profits or other assets on the balance sheet that could be used to pay a dividend, even though the LIC did not make a profit that half or that year, they could still pay out a dividend. He’s very focused on his suite of LIC’s paying out a high yield; that’s what attracts a lot of people to, particularly, WAM capital, the biggest of his LICs. So, I think last time I had a look it was probably on at least 5% yield, and then fully franked grossed up it more than that, you know, sort of 7.5%/8% yield. So, he’s worried that there might be an implication whereby if he technically doesn’t make a profit in his LIC, that somehow, it’s seen as a capital raising if he pays it out of retained earnings. That’s my guess, but, you know, I haven’t delved into it too deeply.

Cameron  21:49

Alright, well, thanks for that. I thought I’d do a portfolio update. The dummy portfolio since inception, which as we said is just over the three-year mark, is currently tracking at 12.96% per annum. Not quite the 15.

Tony  22:04

No, it’s gone down.

Cameron  22:06

Well, a week ago it was 18.

Tony  22:08

Yeah.

Cameron  22:10

Now it’s down to nearly 13 after the last week. Versus the SPDR 200 Fund, which is at 4.46% over the same time period, so we’re outperforming by roughly you know, not quite three, I guess. I don’t know what that is. Two point something.

Tony  22:28

So, the index has fallen quite a bit, too, hasn’t it?

Cameron  22:30

Yeah, it was about 6.66 last week — no, sorry, a month ago. A month ago, it was 6.66, we were 18.51. We’ve dropped down. You go back to July ’21, we were running at 38.74% per annum versus 9.3% for the SPR 200. This halve we’ve come down by 60%, so it’s been a rough year and a bit for our portfolio. In the last couple of days done a bit of trading, last week actually, I’ve sold off Yancoal, PWR — bought and sold PWR, bought it one day, sold it the next. BFG, sold that, MQG I sold last week, TER I sold last week, and that’s it. The only buy I’ve had in the last week was PWR and then sold it the next day, as I said. It’s been really hard to find anything that’s not a Josephine or not having a down day in the last week. It’s been really tough.

Tony  23:37

Yes, it has been. Especially in the last twenty-four hours. The markets up a little bit today, but Wall Street was down again, so I’m not sure how long that rally is going to last. But yeah, I sold seven of my stocks in the last twenty-four hours as well.

Cameron  23:47

Wow.

Tony  23:47

It’s been tough. Those numbers over the longer term, I mean, they’re illustrative of the fact that we tend to follow the ASX index in terms of direction, but we still outperform. I guess that’s one of the things that I’ve found over the years, is that we operate in the same market; so, the market goes up, the market goes down and our portfolio does too, but it still tends to outperform or does outperform over the long term. It just does directionally still follow the way that the index is going.

Cameron  24:16

Well, we’re still outperforming, and I guess that’s all we can really aim for. If I look back, what was last week? So, the 20th, we were 15.65 last week versus 5.84 for the SPR 200. So, it’s been a brutal week for us.

Tony  24:34

And the market, too.

Cameron  24:35

Yeah, but compared to the top funds in Australia, we’re up in the top five easy. So, yeah, it’s all relative.

Tony  24:43

Yeah, and I guess to put it in perspective it has been a brutal twenty-four hours and last week wasn’t great either. You know, this is part of investing. These are tidal flows: the tide comes in, the tide goes out. The thing that I take solace in is the fact that I’ve now got some cash and when things turn around, I can invest it. But also, too, I haven’t been wiped out; no one gets wiped out using this process, right? We can drop in performance, and that’s, you know, hard to take emotionally, but we don’t get wiped out because we sell up and move out beforehand. And that’s why even repeatedly over the last three years, and even why as late as last week I was saying, “look, don’t margin lend in times like this. Don’t borrow too much. Just keep your keep your powder dry and wait for a definite turn in the market before getting back in.”

Cameron  25:34

Really?

Tony  25:35

Yeah. I’m still using the same system to sell things, so the rule ones and the three-point trend lines, and when we can’t find anything else to buy, then that goes to cash, and we wait for the good times to come round again. So, we’re not being wiped out. But if you’re leveraging a lot, particularly into this kind of volatile market which is going against us at the moment, you can get wiped out. You know, Buffett famously said, if he’d margin loaned Berkshire Hathaway, he would have been wiped out twice during his life.

Cameron  26:06

No, I meant, sorry, when you say wait for the market to turn around, you’re still buying stuff if it turns up as a buy on the buy list, right.

Tony  26:13

Correct, yeah. If it’s not a Josephine, if it’s having an up day, all those things, yeah. So, I did buy some more Whitehaven Coal today, but that was the only thing I could find a buy.

Cameron  26:22

I might have to do that with the dummy, you know, look at things that we already own and double up on some stuff if they’re buys. I think it’s still going to be hard to find anything.

Tony  26:32

Yeah, I think that’s fine.

Cameron  26:34

Put some of that money back to work. What else have you got to talk about today, TK?

Tony  26:39

Yeah. So, I mean, I don’t want to labour the RBA again, but just one thing that struck me out in all the writings on the weekend and last week about the RBA, is it’s not going to pay a dividend this year. So, while interest rates are going down — which means, if you remember, interest rates are the reverse of what’s happening with the capital gain or loss on the bond, bonds have been gaining in capital. And so, the RBA sitting on all those bonds has been making money on paper and then paying a dividend of about $2 billion a year to the government. That’s not going to happen this year, and actually if it was a separate company, it would be trading insolvent. So, its liabilities now outweigh its assets because of all the bond write-downs it’s had to do in the last six months because of rising bonds. And wouldn’t you know it, they were buying bonds during the QE phase. So, they’ve stocked up and now they’re suffering from that, too. The last time I remember this happening it didn’t end well, and the government actually had to inject billions of dollars onto the RBA balance sheet to keep it operating. So, watch this space. It may not happen again this time, and hopefully it won’t, but it’s not going to pay a dividend for the foreseeable future. And that’s not the end of the world. I mean, the government is making a lot of money out of mining taxes in particular, with the iron ore boom and now the coal boom going on. So, the government aren’t crying Paul, but it’s again one of these interesting intricacies with the RBA that as far as the accountants are concerned, it shouldn’t be operating and it’s now sitting on a big loss. Anyway, a couple of stocks in the news during the week. So, up until yesterday, I’d owned Viva energy, which is the old Shell business — which I used to work for — and they were in the news because they bought back the Coles Express retail site. The fuel business was leased over to Coles fifteen or so years ago, back when shopper dockets were first introduced and they were all the rage, and they created a big increase in volume for Shell and BP and Caltex in particular, which aligned themselves with the shopper dockets. At least Shell and Caltech’s did, I’m not sure about BP, but Shell and Caltech did. Coles has decided it’s going to end that deal a bit early, and Shell are very happy to take back the operation and the profit of the retail sites, and I guess it’s a good time. Fifteen years ago, the retail market wasn’t earning anything at all out of petrol sales, and all the income was coming through the convenience store. That income through convenience is still there, but the retail petrol margins are strong again, so Viva energy is happy to buy it back. The other two stocks in the news: Whitehaven Coal has announced a $2 billion buyback, and that suggests to me that they see that the mega profits in coal are set to continue. They wouldn’t be buying back their stock if they thought that the coal price was going to drop off in any meaningful way. And lastly, one for you Cam, I saw in the paper on the weekend Apollo Tourism and Leisure shares went up because they…

Cameron  29:46

Somebody’s buying something that they’re selling, but it ain’t me.

Tony  29:50

Yeah, so Apollo tourism and Leisure have been trying to merge with a New Zealand Company called Tourism Holdings for a while, for the last six months, and the competition regulators haven’t liked it because it lessens competition in that holiday campervan rental market. Then Apollo announced last week that they were going to sell off some assets to their competitor, Juicy, which operates camper vans, and they also are going to sell their star rental brand as well in the hope that that was going to appease the competition regulators concerns about having too much concentration in the proposed merged company. And on the basis of that, the Apollo shares rerated to be closer to what the valuation is if the merger goes through. So, three shares in the market from our buy list.

Cameron  30:38

The joke there for people that haven’t been around very long is, when we first started the dummy portfolio three years ago — or three and a half years ago is when we started buying shares — Apollo was the first stock that we added to it and then we had to sell it like a week later. And then we bought it again a month later and had to sell it a week after that, too, so I was like, “that’s it. We’re never buying Apollo again.” But I look at it now, I think back then it was trading around two years ago, September 2020, it was trading at 26.5 cents. It’s now at 65 cents, so if we’d held on to it, we would have done very well out of it, but it’s been a rocky road over that period.

Tony  31:23

It has, hasn’t it? The last thing I wanted to talk about was the ABC news on TV have been upping its business news section over the weekend, which I quite liked. So, they’re devoting more to what’s going on. The reporter by the name of David Chau did an excellent job in summarising what was happening with the markets that were in turmoil Friday night, and with the UK election, so well done to him and to the ABC for giving him some space. But it was a bit of a “don’t look up” moment on the weekend, I think it was Sunday morning, when the two blonde reporters behind the desk watched David Chau do his very in-depth coverage of what was going on economically, and they were like lambs in the headlights. He finished and they didn’t know what to say, and then one of them said, “oh, and now an article about old people exercising where you get to meet new people.” It was a real clanger.

Cameron  32:17

How many times did he mention King Charles in the news report?

Tony  32:21

None.

Cameron  32:22

Really? I thought it was obligatory that every ABC story had to mention the royal family at the moment.

Tony  32:29

Well, not that one. He was good.

Cameron  32:30

That’s good. And you’re doing a pulled pork for us this week, TK?

Tony  32:35

I am. And it took me a while to find a company that we hadn’t covered, and particularly one that was going up and worth having a look at, but I found one. It’s on our buy list. It’s one I haven’t come across before and it’s only a small one, but it is worthy of people having a look at: it’s called Xtek. The ASX symbols are XTE, and it was up 4% yesterday when the market was going down. So, that was good.

Cameron  33:04

But do you know why?

Tony  33:06

Well, they announced a contract, apparently.

Cameron  33:09

Well, that’s one reason, but it’s also according to Doug — QAV Club member, Doug — it was all the QAVericks driving it and buying it yesterday because it was on top of our buy list. And I went to buy it yesterday midday because Doug was talking about it and it was on our buy list, and it was down 7%. I was like, well I’m not buying it, its down 7%. And then it finished up 4% at the end of the day. Doug Vass’s theory — a QAV club member who lives in Spain of all places, but he’s an Aussie — thinks it was the QAVericks who were buying it even though it was having a down day and drove it up. I did buy it today, though, and then it went down 2%. So, thanks everyone who dumped it. Anyway, on to XTE, Tony.

Tony  33:58

Yeah, so I didn’t know that about Doug. I found this one this morning as well. So yeah, it’s a company based in Canberra, but it has factories in the US and Australia, in South Australia. It produces and sells helmets, body armour, and vests, so personal protective gear, for the military and for police forces, and also security tech systems as well as security tech hardware. So, things like drones and sensors and those little robot vehicles that look a bit like bomb disposal vehicles, apparently are like drones but operate on the ground. In Xtek speak, they’re a personal ballistic protection equipment company and reconnaissance and surveillance UAV and UGV company. I guess UAV’s unmanned aerial vehicle and UGV unmanned ground vehicle. That’s what they do. I guess I should point out the risks with a company like this; the fact that they’re based in Canberra with facilities elsewhere makes me think that they survive on contract wins. So, they want to be close to where the contracts are assigned, but they manufacturer were its cheaper. This can be good and bad. It’s a good allocation of division of labour, I guess, but they reminded me of another company which I’ve had in my portfolio over the years, I think it’s been on the buy list in the last three, called Austil, ASB, which started life as a ship manufacturer, ship builder from Perth. Originally, I came across it because they had a lot of tailwind when they came up with the design for the catamaran ferries that people will have travelled on at some stage, especially if you’ve been out to places like the Whitsundays, Hamilton Island, that kind of thing, where you get on a very large catamaran. So, the Shark Cat type ferry that takes you over very smoothly. They can hold lots of passengers and they’re cheaper than the old style of boat to produce. They eventually got into the production of combat boats for the Navy, especially the US Navy, in what they call the littoral craft and business, which I understand is another word for coastal. So, it’s not in international waters, it’s in local waters, and they just converted their catamarans to have guns and armour plating. And that became a big business for them. But it is lumpy, and I guess the takeout from that is it does rely on contract wins to keep the profits flowing. Anyway, that’s the first risk. Second risk is that it’s a very small company, it’s $58 million in revenue, but a very high profit margin which is good. I know it’s a small ADT company, so it won’t appeal to all people. I do hesitate myself to buy small companies like this with sub 100-million-dollar revenue items. This one’s probably okay, because the net profit is high, but the basic rule of thumb is that companies make around 4% net profit after tax, usually about 10% gross profit based on revenue. And so, if you’re not making $100 million in revenue, and you’re only making say $2-$4 million in net profit, you’re not able to sock away that much for a rainy day. If you do have a bumpy year and you’re not making profit, it can be company ending. As opposed to, you know, a company which has got much higher revenue and that 4% can become a meaningful nest egg on the balance sheet for a rainy day. But anyway, I mean, that’s not to say that small companies aren’t investable. And obviously, they often have the benefit of high growth because they’re coming off a small base, and we’d all like to buy an acorn and watch it turn into an oak tree. So, that’s essentially the case here. But I just highlight those two risks. The numbers though, which are just as important to us, if not more — and I’m using 47.5 cents which was the price yesterday when I did the analysis — the first thing to note about the numbers is there’s no consensus forecast, and no dividend. So, we can’t score based on IV 2 census forecast or dividend yield. However, the financial health in Stock Doctor is strong and recovering, which we like. So, that scores well. A couple of metrics we don’t score I just wanted to call out: the ROE is 20%, the PE is 7.5, so high capital generation and low PE which is good. Pr/OpCaf is 1.84 which is really low, so that’s great, throwing off lots of cash. And again, I point out that’s probably because of the contracts it wins, so that mix could change, but doing well at the moment. Net equity per share is 35 cents, and so book plus 30% is 45 cents, which is almost the share price at 47.5 cents. So, if it drops a little bit it may score on that one. Interestingly enough, no owner founders. I found that strange for a small company, but I’m not sure the background of the owners of this one. I did note there was an interim CEO in the role, so there could have been some corporate activity recently for this company. And in reading some of their releases, they were talking about getting back to basics on what they do. So, there could have been some corporate activity in this company in the last little while. Overall, though, the quality score for this company is 10 out of 12, or 83%, and the QAV score totals 0.45, which is high up on our buy list. So, checkout XTE.

Cameron  39:32

Thank you, Tony. Should we get into some Q&A mate?

Tony  39:36

Yeah, sure.

Cameron  39:37

Coincidentally, the first questions also from Doug. “Just an update on my shorting experiment,” he mentioned recently, I’m not sure if it was last week or the week before that he was doing some shorting and we said good luck with that, be careful. That’s when you were talking about being careful about leveraging, I think. “Now the big question is when to get out when the main market indices become buys again, or could that just be false positives? Ie the ‘buying the dip’ scenario. More research to do, stay positive my QAVericks.” He included a little chart of his performance, looks like it’s doing very well. I know you’re not a shorter, but do you have any thoughts on when to get out of shorting, Tony?

Tony  40:16

Yeah, so what Doug’s doing, I guess, isn’t shorting himself, he’s buying into funds that short the index. So, I’d love to know how this turns out for Doug. But what Doug has done is when the market became a three-point trend sell, he bought into a couple of funds that were shorting the index and so he’s been profiting from that situation. But the question he asked is when to reverse that, and I think that, well, if I did this what I would do is when the market, the index becomes a buy again, I’d sell the fund that shorts the index. But yeah, I mean, certainly something I’ve been thinking about a lot over the last week is whether we should short or sell out of our portfolio when the market turns down in general. I noticed AFI became a three-point trendline sell last week, so, you know, starting to reduce our position in equities around that time might be helpful. The last time I did a deep dive into this, though, I wasn’t finding a strong correlation. So, in other words, going back in history and looking at my performance versus downturns in the ASX, sometimes it worked, and sometimes it didn’t. So, that’s what stopped me from doing it, but that’s for a couple of reasons, I guess. One is that our portfolio, even though I said before it does for the ASX as a trend, it certainly does, it doesn’t always correlate exactly. That can be because, you know, we can hold stocks which don’t correlate to the way the index is going. And, you know, classically, for example, oftentimes when the economy’s not doing well, gold goes up as a safe haven, and I’ve owned gold stocks during those times in the past, which has turned out well. So, yeah, I still operate company by company rather than overall on the ASX. But the thing I’m probably even more interested in looking at and exploring further is whether we shouldn’t be doing something to reduce our exposure to equities when the actual portfolio performance becomes a three-point sell, like our dummy portfolio has done in the last little while. That might be a better indicator for us than using something like the index, but it still requires a lot more research.

Cameron  42:28

Okay, you need to explain a few of the things you said there to me. So, when you’re talking about if you were to be using shorting tools, buying these funds. So, BBOZ, BEAR, BBUS, these are indexes that are shorting the index?

Tony  42:43

Yes.

Cameron  42:43

Is that what they’re doing?

Tony  42:43

Correct. Yeah, so they should operate as an inverse to the index: index goes up, they go down, index goes down, they go up.

Cameron  42:53

And so, you said if you were doing this you would sell these indexes when the overall index becomes a buy again. So, you would just be using a five-year monthly chart to determine when it becomes a buy again like we do with a stop?

Tony  43:12

Correct. And that could be too late. As we’ve seen sometimes with charts, the buy line or sell line could be a long way off where the current position is. So, it could, you know, I’ve never done this so I’m not talking from experience if I were to do it and given that it looks like Doug has taken the three-point trend sell line for the for the index, I’d be looking at three-point buy line for that position.

Cameron  43:35

And you said that might be something to consider when our portfolio reaches its sell line. You’re doing the same thing? We haven’t been around for five years; how do you determine when our portfolio overall is in sell territory? Three-year monthly chart?

Tony  43:54

Yeah. I guess in my case I’ve been around longer than that, but for the dummy portfolio it’d be a three-year monthly chart. We can see when if we had applied a three-point monthly chart to our performance, you could just look at Navexa to get that, we could see when it became a sell. And there’s a lot more work I need to do on that, Cam, because does that mean we sell everything in the portfolio? Does it mean we buy inverse index funds like Doug is doing? There’s a whole lot of work that I need to do before I can even recommend anything on this sort of score.

Cameron  44:25

Well, I think Navexa’s charts are monthly by the looks of it, and I can go back three years and try and draw something here. Have you already done this exercise?

Tony  44:44

I did. And from memory, it became a sell around Christmas, I think.

Cameron  44:50

looking at this, it would have become a sell probably June ’21. It was still going up then. If I take the COVID cough as L1 and I take November 2020 as L2, it would have become a sell June ’21, I think. But then there was another low point after that, which means, depending on when we were to sit down and do this, would have been a sell probably August ’21.

Tony  45:25

Just looking at the Navexa portfolio in August 2021, I’m not sure what the portfolio value was back then.

Cameron  45:32

I mean, I could just type the numbers in here. What do you want? What date do you want? End of August 2021? Portfolio value would have been $31,616.

Tony  45:42

Right. And the portfolio value now is $28,600. So, we would have benefited from selling back then.

Cameron  45:49

But we would have been out of the market that entire time.

Tony  45:53

Yep, I would think so.

Cameron  45:53

Right.

Tony  45:55

I can’t see a buy since then. So, it’s interesting, it’s worth looking at. But like I said, I did do a deep dive a while ago and it didn’t correlate one to one.

Cameron  46:07

Okay.

Tony  46:08

Sometimes it works, sometimes it didn’t.

Cameron  46:10

Very interesting.

Tony  46:11

It is. I’d be glad to even get Doug on the show and take us through his learnings at some stage, too.

Cameron  46:17

Yeah, that’d be great. Let us know, Doug, when you’re ready to do that. Moving right along. Ed: “hi Cam. Wondering whether TK had any thoughts or back testing around observing major triggers of a general downward trend in the market? This is a shot of the ASX 200 yesterday, close of business. Using the rules, this suggests we should have exited the market when it crossed the three-point trendline last week. Hindsight is a beautiful thing.” Similar sort of approach, Ed.

Tony  46:42

It is. Yeah. Well, I think I’ve just covered that. I think if you’re an index investor and you only own the index, then yeah, for sure. It’s time to get out. Like I said before, Australian Foundation Investment also crossed its sell line. But we have a different sort of stock-by-stock approach, so that’s why I haven’t been exiting. But as it turns out, I’ve exited half the portfolio anyways. We may be looking at this and then it’s solving itself for us anyway using the current system.

Cameron  47:15

Yeah, so we go to cash on a stock-by-stock basis. And as you say, sometimes your portfolio has followed the index and sometimes it hasn’t, so if you had sold and gone to cash in those times when it didn’t follow the index, your overall performance results may not be as good. Is that the thinking?

Tony  47:35

Yeah, correct.

Cameron  47:37

Julian: “I want to start a conversation about the pros and cons of ETFs. I’m only new, but it seems that in the past ten- or fifteen-years ETFs have just exploded on the back of Buffett’s advice on diversification and observation around managed funds versus the market. The premise for investing in an index ETF seems extremely sound, especially if you get one with low fees. My concern is in two parts: 1) if every fund manager, Superfund and risk adverse investor now includes an ASX 200 ETF, for example, as a large part of their portfolio, is there a danger that this may artificially inflate the market cap of the top 200 companies just because they were in the top 200 when they became a thing? Is it almost an ETF bubble? 2) if the market works on a risk equals reward methodology and ETFs consistently bring back better than managed returns, the reward now seems to be outstripping the risk. Thus, is it likely that ETFs will see, like all streaks, a violent correction?” Now I know we have talked about this before, but I thought it’s always good to recap something like this. Do you have any thoughts, Tony?

Tony  48:46

Yeah, I do. A couple of thoughts. So, Buffett’s comments on ETF funds — and I don’t think he’s actually called out ETF funds so much as he’s called that index funds — as being a default investment for most of the population is in the context of him saying that most fund managers don’t beat the market, most active fund managers don’t beat the market. And also, in the context of him saying “if you don’t do it yourself, and you’re not good at it, then buy an index fund” rather than give your money to, you know, the typical Wall Street 2&20 funders he calls them — so, the fees are 2% per admin and 20% of performance. And that’s pretty sound advice, and we spoke about in the past that most actively managed funds don’t beat the index, so why would you invest in them? And a lot of Buffett’s comments around this came about because of academia going back to the 80s, I think, from memory. Around the time when I was first getting involved in investing a guy called professor Eugene Fama came out with a thing called the “efficient market theory”, which is basically that you couldn’t get an edge in the market because all of the information was baked into the price as soon as it was known, and therefore the market was always efficient and you couldn’t get an edge, and therefore you should buy an index fund. And that was kind of the birth of index investing, I think pioneered by Charles Schwab. Buffett pointed out that he didn’t agree with Fama because he had been able to exact informational edges and invest above market returns over a number of years, and he also pointed out to a whole heap of other people who are value investors who had that similar sort of record, just not the profile of Buffett. If anyone wants to look at this, it’s a famous paper of his called “the Super investors of Graham-and-Doddsville,” which he presented as a rebuttal to Fama’s efficient market theory. Both Munger and Buffett even went as far as to tell people not to get financial higher education, because they were being taught rubbish at the at the universities. Having said all that, he did also say that most actively managed funds didn’t beat the index, and that if you weren’t prepared to do it yourself and do it well, that you should buy an index fund. So, all of that, I guess, has been distilled into the market and has come to pass. And now, sorry, I forget the name of the person who was asking the question, but they point out that index funds and ETFs in particular are now dominant. And they are very large. A couple of comments to make about that: I do hold some sensitivity towards large ETF, because just like a large managed fund — if managed funds ever grew to be as big as ETFs — they can move the market and they can move the market where you least want it to move the market, which is down. So, in times like these last little whiles, as the markets are rocky and shares get sold off, then they also have to sell off shares to to keep the index weightings actively tracking the index in their funds. Then that could tempt other people to sell off and it becomes a bit of a vicious cycle, an amplification of a market downturn. And of course, the same thing happens on the way up, and so you can get overinflated asset bubbles. From what I’ve seen, even though ETFs are very large in this market, and if you buy market cap, if the top traded entities on the share market are generally ETFs and they’re even bigger than BHP and Rio and some of the other big companies on the ASX. So, they do have an impact; if they continue to grow, there’ll be a problem. And they’ll also be a problem in what’s called price discovery. And this has probably been one of the issues raised the most when it comes to ETFs, is that if you had a market that didn’t have Warren Buffett in it or other actively managed fund managers in it, then who sets the price for BHP? If the ETFs are merely following the market and balancing their funds to reflect the market, who sets the market? The current thinking is that ETFs will never get to a stage where they’re completely taking over the market, because then there’s no one setting the price for BHP and Woolworths and the banks and all that kind of stuff. But certainly, I do agree, I think that there is an amplification or even an echo chamber that goes on which is making the market a little bit more volatile than it has been in the past.

Cameron  53:05

There you go, Julian, I hope that helps. And sorry that I was a bit slow getting to that; Julian posted that on our group chat on the website, but I only noticed that he created a new forum today. Got a late one, late question from Phil, Tony, that came in on Facebook this afternoon. “With something like ECX continually buying back shares, how do you take that into account in setting the 10% rule number one.” Do you factor in buybacks at all into rule number one?

Tony  53:37

No, not at all. And ECX is probably a good example of why I don’t. ECX, which is Eclipse, which is a share I sold yesterday but had owned for quite a while, actually, and quite liked, has been drifting sideways and downwards for the last six months or so. It’s a vehicle leasing company, so rising interest rates may not help it. But anyway, interesting case that Eclipse was taken over maybe two or three years ago from memory, and it’s now run by an ex-investment banker. He believes the best way to reward shareholders is not to pay a dividend but to do an ongoing buy back, continuously. So, Eclipse has been in buyback phase now for a while, well, since he took over so at least the last couple of years. But that’s by the by. I mean, the buyback is supporting the share price, and maybe it should be falling faster. However, the share price is still falling, and it’s gone through our three-point trend sell line as of yesterday, and if I bought it recently, it would have gone through rule one. So, I don’t take the buyback into account at all.

Cameron  54:39

And that’s sort of the same thing Buffett believes in too, right? Buying back shares, we’ve talked about that before. It reduces the number of shares on the market which means that every individual share that a shareholder owns is, in theory, worth more.

Tony  54:54

Yeah. It’s worth more and it’s also more tax effective, because eventually If your shares are going up, you’re paying capital gains tax when you sell, or no tax if you don’t sell. Whereas, if you’re getting dividends every six months, you’re paying tax on those dividends. So, it’s more tax effective for a buyback. The only caveat in Australia which is different to the US in this respect is the franking credits. So, there are benefits to some people, particularly retirees of getting franking credits, because they get a check from the government equal to the franking credits. So, they’re not getting taxed and they’re getting a refund, or they’re getting taxed at 15% maybe in Super, and they’re getting a refund. So, that negates the buyback argument. And it’s interesting that this tug of war is going on, it’ll be interesting to see what happens with Eclipse because there is certainly a large appetite in Australia for dividend payers with franking credits, as opposed to companies buying back shares. So, interesting to see how this all plays out.

Cameron  55:49

So, there’s no equivalent of franking credits in the US?

Tony  55:54

Not that I’m aware of. There was something in Canada, but I don’t believe there’s a franking credit in the US. But I’m not familiar with the US that much.

Cameron  56:04

All right. I hope that helps, Phil. Thank you, Tony. That’s it. That’s a full lid

Cameron  1:07:16

The QAV Podcast is a production of Spacecraft Publishing Proprietary Limited, authorised representative of AFS sell 520442, AFS representative number 001292718. Please don’t make any investment decisions based solely on listening to this podcast. This is presented as general advice only, not personal financial advice. We don’t know your personal financial circumstances. Please see a financial planner before making any investing decisions.