Transcript for QAV 426

Title: QAV 426 Club

Length: 2:06:06

Cameron Reily [0:04]: Welcome back to QAV, this is Episode 426; Season Four Episode 26, recorded on Tuesday, the 29th of June 2021. I just wanted to give you a little bit of a warning, particularly for club members, this is going to be a huge episode, I think this is about a two-hour-long episode. Tony and I talk about some stuff, news of the week for about an hour, we do about half an hour of Q&A and then we’ve got an interview with QAV club member, James Oliver who’s an auditor with a big four accounting firm, helping us understand what we should look for when we’re looking at audit. So, we’re looking for these qualified or modified or red flag audits, so you might want to do this in several sittings probably a lot longer than our regular episodes but we just had a lot to get through this week. So enjoy, sit back, pour yourself a negroni, and let’s get into it. TK you’re in lockdown?

Tony Kynaston [1:14]: I am yes. Again, doesn’t change my life a lot, probably the only difference this time is, it’s in our area. So I’m reticent to leave the apartment at all at the moment at least for a couple of days, see what the case numbers are like, where they’re happening but as you know, we had someone visit their local cafe on Monday of last week that was infected. So I got to experience contact tracing firsthand, which was good. I was impressed.

Cameron Reily [1:50]: You got a test?

Tony Kynaston [1:54]: I did. I got a text, they didn’t find out until Thursday that the person was infected and where they’d been. But by lunchtime Thursday, I got a text saying you visited a site go and get tested. The text originally said quarantined for two weeks, regardless of the result so, isolate for two weeks, regardless of the result. So that was all I was like, went and got tested by the time I got home, jumped in the shower, just to try and wash all the COVID off me, I got a phone call from a contact tracer and we spent probably 20 minutes on the phone going through everything. I had all my data she said are now you’re in the store from 12 to 12:03, which is outside of the person’s visit time so you’re fine, just get tested when it comes back negative, you’re fine so that was good. So that cafe that I’m talking about is at the bottom of our building so just hasn’t felt safe walking around the building so I’m just hunkering down at the moment.

Cameron Reily [2:55[: Downside of being a rich guy living in a flashy part of Sydney with lots of people in your building in a cafe downstairs.

Tony Kynaston [3:03]: Correct that is a downside.

Cameron Reily [3:05]: No cafe downstairs in my house, Tony unless it’s Chrissy on the coffee machine.

Tony Kynaston [3:12]: That’s the thing, isn’t it? We’re a vertical cruise ship, so that’s made me very wary.

Cameron Reily [3:19]: Well, in brighter news. Saw my cardiologist last week, did all the stress tests. He said you’re 100% fine, get out of here, don’t worry about it just go back to the life you’re great. You’re a superman, superhero, immortal. So, that was nice.

Tony Kynaston [3:38]: That’s great he gave you immortality. That’s fantastic.

Cameron Reily [3:41]: I thought it was generous of him. No, he said, look, no signs of blockages, heart functions, great; your cholesterol levels are where we want them to be, blood pressures where we want it to be just keeping doing what you’re doing. So, that’s exciting.

Tony Kynaston [4:02]: That’s good news, isn’t it?

Cameron Reily [4:03]: It was a very surprising piece of news. I went in there fully expecting him to go, look, you’re not going to fall over tomorrow but you got significant blockages, and we’re going to need to keep an eye on it, etcetera. And he was like, no, it’s nothing, you’re great, 100% fine.

I just wanted to thank Steve Mabb again today for giving me the prompting to go and get my test done a couple of months ago, which scared the living daylights out of me but all for the betterment I think of my next 20 30 years at least I’m taking some of this stuff way more seriously than I had previously.

Tony Kynaston [4:46]: And thanks to Steve he dropped by when he was in Sydney for the ASA meeting and shouted me dinner which was very nice. We had a good chat.

Cameron Reily [4:54]: I believe you invited him up to the sky palace.

Tony Kynaston [4:57]: We did. We have a couple of negronis before we went out and we add a few more and some nice Mexican.

Cameron Reily [5:03]: That’s good. Good guy.

Tony Kynaston [5:06]: We’re talking about ailments, that remind me of the quote, I think Jeremy Clarkson said, when you think about death more than you think about sex, it’s a sign you’re getting old.

Cameron Reily [5:16]: Well, I’m not there yet, because let me tell you, I think about sex constantly, and death only half that time.

Tony Kynaston [5:24]: Based on our conversation this morning, it’s been fairly morbid.

Cameron Reily [5:30]: Well, let’s move on to investing stuff. Coming up later on in the show, we’ve got an interview that we recorded last night with QAV club member and auditor, James Oliver.

Tony Kynaston [5:41]: James Oliver, the naked chef.

Cameron Reily [5:44]: The naked auditor, we’re calling that part of the show so thanks James; we’ll get into that a little bit later on. I also want to shout out to Cosmin and James and everyone else on the Facebook group in the last week who has been sharing their scorecards and their charts. And there’s been a huge amount of terrific discussion in the Facebook group from everybody else, looking at the scorecards and asking questions, why this? Why that? Looking at the charts and correcting them or commenting on them and that I think, is a great step in the QAV community.

We want to see everyone contributing their work, their results, and their scorecards so we can all sort of refining our processes and it’s the groupthink of the community I think, which is where we’ve always wanted to get to, and we seem to be getting there, which is great. So shout out to Cosmin and James, who I think was the first to have the colonies to put some of this stuff out there last week, so good on you guys. I know other people have done it before, have shared stuff but that’s great. Keep it up, it’s great.

Tony Kynaston [7:01]: Here, please do keep it up because apart from the fact that will make you better at what we’re doing but I’m only putting out my scorecard monthly at most, so people might need more access to scorecards in between, it’s a good way to do it.

Cameron Reily [7:21]: And as we’ve talked about before, we don’t want this to be the thing where people are waiting for you to do stuff. You’re here to teach your system not to put out scorecards for people but hopefully, from time to time, you’ll be able to compare your scorecard with what people are posting on the Facebook group and say, I’m not sure about that one, you might want to look at that a second time or something like that.

Tony Kynaston [7:51]: So, we do the download when we recorded that three-hour introduction session. Has that gone up as the latest scorecard?

Cameron Reily [8:01]: No, because we didn’t finish doing everything, we just did a download; we didn’t finish doing all the analysis. Well, I’m doing one today, which I’ll post up so people can use that to compare to the other ones that are up there and I guess ideally, we would hope that if two or three people do a scorecard each week and post the results up, they should pretty much match the top 20, should be very similar depending on how you score things for a recent three-point upturn or how you’re doing your 3PTLs and that kind of stuff, or how you filter for average daily trade but they should be the same. So if two or three people get the same result, everyone else can do their own, and if it doesn’t match that you’ve probably stuffed something up somewhere along the line.

Tony Kynaston [8:56]: Or ask questions. Go into the group and ask questions about why it doesn’t match.

Cameron Reily [9:00]: Good stuff. Speaking of results, shout out to Gary Martin aka Maestro now on a strawman. Steve Mab again, forwarded to us the other day, the weekly strawman email that the CEO there puts out and it was a list of people who had great results and the top of the list was QAV, had the QAV logo in it and we were like, well, neither of us is using straw man religiously. I should have, just been one thing I haven’t got around to this year, but I just did put my portfolio up in it yesterday as a result of seeing this but it was Gary Martin’s account Maestronow is the name of the account, 64.7 returned for one year he knocked it out of the park and was nice enough to attach QAV to it, a little bit of branding there. So thanks very much, Gary for doing that, and congratulations, well done. I hope that’s a reflection of your real portfolio in the last year and that you’ve had a good year.

Tony Kynaston [10:05]: Brilliant, that’s good. Thank you for doing that and I guess giving us a prop because we talked about putting up the dummy portfolio on a strawman, and we just haven’t done it.

Cameron Reily [10:14]: I forgot all about it. We even had the CEO on the show and Buffett has resigned from the Gates Foundation, well from the Board of it, Tony, did you see that?

Tony Kynaston [10:30]: I did. That’s classic Warren Buffett isn’t it, trying to avoid controversy? It’s a difficult situation for him, Bill and Melinda are going through a divorce and he doesn’t want to take sides.

Cameron Reily [10:45]: So, he tipped another $4 billion into it but he is stepping out of it. So that’s the end of an era, I guess, in some ways but I read that he has contributed, I think 100 billion in whatever it’s been 10 years or 15 years since he has been part of the Gates Foundation.

Tony Kynaston [11:09]: And he’s pledged to give me think it’s 95% of his fortune away too, at least 90%, so that’s a huge amount.

Cameron Reily [11:16]: He gave away 100 billion already and he’s only 90. He’s got 90 years left. Who knows what he could do?

Tony Kynaston [11:24]: He should see your cardiologist.

Cameron Reily [11:29]: I want to say his cardiologist whatever he’s doing its working. I got to eat more seed candy, I think is the problem.

Tony Kynaston [11:38]: That’s right. For all this stuff about sugar being new smoking, the guy chomps on peanut brittle all day, drinks Coke, not Diet Coke, Cherry Coke all day and he’s in perfect health at 90 years of age.

Cameron Reily [11:56]: It’s being rich. Are you scratching or something in the back there?

Tony Kynaston [12:01]: No, it’s raining

Cameron Reily [12:03]: Is that what it is? I can’t do much about that then.

Tony Kynaston [12:07]: No, it’s not hard to be locked down today

Cameron Reily [12:12]: Stock doctor pricing is going up by 50 bucks on July 1. They sent me an email yesterday just wanting to advise everybody. So if you want to save yourself 50 bucks and you haven’t got to stock doctor subscription yet, go to and you will get our discount on that? Well, it’s nearly the end of the financial year, Tony so we should talk about what our portfolio looks like. I know there’s what a day left, tomorrow is the last day of the year, and I think so?

Tony Kynaston [12:44]: Two more days.

Cameron Reily [12:45]: 30 days has September, April, June, and November

Tony Kynaston [12:47]: One more day. Sorry, today’s the 29th.

Cameron Reily [12:51]: Currently, according to Navexa, our portfolio is up 46.97% for the financial year versus the ASX 200 benchmark which is up 28.31% outperformed by 18.66%. So not a bad year, as it stands for the QAV portfolio.

Tony Kynaston [13:18]: Pretty bloody good all around it’s been an outperforming year. I don’t want to sound like Scrooge, it doesn’t often happen two years a row. So we may see some corrections in the market going forward in the next 12 months but anyway we’ll sail through those like we did during COVID, we’ll work our way through them anyway. But it’s just one of the highlights when you’re up 46 47% in a year, don’t expect it to continue at 47%.

Cameron Reily [13:53]: No, I know we did. We did an episode a long time ago where you took us through your annual results over 30 years. And some years were bonza years and other years that were terrible years and other years that were average. So it just averages out over time but there’s seems to be one or two good years, every 10 years and if you miss that, that would take a big chunk out of your average returns.

Tony Kynaston [14:21]: Correct, that’s right, time in the market. This is why you want to stay as close as you can to fully invested all the time, and don’t try and guess where the stock market’s going. And just one more thing about financial year-end, I don’t think people should watch their portfolios tomorrow too closely but oftentimes, the market does funny things in the last couple of hours of the financial year because a lot of people in the fund management industry have invested interest in particular results and they can move the deckchairs around to try and boost their bonuses in the last couple of hours and then reverse it the next day. We may see some funny moves tomorrow afternoon, but it shouldn’t affect us too much.

Cameron Reily [15:07]: Well, it’s been a good year and I hope everyone out there has had a good year and is learning a lot. And it’s been a tremendous learning journey for me this year coming out of COVID, watching that whole thing, watching the markets rebound in a way that I don’t think any of us thought they were going to go back to March, April last year. We were all thinking, this is going to be a 6 – 12 months big hole and it just bounced back with all the financial incentives that the government was producing to bail out the economy, here in the US.

Tony Kynaston [15:49]: Well, that’s right. It’s pleasing that we’ve had a great year and it’s doubly pleasing that we know, a lot of our listeners have too, but I think the highlight for me in the last year to 18 months was taking people through the COVID process just showing them how you invest in that time of uncertainty, I think that was a big learning. If we hadn’t have had that and we’d had a good year, I think people would be so Euphoric Diaby selling their grandmas and putting their money into the share market, which is not the right thing to do. But I think having seen both the highs and the lows, and now you can navigate your way through it successfully. I think that’s the learning point for the last 12 to 18 months.

Cameron Reily [16:31]: It was tremendous for me just to see how QAV as a process, and you guiding us in terms of thinking about stuff, how it played out, it was kind of boring like the sky was falling. I’m talking about from an investing perspective, it was like, well, you just do the thing that it says to do, you sell it when it hits the line, you buy it when it hits the other line and the scores good, then that’s it, it’s the same as you do any other day. It’s just trusting the process, it’ll guide you through and it did, it was great to see not that I doubted it. But I’ve been saying to Taylor recently and he’s like, watching his portfolio every day, calls me every day a good day, things are up, well it’s down, this is great, he’s into it. That’s great but after doing this, when watching it for two years with Tony, I look at my mine too but I know from experience now, just not from faith in believing you but just from experience that it just works long term, it will pens out. So don’t worry about it.

Tony Kynaston [18:02]: Turn off the noise, turn off your emotions and follow the process. I remember just after COVID last year I went on Phil Muscatello’s shares for beginners program to comment on what was happening in the market and he finished up calling the episode situation normal because it is; the markets going to go up and down by those huge swings at some time, it’s how you deal with it that’s the important thing. That’s what markets do.

Cameron Reily [18:29]: And it’s great. As I’m sure everyone has been around for a while listening to this will agree it’s a machine. I think of QAV like a machine, you just keep it running and set the dials and the knobs and switches and then just let it do what it’s got to do, anyway, a tremendous achievement. Mr. Kynaston.

Tony Kynaston [18:51]: Thank you and thank you for putting together the podcast. It’s been a great journey; we’ve been going for more than two years now. Something popped up in my Facebook feed last week; it’s been just over two years.

Cameron Reily [19:05]: No, it’s been way more than two years.

Tony Kynaston [19:08]: I think we started in March, so probably a bit more than two years.

Cameron Reily [19:10]: March! So, two years and a few months, so what else have I got on the news list here, your stock of the week?

Tony Kynaston [19:21]: I’m going to call out a company called Beacon Minerals as stock of the week, code is BCN, and all the usual disclaimers. This is by no means a recommendation for people to buy it but it’s on our scorecard with a good score. I think the QAV score for Beacon is .34 and the reason why it’s scored as well as it’s a gold miner out Coolgardie way and it’s moving from the exploration phase to the production phase. So, if you have a look at its operating cash flow, up until 12 months ago, it was negative, that’s what while they were exploring, and then the June half in 2020, it made 7 million bucks and in the December half, it made 39 million bucks of operating cash flow.

So that drives our QAV score in a big way, that improvement in operating cash flow but it’s a classic example of how companies in the mining sector can work. They go from being a sinkhole of funding to being just like a cash flywheel, just throw off cash as they start to produce. So, it’s pretty high up on our scorecard. I looked at the graph for it. So it is getting pretty close to its sell line. It’s one of those graphs, if you look at it in a macro sense, its low on the left; it’s high-ish on the right, although it’s been trending sideways for a long time. So definitely not saying someone should go out and buy it, last month was a downtrend but certainly one to watch and if it turns up and confirms positive sentiment, it might be something of interest to people.

Cameron Reily [21:19]: Sell line is pretty obvious on this one. How would you draw the buy line for this? Where would you start? And I’m thinking probably June 2017, and then through early 2018 and it’s been in the buy since then, I think.

Tony Kynaston [21:36]: So, if you just looked at the high point on the chart of September 19, it’s certainly been a buy after that but I think if we went back and iterated, but the last sell, I think, before the current sell, would have been somewhere about June 17 probably or even a bit before that, so you’re right, I think maybe April 17. But it would have been buying and selling all the way along there, I think. So one of the things I tend to do is look at the current sell line, and then moves the ruler up through the past troughs. So the current sell line, this is another flat bottom one, so the low point is flat, there are three months at the end of 2016, where the price was 27 cents and didn’t move.

So I’m taking the December 16 point, the last of those three points as my first low and then let’s have a look at April 2019, eventually, it would have cycled through finding that as a second low point and that gives us our current sell line, which is just going to be below where the current price is now but that whole way along, it did a big uptick after December 16 so the whole way along from probably April 17 it was going through a whole series of buys and lows, buys and sells sorry. So that’s why I’m going to go forward, I think possibly August 18 would have been the last time it was a buy without hitting a sell, but definitely by the high point there September 19, and then the second point to the right would have been December 19, high point September 19, second high point December 19 and draw a buy line through there.

Cameron Reily [23:44]: Well, on my download I did this morning, I haven’t done the manual data for that yet but I can give it a positive here for sentiment check, that just pumped it up. I had a score of .19 without the manual data done.

Tony Kynaston [24:07]: This one has in my download has a quality score of 104% so it’s not only got good operating cash flow but it’s scoring well on the other metrics, too. So let me just have a look at the manual into data I have for it, it’s a record low 6 PEs, which is giving it a two. It’s not a new three-point uptrend, and it doesn’t have consistently increasing equity, so that’s how I’ve scored the manual entered data.

Cameron Reily [24:37]: Well, if I do that, it gets it up to .33 for me, which is pretty good.

Tony Kynaston [24:44]: I have .34 and my download would have been last week, so the share price might be out of date a bit too.

Cameron Reily [24:52]: You’ve checked it for a qualified audit.

Tony Kynaston [24:55]: I have.

Cameron Reily [24:57]: Okay so that’s a big jump .19 to .33. I often stopped doing my manual data’s when I have a list of 20 above that but looking at what I’ve done today, I’ve got a lot of no’s in sentiment today, taking out a whole bunch of the ones that have a native high QAV score, a lot of them are failing on sentiment.

Tony Kynaston [25:27]: Is that your sentiment checks, or is that the SDMAX and six months and five year price.

Cameron Reily [25:37]: That’s mine. I’ve just been going through and rechecking the top 20 or 30 on my list. Okay. Beacon. Now let’s talk about Dylan, and flat tops and peaks, and troughs.

Tony Kynaston [25:53]: So he’s done some analysis for me, if we were looking at a flat top or looking at a flat bottom, what’s our tolerance for flat in terms of the share price? So that last one we spoke about, there were three points at the bottom, which were all 27 cents, but in some cases, we’re seeing cases where the first point might be 27, a second might be 27 and a half, and a third 28. So it’s when do we stop saying it’s a flat bottom or a flat top? We’re doing this analysis. So he’s run some back testing for me and originally, it came through and said that he thought a 4% tolerance gave the best result? I think it does but he then came back and said, if you go out to 8%, it doesn’t make a whole lot of difference, it’s slightly worse but it’s probably within the margin of error for his analysis. So I think I’ll be using 8% going forward as the difference between the prices in that flat bottom or flat top before we say it’s not a flat top or a flat bottom.

Cameron Reily [26:59]: And without wanting to be a dick about it, two weeks ago you told me they had to be close together. Last week, you said you never said that but then I went and checked the footage and in fact, you did say that, your current thoughts now?

Tony Kynaston [27:18]: You were assuming when I said close together, I meant temporally. I may have meant price-wise. Don’t want to be a dick about it. Check the tape on that one.

Cameron Reily [27:37]: I’m going to go check the tape on that one. Let me, hold on.

Tony Kynaston [27:44]: We’ll do a slow-motion replay.

Cameron Reily [27:49]: I posted it on Facebook and you just said fake news. It’s the greatest get out of jail line ever, right?

Tony Kynaston [28:06]: Worked for the President.

Cameron Reily [28:08]: Well did it though? I’m not sure, did it? In the long run. Rudy Giuliani is not allowed to practice law in the state of New York anymore. What a fall for Rudy, my old mate Rudy.

Tony Kynaston [28:18]: Yes, it is, isn’t it?

Cameron Reily [28:21]: Here we go; here are your literal words. So I’m coming over to the point of view that we should use the right most peak, when there’s a couple which are near the high point and they’re close together, they’re almost a flat line. In some cases, they are a flat line, etc., and they’re close together. So you meant price, not temporally, as you say.

Tony Kynaston [28:43]: Correct. That’s my story your honor and I’m sticking to it.

Cameron Reily [28:49]: So it doesn’t matter how close they are temporally. They could be a year apart is what you’re saying and it’s just that the prices are close together. Under 8%.

Tony Kynaston [29:0]1: We looked at Gascoyne Resources recently in the last couple of weeks, and it had a whole flat bottom that went on for six or eight months from memory but it was at the same price. So we take the right most part of that.

Cameron Reily [29:20]: I know that we’re working on some new wording, around 3PTL’s, based on your work with Dylan.

Tony Kynaston [29:30]: Dylan’s just finished his exams, and he’s on holidays now. So we’re catching up after this to go through and prioritize his work and check what he’s done but he just sent me some stuff through three-point trend lines this morning, so we’ll go through that. But I’m hoping that while he’s on holidays, we’ll cut through a fair bit of the workload.

Cameron Reily [29:52]: So I just wanted to let people know that we are working on some new wording that’s going to come out of all of this which will go on the Bible and so, at some point we will formalize all of this into some wording for people to help guide them through.

Tony Kynaston [30:13]: As I said, last week or the week before, we’re getting pretty close to having an algorithm that works, but it doesn’t work in every case, it works in the vast majority of cases, so we’re trying to tweak it so it works in every case. But potentially, we won’t get there; we may not be able to solve every case. So the algorithm we can set it out in the Bible but will still require some manual checks before you rely on it. But anyway, hopefully, we’ll get to the stage where it’s 100% universal, but we’ll see.

Cameron Reily [30:49]: Listener Rowan sent us an email during the week, talking about qualified audit reports suggesting the term modified audit report. Somebody else said the flagged audit, red flag audit report; have your thoughts on this changed after our chat with Jamie Oliver?

Tony Kynaston [31:09]: I think he gave us three to look for; modified opinions, qualified opinions, and emphasis of matter. So I’m thinking if we just generally say something like a modified audit report that might be enough.

Cameron Reily [31:27]: I’m still going with the red flag.

Tony Kynaston [31:30]: You don’t like to give up  your position, do you?

Cameron Reily [31:35]: I’m happy; it’s my job here to think like a normal person not like a nerd.

Tony Kynaston [31:47]: Yes, History boy.

Cameron Reily [31:52]:  Anyway

Tony Kynaston [31:54]: Anyway, yes.

Cameron Reily [32:02]: Thanks, Rowan for that. Anyway, that’s a good, modified, red flag. I’ll set up a poll people can tell us what they think.

Tony Kynaston [32:08]: That’s a good idea and listen to James’s podcast before you vote because he had a lot to say about it.

Cameron Reily [32:16]: The interview that will be coming up after we do the news, I’ll stick that in there. Glenn had some feedback about your recent comments on technical analysis; I think it was in last week’s episode. He said the performance of investors using strategies other than the value approach. Tony’s comment in last week’s podcast about investors using technical analysis versus Buffett has prompted me to respond technical analysis is often viewed as a specific method that usually is predictive. Whereas for most, it’s another way of describing quantitative and rules-based investment strategies Jim Simons has returned above-average 50%. Isn’t he the quant guy, Jim Simons?

Tony Kynaston [32:57]: I don’t know. I think he might be the guy who set up the company which funded Trump isn’t he?

Cameron Reily [33:03]: No, that wasn’t him, no.

Tony Kynaston [33:08]: He might have set up the fund, which then one of the partners went off and funded Trump?

Cameron Reily 33:14: That was the Mercers, I think that funded Trump but I don’t know if Jim Simons involved with the Mercers.

Tony Kynaston [33:24]: So the guy I’m thinking of that quant fund was exceptional but they were doing a lot of detailed work on not just technical analysis, far from what they were doing, stuff like looking at weather patterns in Florida and all sorts of different data analysis to try and find an edge with every investment which worked out for them.

Cameron Reily [33:49]: I think Renaissance Technologies and its Medallion Fund is Jim Simons.

Tony Kynaston [33:56]: One of his partners was Mercer, I think. I read their book a couple of years ago just after we started doing the podcast.

Cameron Reily [34:04]: I remember you telling me about it. So getting back to Glenn’s comments, Jim Simons has returned over an average of 50% per annum over 30 years in his billion-dollar Medallion Fund using a non-Buffett approach. Jack Schwager in his market wizard’s book details the long-term public records of many investors using both value and non-value approaches. These books are educational and are seen as Bibles to many.

Tony’s wonderful success and his three pillars of analysis can be described as a quantitative QAV score in brackets rules-based approach using fundamentals e.g. priced operating cash flow, and price three BTL. It’s Tony’s use of price sentiment that first attracted me to QAV. The study of price sentiment is often called technical analysis and the concentration on the 3PTL in our discussions is a great example of TA, which doesn’t mean T and A. With a more T and A, I think, in QAV, but I think its technical analysis. So what do you think about Glen’s comments, Tony?

Tony Kynaston [35:11]: All very valid comments, sometimes I say things that are glib, but I wasn’t trying to say that value investors were the only people who do well on the market and the points that were just made back that up, there are plenty of people out there who’ve made lots of money from all different ways of investing. My point was that I can’t think of a successful technical analyst. So just somebody who looks at the lines on the graph and applies all the various methodologies, which we talked a little bit about last week, like the MACD and the RSI indicators, and moving averages and all this, I could go on and on, roman candles, chandeliers, triple heads, head and shoulders, there’s been a whole library of books written about how to interpret share graphs and then use that to invest. But, as I said, I can’t think of a single technical analyst who has made lots of money out of it, there’s possibly someone out there, I haven’t heard of.

People tend to be either quant based or fundamental investors or value investors or growth investors, all those kinds of things. So that’s my point and I made that point not to pick a fight with people who are technical analysts but to underline what my experience is, and I’ve read dozens, if not hundreds of books, probably dozens of books on technical analysis because, like everything else, when I was starting out, I was trying to find my way through the investing universe and none of that stuff worked for me. And it seemed like every time, a bit like with a three-point trend line sometimes, there are always exceptions. As soon as you try and apply some rules, then you’ll encounter the exceptions and you got to work your way through a decision about whether you ignore the rule or whether you apply the rule.

So my point is, learn from my experience and don’t go down the rabbit hole with technical analysis too far. And that’s why I like simple as using a simple ruler on paper or on a screen to do my technical analysis, which was a three-point trend line because it’s high level, it’s simple. Even though we have lots of questions about it, I still find it fairly simple and it doesn’t need to go into all the math and complexity of the whole history of technical analysis, which is interesting to read about, but its application, I found, hasn’t been all that useful. So that was my point. So save yourself the trouble, people.

Cameron Reily [38:02]: When you’re running down that list of all the different technical analysis approaches, it sounded like a list of ecstasy brand names at a Fortitude Valley nightclub on a Saturday night to me. You want some Roman candles? You want some MACD? I just watched Wolf of Wall Street again the other day. Hadn’t seen it since it first hit the cinemas and liked it a lot more this time around.

Tony Kynaston [38:32]: Funny, isn’t it? It’s very clever.

Cameron Reily [38:34]: It is. But it just reminded me of that scene where DiCaprio is talking about the drugs that he has to take to wake himself up in the morning and then the drugs he has to take to bring him down off of the drugs that he took to get himself up in the morning and has this strict regimen of balancing get all of his drugs so we can function during the day?

Tony Kynaston [38:56]: Did I tell you that I got called by the Boiler Room guy from the States once?

Cameron Reily [39:01]: No.

Tony Kynaston [39:02]: 20 years ago, when I was running Myer Direct, I’m sitting in my office and the phone rings. And it’s this guy from the States and now I’ve seen Wolf of Wall Street, he did that classic “Do you like to make money? Wouldn’t you like to make money? I can make money for you? Have you seen this stock? It’s guaranteed to go up by 100%, you’d be foolish not to, how much can I buy for you?” And I just sat there let the guy go through his whole spiel and said thanks but no thanks. But it’s an interesting experience; they have a very slick salesman.

Cameron Reily [39:32]: Fascinating, alright, just finishing up for the news stuff. I was doing my scorecard as I said before we started our call this morning I got stuck on the chart for MIL. Would you mind walking through the MIL chart with me and telling me what you think? This is Millennium Services group, in light of our new flat-bottom rules.

Tony Kynaston 40:11: So the low point is April 19. And then you’ve got June and July are both pretty close to that and so is September. So if I have a look at those points, the low point is 16 cents on April 19 and then we go to the right and it gets out to 17.5 so we apply that 8% rule I’m just going to pull out a calculator.

Cameron Reily [40:45]: Do I need to buy a calculator?

Tony Kynaston [40:47]: No, you can use Excel or whatever. So I’ll just double-check that 16 cents times 8% is 17.28. So I’m going to suggest the 8% is that point on the July 19 part of the flat bottom?

Cameron Reily [41:11]: So this graph has a fairly flat bottom, isn’t it?

Tony Kynaston [41:15]: For the sell line?

Cameron Reily [41:17]: Yes.

Tony Kynaston [41:20]: If we did use 17.5, what difference is that? So 17.5 minus 16.15 that’s 9%. So it’s tricky, isn’t it? Having just said we’re going to use 8%, of course, I am tempted to use a September number which is 9% above, and that gives us a sell line, which is probably a bit more useful but either way the share price is way above both of those anyway.

Cameron Reily [41:52]: So what about the byline for this?

Tony Kynaston [41:55]: So we have a look at the byline. So high point looks like its March 17 $1.68 and then to the right, $1.675, so we probably use that point next. So $1.68 is March 17.

Cameron Reily [42:16]: The one right next to it is a $1.675

Tony Kynaston [42:18]: Correct.

Cameron Reily [42:18]: April 17.

Tony Kynaston [42:21]: And then there’s a bit of another one there in June of $1.645, and then one in October the $1.615. So the first one is $1.68, so let’s just see what percent is on there. Sorry, $1.68 time’s point eight is 13.44. So a $1.68 minus 11 that’s not right. I’ve done something wrong there.

Cameron Reily [42:51]: Start programming here, ladies and gentlemen.

Tony Kynaston [42:53]: Go play with the calculator; $1.68 what percent of $.168 8% 13 cents, 1344 so $1.68 minus .1344. For $1.5456 is 8% below so we can use that, most peak on October 17 there to start drawing our byline? That’s within the 8% tolerance; the second high point would be January 18. And putting the ruler across those gives us a buy, going to say May 2020. So let’s see, going to go down through there, and then we’re doing that one through there.

Cameron Reily [43:52]: Well, that’s good. So that’s got positive sentiment.

Tony Kynaston [43:59]: Thanks. I haven’t checked out this company before. What are my new services do?

Cameron Reily [44:04]: I don’t know

Tony Kynaston [44:07]: Security services specialist.

Cameron Reily [44:11]: I haven’t finished all the manual data but they’ve now got a 1.03 QAV score. Is that a new three-point turn? Let’s see, the last period analyzed was December 2020. Got a new uptick? We do it since the cross of the buy line, right?

Tony Kynaston [44:40]: So I’m saying the Buy was about May 2020 and the last results were released in February 2020.

Cameron Reily [44:52]: February 2020?

Tony Kynaston [44:54]: February 2021, sorry.

Cameron Reily [44:56]: I’ve got last period analyzed December 20.

Tony Kynaston [45:01]: So they were released in February 21.

Cameron Reily [45:05]: I see what you mean and it started to an uptick in November 20, 2020.

Tony Kynaston [45:13]: May, I think, was probably the Buy.

Cameron Reily [45:15]: The price started to pop up in September 2020 it’s when the price started to go up. So the upturn is well before the last results came out. Let me look at the rest of the stats while I’m here. P/E… June 20 107 no, P/E’s four half’s before that and then a 1225 and a 1487, December 20 – .87, current .75 So it is the lowest P/E?

Tony Kynaston [45:54]: Correct. We don’t have a full series, but it is the lowest.

Cameron Reily [45:58]: Gets a two for that. And let me look at the equity, December 20, minus 2.7 million, minus 19 million, minus 37 million, minus 36 million, minus four. Okay, so it’s not consistently increasing equity. So it gets to zero. Well, that gives me a QAV score of 1.26 which is currently considered number two on my little chart here on my scorecard. I mean, he got

Tony Kynaston [46:39]: I didn’t pick it up the last time. I just have a quick look at my last download. So it was there.

Cameron Reily [46:46]: I haven’t checked it for a qualified audit yet. The CEO resigned in May of 2021. It’s interesting.

Tony Kynaston [46:58]: I did not pick it up. Let me have a look. Mr. Darren Boyd resigned sounds like it was a little bit sudden. I can see why didn’t pick it up in the calculated sentiment line and showing it as a downtrend. So I never checked the sentiment on it, there you go. Good pick up Cam.

Cameron Reily [47:17]: Thank you, Tony. That’s why I’m here.

Tony Kynaston [47:31]: The hive mind, isn’t it?

Cameron Reily [47:33]: It is part of the hive mind, full-year results presentation, no half-year results presentation.

Tony Kynaston [47:46]: You’re looking for the red flag

Cameron Reily [47:48]: I am. Here we go half-year accounts which sound about right. Here we go. The financial statements were subject to review by the auditors and the review report is attached as part of the half-year financial report with an emphasis on the matter concerning going concerned in COVID-19.

Tony Kynaston [48:05]:  Emphasis of matter. That’s one of the text strings that James Oliver said we should look for.

Cameron Reily [48:12]: This will be coming up soon. Scrolling down to the bottom, here we go more Australia audit. The emphasis of matter related to growing concern, we draw our attention to note one growing concern in the financial statements, which identifies that the group is currently in a net asset deficiency of 2.7 billion, no 2.7 million, and its current liabilities exceed its current assets by 22.26 9 million. The preparation of the financial report is a going concern basis is based on the events and then the emphasis of matter related to COVID-19. The unique and early economic impact may have a significant bearing on the operating environment as the company’s major customers operate, but in particular, not limited to retail and commercial their opinion is not modified. So based on people who haven’t heard the chat yet, but based on our chat with James yesterday, is this a red flag or not?

Tony Kynaston [49:18]: That’s a huge red flag. It’s a qualified audit. You didn’t just continue from what you’re reading their emphasis of matter related to going concerned is the one that I think is the red flag it says after you read out but the fact that they didn’t have positive current assets, says the preparation of the financial report on a going concern basis is based on the events and conditions along with other matters as outlined in note one going concerned, the outcomes of which are uncertain narrow opinions are not modified in respect of this matter. So what they’re saying is that as you’re hearing the James Oliver interview people is that the auditor is drawing people’s attention to note one going concerned.

So the financial statement has been noted. And oftentimes, if you ever do read a financial statement, you’ll see sometimes there are 20 25 notes, where the CFO or the board or the CEO have made certain assumptions or decisions about how things are recorded, and then they note them in the financial accounts. One of the reasons why I like operating cash flow rather than profit is because you have all these interpretations that go into calculating profit. And they’re set out in the notes and the first one is saying that the company may not be able to continue operating. Just a fine note one.

Cameron Reily [50:46]: I’ve got it. The consolidated financial statements have been prepared on a going concern basis, which assumes the continuity of normal business activities and the settlement of liabilities in the normal course of business during the period ended 31 December 2020. The group’s profit after income tax expense amounted to 17.05 1 million, December 2019, loss of 823,000. And at that date, the group’s current liabilities exceeded its current assets by 22.26 9 million, the group’s net deficiency amounted to 2.7 million as of 31 December 2020. The results for the current period included 7.83 net government COVID-19, job keeper grants, and wage subsidies in Australia.

After taking into account the incremental wage top-ups paid to employees and the recognition of 4 million of deferred tax assets, not previously recognized the net cash generated from operating activities for the current period was 29.15 6 million compared to 5.7 4 million of net cash used in the previous comparative period, there were non-recurring cash outflows of 4.41 8 million in the previous comparative period. They’re related to wages to employees due to historical errors in the application of employee instruments. Well, that’s all a bunch of mumbo jumbo to me. Tony, can you turn that into English?

Tony Kynaston [52:08]: We’ll keep reading in a minute. So basically, when liabilities exceed assets, you have negative equity, which is, the basis of the balance sheet. So it’s saying that they owe more money than they have assets available. They’ve said that they’ve received $17.3 million of job keeper subsidies. So that’s great. That might be an issue if they don’t get more job keeper subsidies, but companies are still experiencing problems related to COVID. And they’re also saying they had a bit of cash payment, I had to make the employees in the past $4.4 million because they didn’t pay them properly. So there are a few things is going on there but it’s the negative equity, which is the real issue, then goes on to say in the notes continued.

The directors have had regard to the debt facilities with the ANZ bank, which were refinanced in October 2020 for a further two-year term expiring in October 2022 without taking on any new borrowings. The group has access to $22.8 million of unused financing facilities as of 31 December 2020. The group’s cash flow forecast and budget for the next 12 months show positive operating cash flows and an improvement in profitability respectively. So I continue to talk about their plans to cut costs. The considerable improvement in the group’s current operating results compared to the prior corresponding period is primarily due to the Strategic Initiatives formulated and implemented by the board and senior management team.

The group’s ability to continue as a going concern is dependent upon the items listed above should these events not occur as anticipated, the group may not be able to pursue its business objectives and will have difficulty continuing to operate as a going concern, including realizing its assets and extinguishing its liabilities at the amount shown in the financial statements. So that’s probably the important one. So in a nutshell, what they’re saying is that they’re improving their profitability, and they’re improving their operating cash flow. And I guess my question there is, I’m not sure where that job seeker money goes, if it goes into cash flow or not, that might be a job seeker monies might be recorded and operating cash flow, I’d have to dig further and see if it is but anyway, they received 17 million in Job Seeker last year and they had 22 million and sorry, they had operating cash flow. I can’t find it quickly. But anyway, it was not much more than that.

So that’s the first question I want to dig down into a look at. But anyway, what they’re saying is they think they’re going to try their way through this problem. Notwithstanding further COVID problems they’ve got access to some debt. But the last thing I think a company like this needs to do is to borrow more money, given that they already have liabilities exceeding assets. And if everything goes, right, they tried their way through. So in terms of risk mitigation, I’d be calling this a red flag, they may well try their way through, they may well come out looking like a good company. But let’s wait until some more results come out before you invest. So I’m calling it as up and the old pilots a qualified audit or new pilots, a red flag.

Cameron Reily [55:42]: And the CEO abruptly resigned in May

Tony Kynaston [55:47]: Haven’t even looked at that yet as to the reasons for that.

Cameron Reily [55:50]: Well, I’ve read the announcement, which was that he said, he did do everything he came to do which is run up more liabilities than the head assets. It’s time to go, short mission. For George W. Bush’s mission accomplished banner put it on top of the battleship.

Tony Kynaston [56:15]: Men fly [inaudible 56:16] button.

Cameron Reily [56:23]: Well, there you go. That’s interesting so good. School looked good for a minute there but then a bad red flag on that.

Tony Kynaston [56:32]: And I may hasten to add, and Jamie talked about this in an interview. It’s not necessarily saying the company’s going to go broke. It’s saying there’s a risk and there are plenty of other companies we can invest in. So why take the risk?

Cameron Reily [56:48]:  Well, we’re an hour into this. And we haven’t even gone to Jamie’s thing and done any questions yet. So, what do you think?

Tony Kynaston [56:59]: Well, I’m happy to keep going but there’ll be a big episode for people. Why not?

Cameron Reily [57:05]: I think people think they can listen to it slowly over a week [inaudible 57:09].

Tony Kynaston [57:10]: Just take a break and get yourself a cup of tea or something and then do the questions.

Cameron Reily [57:18]: Meet you back on here in five. Welcome back, all together. This is a long segment, Tony. But let’s talk about ATL I noticed yesterday, it was down I think about 16% from when we bought it.

Tony Kynaston [57:58]: Getting close to it, so alignment.

Cameron Reily [58:00]: I don’t know. Let me bring it up.

Tony Kynaston [58:03]: But while you’re doing that, we can just talk a little bit about qualified audits again or red flag audits again. So following our discussion with James last night, one of the issues we were talking about is and people will hear it is what happens if when an auditor modifies their opinion or points out a note in the financial statements about a matter of concern? And yeah, James said that it’s usually a full and frank discussion and that the directors will try and fix the problem. And he said, In a lot of cases, the problem is fixed before the annual report goes out, or the half-yearly accounts go out and so that can be old news, but he also said that the directors may well take whatever other means they can to remove the qualified audit or the red flag and one of those ways potentially is changing auditors.

And so hence the call out of Apollo tourism and leisure because back in December, it had a matter of concern raised by its auditors, a red flag, about its ability to continue as a going concern and clearly, it has continued as a going concern because it’s six months from when that was raised and that they qualified, all that went away in the current half-yearly results announcement back in February. But there’s a new set of auditors so they’re different from the ones in December. So, it’s a bit of a tricky situation. I’m going to say that was a bit of a concern for me now. Again, in terms of risk mitigation, I think we should probably take it off the QAV list and call it out as a red flag.

Again, not because we necessarily think there’s a problem with ATL and we don’t know, but just for the fact that there was one, and it’s gone away, but the auditors have changed, which could potentially be nothing probably is, but it could also be a problem. And again, it’s just highlighting another situation where this could be risky and so why take the risk? Why not invest in something else? And I think it is getting pretty close to its sell line now, isn’t it?

Cameron Reily [1:00:27]: Yes, well, I just looked at it. So, it’s got a couple of low points here, the first one is March 2020, the COVID cough, at 16 cents, then in July 2020, close to 21 and a half cents, and then October 2020, close to 23 and a half cents. I did my little spreadsheet up. So 16 cents plus 8% would be 17.2 cents. So the next lowest line is above that. So I think we do start with the COVID cough and then draw a line through that. Draw a line through the next low point. Well, if you did that, if you went through the July 2020 line, it’s on that line. But if you took the trough at March 2021 26 and half cents is Alto.

Tony Kynaston [1:01:34]:  That’s the one I would use.

Cameron Reily [1:01:36]:  Then it’s still a little bit above the sell line but it heading towards it pretty quickly.

Tony Kynaston [1:01:45]:  It looks like it going to be selling around sort of 30 31 cents and it’s currently 36 and dropping. So, I’m going to call it as a sell. Mostly for the fact that as James pointed out, that a change of auditor following material concern about going concern with what’s called a material matter. The emphasis of matter raised about going concern might be an issue. I guess I’m choosing my words wisely here because I don’t know that it is, again, why take the risk?

Cameron Reily [1:02:26]: So does this mean every time we an audit check, we have to go back and check the previous audit as well to make sure that the auditor hasn’t change.

Tony Kynaston [1:02:40]: It’s hard, isn’t it?

Cameron Reily [1:02:41]: Yes.

Tony Kynaston [1:02:49]: I guess so but having said that, we’ve got half a dozen also qualified all that’s in the spreadsheet already. I think it’s going to be more of an issue that when we see one of those improve, we should look and see whether the audit has changed or not.

Cameron Reily [1:03:06]: If you’re already flagged it, and then it comes out of it just check.

Tony Kynaston [1:03:13]: I think so. And again, probably conservative audit has changed for all sorts of reasons. But I think it’s just one more level of risk that we don’t need to take.

Cameron Reily [1:03:29]: Okay. Well, I told you, ATL, bloody ATL they never fail to fail. Alright, so we will be selling ATL out of the QAV portfolio today, then.

Tony Kynaston [1:03:53]: So, you’ve done a download have you? We need to replace it with something.

Cameron Reily [1:03:57]: Yes, I will share the 3d when I finished. I’m still halfway through doing the manual data but I’ll send a 3d when I’m done and we can pick something. Well, let’s get into some questions. This is going to be a really long episode, by the way, folks, because we got to put the Jamie Oliver in there thing so strap yourselves in. Okay, with some of these questions are getting pretty old we haven’t got to them over the weeks; apologies again to everyone. So we get to your questions in order that they come in as quickly as we can with the time that we have available.

So anyway, these are few that are getting a little bit hairy, little bit of green mold on these ones in the past the use by date, but as my mother would say, there are fine didn’t have used by dates when I was your age, you just did a sniff test. And if it seems like you just eat it and then if you get food poisoning at 3 am, you probably shouldn’t have eaten it but apart from that, we’re all fine.

Tony Kynaston [1:05:04]: And you’ve got sibling, so it doesn’t matter if one of them takes [inaudible 1:05:07].

Cameron Reily [1:05:09]: That’s why Catholics had 12 Kids. Andrew, this is Andrew one thing Andrew wanted to mention is the use of a 52 week simple moving average, as an additional buy sell indicator, have a play around with using a five year weekly three point trend line and a 52 week simple moving average, both as an indicator for buying and selling just something that works for me, he says, no doubt you’ve looked at this before?

Tony Kynaston [1:05:40]: I haven’t looked at this one in detail I didn’t have a look at it when the question came in and I think I went back to Andrew and said which one takes precedence that five year weekly 52 week, simple moving average, or three point red line? So, I think he came back and said you just sort of look at all three but I could have that wrong. I don’t want to miss attribute anything to Andrew, if it works for him that’s great. The question I have about using anything other than a five year monthly is my experience of using weekly graphs is that I was trading out of stocks too soon and they turned around.

That was my experience, I can remember very clearly owning a stock called NWH, NW Holdings], I think it was the name of the company NWH might be the code or vice versa. Consultancy or contractor to the mining industry. And it was getting close to its three point sell line and so I started playing around with weekly graphs to see if I could finance the exit point and I got out based on that and it promptly turned around and shut up. So if I had stuck with the five year monthly, I would have made a lot more money than I did using the weekly. And that’s just the general observation that whenever you’re dealing with weekly data, it’s very volatile and it can have that kind of whips or effect on your shares.

Cameron Reily [1:07:20]: Well, I’ve got Andrews reply here, when you asked which takes precedence he said sure the answer is neither takes precedence. I found in the past that if I rely on just one indicator, it can get me in or out of a stock too quickly. I.e. not letting the price go through the normal ups and downs of the market, I try to use two indicators to confirm sentiment. If either two of the three listed below happens, then that confirms sentiment for me, the buying indicators one breaking above an accumulation period usually breaking above a trading range and or to breaking above the 52 week SMA and or three breaking above the three point trend line five year weekly buy signal.

If two of the above indicators are met, then I buy at a sort of the reverse for the selling indicators.  So, two he says I assume Tony uses a five year monthly chart because it cuts out a lot of market noise and allows him a long term hold strategy. I have a similar long term outlook. I also use the monthly chart when I’m looking at a price chart; I just prefer to manage the investment using a weekly chart. As I found I can react a bit quicker to any significant movements in the price. Hope this helps and have a great day.

Tony Kynaston [1:08:35]: Thanks, Andrew; I’m glad it works for you. I’ll have a look again, using two out of three. But my experience using weekly charts was it was too volatile for me.

Cameron Reily [1:08:4: Maybe it’s something we can get Dylan to look at, at some point. Do some analysis. Thanks, Andrew. Great, here’s the hive mind again, coming up with new things to look at new things to think about, which is the point lots of really smart people thinking about how do we even improve QAV even further. Here’s one from Simon again regarding the three point train line. So I’m wondering if Tony is considered using moving average crossovers or chandelier stops using ATR what’s ATR?

Tony Kynaston [1:09:21]: I have forgotten like to Google it to get it right. It was basically a logarithmic graph.

Cameron Reily [1:09:30]: Average True Range.

Tony Kynaston [1:09:33]: It was using much candlestick graphs. So, you got not only the share price for particular day, you got the highest price, it got to the lowest point price it got to and it was feeding that into the calculation to work out The Average True Range.

Cameron Reily [1:09:55]: Sorry. The rest of Simon’s question is, or even a combination of say one ATR below 150 day moving average. Obviously, the trick is to find the right balance of not getting stopped out too early and watching a bounce after the stop is triggered versus giving back a lot of winnings.

Tony Kynaston [1:10:15] I’ve never used ATR, I think some of these are available if you go into the study’s drop down box, if you’re using the stock doctor graph, the advanced graph, so you can overlay these kinds of trend lines and make your own decision. I haven’t used it so I can’t really comment on it. We can do some back testing on it, I guess. Okay, as I said, I’ve used moving averages in the past, and they have a reasonable correlation with the three point trend line. But they don’t correlate completely and they do have issues. Sometimes they work better, and a lot of times they work worse. But looking at it Simon’s comfortable with that, please use it go ahead.

Cameron Reily [1:11:10]: Duncan had a question about VUK being close to sell line, but I think we’ve already concluded that he was probably right, we’ve already got out of VUK and then we got back into VUK.

Tony Kynaston [1:11:28]:  I had an interesting week last week, after I declared I was going to sell my ANZ and VUK and then I waited for a day or two to get that message out before I did. I lost money selling ANZ two days later, but I managed to hold on to VUK, so it was swings and roundabouts.

Cameron Reily [1:11:47]: You’re like Jerry Seinfeld, Even Stevens. So, Duncan, that was. Thanks, Duncan. Sorry, might have been a little bit late getting to that but sounds like you were on the right track there. This is from James. Here’s something I’m struggling to get my head around I’m here to keep Tony’s thoughts on a please. If 60% of the stocks one holds is to deliver an annual return of 20% of the total portfolio. Each stock that delivers must increase on average by 33% per year, or 33.3% CAGR. That’s quite a sobering thought. So with that in mind, I struggled to understand why Berkshire Hathaway still holds KO, Coca-Cola.

Tony Kynaston [1:12:38]: I’m sorry; I bumped the microphone reaching for my pen. Just making a long question I’m making some notes on it.

Cameron Reily [1:12:45]: I thought you’d fallen over and…

Tony Kynaston [1:12:48]: Well, let me talk it through then just there’s two parts of this question. The first one is about 60% of the stocks delivering all the returns, which is true. I’m not sure about the math of 33% CAGR for those because the 40% underperform, and straight losses, we might only lose, we might break even we might lose one or 2% on them. So, well, we actually might get out without losing money. So, I’m not sure about the math on that. Certainly the 60% that we hold, delivers our returns has to be greater than 20% because the overall portfolio goes up by 20% but it may not be 33% for each of those 60% of stocks.

Cameron Reily [1:13:38]: Okay. So, the second part of his question is, I struggle to understand why Berkshire Hathaway still holds KO, Coca-Cola, which has a 10 year CAGR of only 5.5%. And I’d love to hear Tony’s thoughts of it, please. I understand they get more in dividends now than they paid back in the day, but they’re only 2.15%. What about putting the 21 billion they have in kayo and 5.5% per year into something that’ll give them 15% a year? Does Warren share with you these thoughts on why is Coca-Cola?

Tony Kynaston [1:14:13]: Doesn’t even share with me who his cardiologist is. No it’s a good question and I think that should be put to the Berkshire Hathaway AGM. I haven’t heard this question asked before and I think it’s very good. I suspect that there are a couple of things at play here. Buffet may well think coke will improve that’s a possibility; he may also think that he would have trouble selling a big steak like that. So, you would have to do it slowly and not depress the price so that could also be an issue. But I think James’s analysis is spot on, if it’s not going to improve if you can Hanging out of the stock over time without the pressing the price, then what was a good idea 40 years ago is probably not a good idea these days, and you could probably put the money somewhere else and use it better.

So I agree with James. And I just read that the Zell book, biography, Am I Being Too Subtle? And he said in there something like every day, if you’re holding an investment, you should consider whether you’d be buying that investment because holding it as like buying it. So that’s the question is Coca buy at the moment and if it’s not why you’re holding it? So, I think it’s a very good question and I can’t defend Warren on that one.

Cameron Reily [1:15:46]: Well, I just read a little bit of history on this. So he bought a billion dollars in Coca-Cola shares in 1988, just after the crash of 87, which then was equivalent to 6.2% of the company. As of March 2021, he held 9.2% worth more than $22 billion so, done okay.

Tony Kynaston [1:16:20]: Correct. I don’t know what the numbers are on trusting James’s analysis is correct at 5.5% per year. [Cross-talking 1:16:27]. Okay, Buffett would say it’s a great company with a big moat, and you can’t compete with Coke around the world. And it’s expanding into third world countries at a good rate and all those kinds of things. So, it’s a good place to be invested but it’s not returning the types of returns we want ourselves.

Cameron Reily [1:16:51]: But they give him free Coke. So, you need to take that into your analysis, I guess.

Tony Kynaston [1:17:00]: It’s good point, James raises, because I remember reading it, I think it’s in the Warren Buffett workbook or something like that. And the author goes through an analysis of why he thinks Buffett bought Coke, and not just because it was after the crash of 87. So the price would have been low, but Buffett thought they were over providing for depreciation. And that would be able to write that back to profit and use that for other things, which they eventually did. So, he did some detailed balance sheet analysis, which was behind his investment thesis but that was 40 years ago. So, and that would have played out maybe over the first five or 10 years, not the remaining 30. So, I think James is spot on.

Cameron Reily [1:17:44]: Well, we should get him on the show. Warren that is not James, get Warren on the show and ask.

Tony Kynaston [1:17:50]: I’m assuming that’s a different James, with one we had on last night.

Cameron Reily [1:17:53]:  I don’t, I don’t write their names down here but we have lots of James’s so possibly. Good analysis, James. Daniel says, I’m looking to add positions in my portfolio, one of which is [DSK], which is [DSK] I think from memory taking a further deep dive into its massive selling down of stock from directors that’s on market trades, the market trades, do we simply ignore this? Or is this classed as a warning sign and we skip to the next stock?

Tony Kynaston [1:18:27]: Good question. I don’t know the details of [DSK] when it comes to people selling down. I’ll leave an analysis of it to answer the question as much as I can. And [DSK] is a recent addition to the ASX, so I went through an IPO and I think that’s nine months ago. And I think sale the sale or the sell down of some of the founders was part of that IPO. And it’s also possible that they had an escrow provision. I don’t know what the case is here but oftentimes, founders and management will be told at the IPO, they can sell some down, but they have to remain invested to a certain position for a certain period of time, six months, nine months, 12 months or whatever it is. And then they can sell some more.

So it’s possible that they had always planned to sell down this time as part of the IPO I’m not sure. I think it is suspicious that these people are selling down but I did notice that they still have a large shareholding in the company and that was the other point I need to make as it sometimes again, deals are done with the institutional investors that the founders will sell the ANOVA time to improve liquidity in the stock. So a lot of times, institutional investors can’t invest in a company if the founders still hold a large percentage because there’s not enough free float. And they asked the founders to sell down so they can buy into it, just like we’ve been talking about, it makes it easier to buy in or sell it out of a company if it’s got freer float.

And so institutions don’t want to be trapped in a company which has, if the founders still held 30 or 40%, and they then hold 10 or 20% themselves, it can become a very crowded exit, if it comes time to sell. So that could be an issue here I don’t know the case with doeskin but they’re generally around IPOs these things are an issue. I’d be more afraid of investing in [DSK], if I’d seen that the founders sold out completely into the IPO and they didn’t. So, the management still retains a reasonable shareholding so I’m not as concerned at this stage. But Daniel should do some more analysis and try and work out why they’re selling down. Is it just to get free float up? Was it part of the IPO deal? Did they have some escrowing and exercising and all those kinds of things are in play?

Cameron Reily [1:21:06]: That’s the sort of stuff you would think about before you invested in something like this?

Tony Kynaston [1:21:10]: Yes, I think Daniel spot on. You saw some selling down have a look at the reasons behind it. Which I haven’t dug down into at this stage, but it will be out there and some of the initial IPO documents I would have thought.

Cameron Reily [1:21:26]: Just interestingly, it was your stock of the week back in April at one point.

Tony Kynaston [1:21:36]: We did talk about it because it was a new float. I think from memory is getting close to it sell line anyway, isn’t it?

Cameron Reily [1:21:46]: Man, it’s an interesting one. It’s a very sheer, straight up sort of chart floating floated in November. I don’t even know how to draw a sell line on this. Where would you start in January 21 and draw it through March 21?

Tony Kynaston [1:22:12]: Yes, difficult one, I’d probably start with the float so November 2020, and then use January 21 after that which puts you pretty close to the current price. A little bit below it are 361 now it’s probably going to be around 350 or so. [Cross-talking 1:22:34] the byline is a hard one, isn’t it? You’ve only got two points, the highest point and the one to the right. And that’s been the case all the way along.

Cameron Reily [1:22:54]: So, it’s probably been a buy for six months. Would you say, hasn’t breached a sell line?

Tony Kynaston [1:23:03]: Yes, I would say it’s been a buy since uploaded, probably. This is a good example of why the three point trend line analysis. If you try and make it an algorithm, it doesn’t take this into account, but he doesn’t.

Cameron Reily [1:23:20]: It’s tricky.

Tony Kynaston [1:23:24]: And maybe that’s like some of the people have suggested maybe better off going back to a two year graph. If you look at the two year graph in stock doctor, it’s much easier to form an opinion, isn’t it?

Cameron Reily [1:23:36]: How?

Tony Kynaston [1:23:38]: Well, the sell line I think it’s going to be formed by those first three troughs. Let me get some dates here, November 2020, through to December 2020. So, you’re getting your sell line much lower than where the current price is now.

Cameron Reily [1:23:58]: December 2020, or January 21. We’re still talking about [dusk]?

Tony Kynaston [1:24:05]: Yes. I’m just going back to the front page of stock doctor.

Cameron Reily [1:24:12]: Okay. I see. Sorry, you’re not using a five year chart here, but you’re using a two year chart on the front page.

Tony Kynaston [1:24:20]: Stock doctor using a two year chart.

Cameron Reily [1:24:22]:  Mine isn’t I have it set up differently on the front page. Okay. So a two year, what is this weekly?

Tony Kynaston [1:24:31]: Yes.

Cameron Reily [1:24:34]: No, it’s daily.

Tony Kynaston [1:24:37]: Okay, let’s just go [cross-talking 1:24:38]; let me click on whatever I got set up here so I can get this right. I’ve got a weekly graph and I’ve got it set as five years but it’s only given us weekly from the float. And so the three low points after the float were 13th of November 2020, 4th of December 2020 and 25th of December 2020. And they’re sitting at a sell line at around $2.50. And, again, it’s kind of being pretty hard to find a buy, but it’s been sort of buys all the way along, hasn’t it? Because if you took, for example, the sort of first peak, where it fell away in 22nd of the 01st 21, it then falls away and then goes higher.

So again, we’re not getting three points, we’re getting two. If you go up to March 2021, 5th of March, you’ve got three points there, which would have been a buy. But I think its common sense here it’s likely the graph is going up. The only concern I’ve got is, if you look at the monthly graph in the last month, it’s gone down but this month, it’s turning up.

Cameron Reily [1:26:15]: Which is a good thing, right?

Tony Kynaston [1:26:17]: It is a good thing yes. [Cross-talking 1:26:19] good to raise I think, good question.

Cameron Reily [1:26:25]: Doesn’t have a very high score in terms of my raw scores but if I give it a positive sentiment, let’s see, pumps it up to .19, new three points up turn. Well, no, really? It’s been going up all the way. Let’s have a look at the PE’s record low. PE’s what? Only one PE what’s the new rule, if it’s only one PE?

Tony Kynaston [1:27:05]: Good question.

Cameron Reily [1:27:10]: Let me bring up the Bible because you just did some [cross-talking 1:27:14] on that.

Tony Kynaston [1:27:16]: I have it scores as a blank but we should check the Bible on that one.

Cameron Reily [1:27:22]: The current wording in the Bible says where the QRP ratio is the first and only P ratio in the last six hours then leaves the score is blank.

Tony Kynaston [1:27:33]: That’s what I had in mind anyway, but that’s make sense.

Cameron Reily [1:27:37]: Okay, and let me look at increasing equity. Well, there’s only one equity; we had a new rule on this too.

Tony Kynaston [1:27:48]: Well, I called a blank two, so I applied the same rule as [inaudible 1:27:52].

Cameron Reily [1:27:55]: Net equity one entry leaves the score as a blank. Okay. So, that gives me a score for dusk at point one, nine, which is not bad, but not great. I haven’t checked it for an audit though. A little bit worried if they’ve only been around for a few years I’ve got a flag.

Tony Kynaston [1:28:20]: I checked it back in April and there’s no material concerned, no red flag.

Cameron Reily [1:28:26]: So point one, nine not too bad. They’re probably making on my top 20 after I filter everything out at the end of the day.

Tony Kynaston [1:28:33]: I’m getting a high score, but I just check if I got the right price so hang on. What’s the current share price Cam?

Cameron Reily [1:28:43]: It is $3.62.

Tony Kynaston [1:28:49]: So, I’m getting a score of point two, six.

Cameron Reily [1:28:57]: Cameron in the editing booth here. So, to cut a long story short, Tony and I compared our scoring on this, and I found that there were a couple of problems on my end. Number one, I wasn’t using the latest version of the flipping sheet. I was still using 1.7 point four because I’m lazy and I hadn’t done the changes to get to 1.7 point five which fixed these errors with the PE history and the consistently increasing equity that we picked up a couple of weeks ago and Tony had fixed his version of the sheet Andrew fixed the AF version. I also through the process of this though, realize there’s another change that Tony had made on his version in late May, regarding future IV, getting a blank, which is in the master version, but I blogged about it, but I forgot to send Andrew an email.

So, he hadn’t made the change in 1.7 point five either, so I’ve let him know today and there will probably be a 1.7 point six in the next day or so it shouldn’t be a big change with the scoring with these things. I think with Tony’s master spreadsheet; he said it did make a big difference. But if there’s no future APS, then the column that asks if the future IV is greater than twice the share price it should get a blank if there’s no future APS, basically. So, it’ll make a slight scoring difference in the scenarios where there’s no future APS but not a huge difference. Thank you, Daniel for dusk and I know you had another question, but I think we’re going to have to draw a line under this one. Tony, we’re an hour and a half into this. Then we got to add James, it’s going to be already a two hour show.

Tony Kynaston [1:30:48]: I only got one more question to go, though, from Daniel. You want just finish it quickly.

Cameron Reily [1:30:54]: The Daniel one. Okay, sure?

Tony Kynaston [1:30:57]: Yes. And then we’ve caught up, I think.

Cameron Reily [1:31:01]: Well, no, I’ve got 1 2 3 more questions

Tony Kynaston [1:31:07]: Have you, did they come in today?

Cameron Reily [1:31:10]: No, yesterday, probably. Okay, anyway, that’s alright, we can get to them next week.

Tony Kynaston [1:31:18]: [Cross-talking 1:31:17], next week, if you’re like, that’s fine.

Cameron Reily [1:31:20]: No, we’ll just finish Daniel. Part two of Daniel’s question, he says, with some commodity graphs trending down as with most of QAV listeners holding commodity stocks, we’d love to know, Tony’s thoughts on the whole commodity cycle. The last thing we want to be doing is trading too much, but if they carry on trending down, do we want to start thinking about some of our positions in these resource stocks? Well we’ve talked a bit about this over the last month, haven’t we?

Tony Kynaston [1:31:46]: Yes. So first of all, if they cross their three point sell lines, like these commodity graphs, then sure, we should be selling the underlying stocks. But I checked the commodity graphs using both stock doctor and index Monday, and they are all doing okay. So, gold, iron ore, copper, oil, and nickel are all in long term, upward trend. So, if there are some sort of short term downward trends, they’re not that concerning. I know, gold’s pullback from 2000 an ounce to 1700 and while iron ore and oil store on the way up, so, I’m not sure about the commodity graphs trending down.

But the general point is that when the commodity graph reaches that three point sell line, we should be out of those underlying stocks that mine or refine or sell those commodities. But I think we’re a long way from that with the commodity graphs, there’ll be other issues, and it’s potentially the case that iron ore might retreat. And it still might be positive sentiment territory, but a share, like for the scheme metals; it’s a sell line before the commodity does. So, we have to watch both the miner in the commodity and those kinds of examples. But I think things are looking good on the commodity front at the moment.

Cameron Reily [1:33:17]: But we are thinking or you are thinking about what to do when they turn down.

Tony Kynaston [1:33:24]: Yes, well, I think one of the things that came out of those thoughts was the flat bottom graph, rather than having a flat sell line for some of these mining stocks, which they often do, is to take the right lowest trough and use that as now one to draw a line. And that that gets us out of Fortescue from memory at $17.50 or something like that current as opposed to if you do the flat line, which is back at 11 bucks or something.

Cameron Reily [1:33:59]: Okay. Cool. Well, thank you, Tony. Thank you, everybody for your questions. We will be throwing in a second to the interview with the naked auditor give you the nitty-gritty on how to read an auditor’s statement. Thank you to James for taking time out of his day to talk us through that we appreciate it. Again, it’s part of the brain trust, the QAV brains trust, it’s great, and it’s exciting, lots of smart people who bring a lot to the table.

Tony Kynaston [1:34:31]: It is, I enjoyed that interview with James just to learn more about that whole process and what to look for it was good, and I’m sure there’ll be other brains, we can pick one of the things in the future too, which is great.

Cameron Reily [1:34:44]: Okay, so that’s the regular part of the show coming up now, James Oliver. We’d like to welcome to the show, QAV club member and professional auditor works for a big accounting firm who will remain anonymous because he’s appearing today, partly under witness protection and partly as a private individual. James Oliver, welcome to the show, James.

James Oliver [1:35:17]: Thanks, Cameron. Thanks, Tony.

Tony Kynaston [1:35:19]: Thanks for coming on.

Cameron Reily [1:35:20]: This is not his real voice, we’ve had to modify his voice and pixilated his image. Tell us a little bit about yourself, James?

James Oliver [1:35:30]: Well, I’m from the UK originally, I studied Economics at UNI and whilst I loved economics, I didn’t know or put any thought into how to make a career of it. And so, almost by default, and I think, quite a few people end up doing this is, I applied to one of the big four firms and with a promise of getting a further qualification, in this case, the Chartered Accountancy qualification under my belt, and so I did that it took me three years and spent an extra year in London and then came over to Sydney, where I discovered the world of Superannuation Funds Management actually in an audit capacity and sort of delved into that industry and loved it, and saw how the Australian compulsory super system has generated quite an industry behind it. I spent 10 years in Sydney, and then I’m now in Melbourne, and I’ve been here eight years now. And still auditing and I actually do a few other things as well more sort of Regulatory and Risk Management related, but certainly I do financial audits still.

Tony Kynaston [1:36:49]: Fantastic.

Cameron Reily [1:36:50]: And how did you end up listening to QAV James, tell us that story quickly.

James Oliver [1:36:54]: Well, just during Melbourne’s big lockdown last year looking for  podcasts to listen to during my one hour of exercise, and you must have done some good advertising Cam, because it just popped up in my feed. And I really quite enjoyed it. So, it’s been a great source of information, fun and laughter at the same time. So it’s been really enjoyable.

Tony Kynaston [1:37:28]: That’s good. How’s your share portfolio going?

James Oliver [1:37:31]: Well, it’s 28th of June, Tony. I’ve made a few capital gains this year, and I’m just looking to see what I should be offsetting them with so it’s been a good year and prior to QAV, pretty shocking to be honest. I had some healthy tax losses too, but we’re getting bigger every year, every silly idea I just jumped into. So, it’s good to have a bit more structure around it.

Tony Kynaston [1:38:06]: Good, well done. Well, we’re here to talk about audits. So, a lot of questions, we get are around qualified audits, maybe you could tell us what that term means and what it means to you?

James Oliver [1:38:21]: And look, it’s not easy, I can understand why a lot of people will get very confused reading any collection of audit reports, particularly of the companies they own and what to worry about or what not to. So, if I can apply how an auditor talks and thinks about these reports and they’re governed by auditing standards, the terminology and the format and how the auditor needs to treat certain things. So, first of all, we start with the term ‘modified opinions’. So, an unmodified opinion is what you might describe as a clean opinion, everything else is effectively a modified opinion. And one of those modified opinions is actually a ‘qualified opinion’.

And that qualified opinion is where the auditor has discovered something, or been told about something, that is material to the users of the report, but it’s not so pervasive to the whole financial report that they’re basically casting a black mark on the whole set of accounts, it’s just something specific, and the wording you look for there is “except for”, so, it’ll say “except for”, let’s say, “the company’s treatment of leases under the accounting standard”. Effectively, everything else, we’re saying, is fine, except for this thing, and when we refer to a qualified opinion, that’s the instance we’re referring to. The next modified opinion, I’m happy to put some notes down, and you can put it on the site, if you want.

Tony Kynaston [1:40:20]: I’m just furiously taking notes myself.

James Oliver [1:40:23]: The next one is the ‘adverse opinion’, that is when something has been discovered that really is pervasive to the whole set of accounts. And it casts that on the all the books and records. And so that’s when the auditor says, no, the financial report does not fairly represent the Corporations Act, and the accounting standards and the like. So that’s what I would describe as probably the worst, although I think there are other bad ones from an investor’s point of view so we’ll get to those. The third modified opinion is called a ‘disclaimer of opinion’. And this is when the auditor just doesn’t have enough information, to enable it to form an opinion on a certain matter.

And it might be, for example, where there’s been a large acquisition of a private business, where there hasn’t been a previous audit, and the books and records are in a terrible state. So, you don’t see that very often in this country, but you do overseas and so there are various reasons why the auditor might disclaim that opinion, they just don’t have the evidence so, they just can’t see the way. So, there are three types of what we call modified opinions. But there is one that I know that’s important to us, that is not a modified or qualified opinion, but it’s what we call an ’emphasis of matter’ paragraph in the audit report. And that’s where there’s something that is so material to the users of the report, that the auditor feels fit to emphasize that matter, through the audit report so that the readers can see how important it is from the auditor’s point of view as well.

So, these are matters that are typically well disclosed already in their report. So the auditor is comfortable with the way the company has disclosed a certain matter and the key one that I know, it gets a lot of attention, as it should, is this material uncertainty relating to going concern. So, the company will disclose often in that one or two to the accounts that it could be that they’ve breached their loan covenants with their banks, might be that they are seeking refinancing. And that hasn’t been signed up to yet. So, they’re talking to their bank still. It might be that there’s some material litigation going on and it’s just not certain yet. So, the company will disclose those matters but the auditor sees them as so fundamental that they emphasize that. And so it’s not that the auditor somehow has some crystal ball, that they know that there’s an issue and they’re calling it out any differently to what the company is calling out, it’s just they are wanting to emphasize the importance of that matter.

Tony Kynaston [1:43:50]: But it is that material uncertainty wording that is usually the one that I look for, it’s usually the one that has the most negative connotations for a company.

James Oliver [1:44:02]: Absolutely. And it’s kind of a, alright, you need to then go do your research; you need to get comfortable that the company will be able to pay its debts and continue trading. And sometimes what we see is, two weeks after the audit report has been signed, they refinance, and they issue that notice to the market. Well, in which case, you’re sort of out of date already, that material uncertainty. In other cases, obviously not and the company doesn’t manage to get out of whatever issues it’s got itself into.

Tony Kynaston [1:44:49]: So, all those other types of qualifications you spoke about, is there anything else we should be searching for in terms of scoring the company and whether we think it’s impaired or whether it’s going to go ahead robustly?

James Oliver [1:45:10]: An adverse opinion, it would be incredibly rare in a listed company environment to get that, I can’t think of examples in the listed environment.

Tony Kynaston [1:45:21]: I can’t either, that’s why I was trying to do when you were talking about it.

James Oliver [1:45:26]: And if it’s a company of any significance, it would certainly get a lot of press related to that. A qualified opinion, it sort of depends what it is but the auditors concluded that it’s not pervasive to the Financial Report. So, you just have to look at what is that qualification, it could be that the auditors believe that there should have been more of an impairment, for example, of goodwill, or there may have been a difference of opinion on the accounting of certain matter, but you need to understand it, and then ask yourself, how much I care about that particular thing? And would it impact my metrics, etcetera, that I’m measuring this company on. So, but it’s certainly not as bad as an adverse opinion. And if the auditor is not able to make a formal opinion, again, in a larger listed environment, that would be very rare. And again, you need to have to actually read the reasons why.

Tony Kynaston [1:46:48]: I can’t think of any examples of that one, either, so they are pretty rare in the listed space, anyway. So, that must put the auditor in a bit of a bind, if you want to make that kind of strong recommendation about the books of a company that you want to call something out that is materially important about stating the future of the company? What kind of pressure would you be put under to do that, or not to do that?

James Oliver [1:47:18]: Well, it’s interesting. From the inside, the pressure to make sure that you’re doing the right thing is incredibly strong. That you’re following your code of ethics, and chartered accountants do take that very seriously and as part of the profession that you’re part of, and so, but you are dealing with human beings, in a company, in a finance department, sometimes the directors, and yes, you have to handle these things sensitively. You have to understand all points of view and we’ve got lots of very highly technical people in the background, who can pick through the accounting standards, look at precedents and how things should be done and kept and have been done? And ultimately, form an opinion on that basis, you’re not there to win friends, you don’t want to lose too many unnecessarily but if you have to, then that’s part of the job.

Tony Kynaston [1:48:37]: I guess the reason for my question. It’s an interesting topic anyway, but of the half a dozen that we’ve come across during our look through the value into the stock market, when they’ve had a seriously qualified audit. Are there many more out there that don’t get to that stage, because there’s some kind of discussion that’s going on between your auditors and management or directors?

James Oliver [1:49:08]: Most of the time, if the auditors find something, the company will correct it. And if they correct it, then the issue goes away largely, as long as it’s not indicative of some other systemic accounting sort of concerns, so, I guess what you’re asking me is how much faith can people put in…

Tony Kynaston [1:49:36]: Not so much that, James, but if there’s half a dozen where the auditors have felt so strongly that they’ve called them out as either material uncertainty or some other kind of qualification. Are there other telltale signs we should be looking at for say the next rundown that might develop into those kinds of serious financial situations?

James Oliver [1:50:05]: I don’t think so, as it relates to going concern. The sorts of things that we look for as auditors, it’s where current liabilities exceed current assets, banking covenants are really important. Plenty of companies have gone under because the banks just decide to pull those levers that they have, let’s say significant litigation, sometimes it’s loss of a major contract but I think if the company itself is complying with its continuous disclosure requirements, then the investors should know about these things anyway typically.

Tony Kynaston [1:50:58]: I guess, where I’m coming from, if you might want to just take us through what a key audit matter is. And one of the questions I was leading to is, if we see a company with a continued long list of key audit matters, is that a signal that there’s a problem?

James Oliver [1:51:14]: No. And it’s a good question, Tony. These are not meant to be indicators of any concern that they were brought in to the audit reporting framework a few years ago and they’re still being rolled out to different types of entities but certainly listed companies were first cab off the rank here in Australia, so key audit matters or KAMS, as they’re called. They’re the matters that are the most material ones facing the company from the auditor’s point of view. And they’re often the most complex and the areas that involve the most judgment. So typically, you’ve got, let’s put it this way, an auditor is most comfortable looking at historical information and checking the transactions happened in line with how the company say they happened.

So, looking at books and records and taking samples and checking. But a lot of the items on a balance sheet, for example, are dependent on some sort of model, or some sort of future forecast view. So, you look at your goodwill, your intangibles, some of the investments you’ve made, non-current assets, but they’re based on these models that are based on forecasts of future sales and cash flows and capital market assumptions around interest rates and etcetera. So, it’s quite difficult for the auditor to absolutely say that these are 100% okay, because nobody has a crystal ball, what they do is they will employ certain experts in their respective firms, and they’ll assess the reasonableness of those models and those assumptions going into the model, etcetera. But that’s all it is, it’s just checking reasonableness and so this is a way to give transparency to users of those financial reports.

What are some of the areas where the auditors have to apply its own judgment? And so they are very much worth reading, I’d suggest, if you’re interested in us investing a company, read them for information, don’t read them thinking the auditors are particularly concerned unless they actually say they are concerned. Just read them to say, well, actually, if the auditor is saying that this is an area that is quite complex and uses a lot of judgment, then well, maybe  I need to make my own judgment as to whether I’m comfortable with the way that the company is doing things in that respect. So, if there’s a huge amount of goodwill, okay, am I comfortable that there’s enough cash coming into that business to actually cover that going forward?

Tony Kynaston [1:54:40]: Okay. And I’ve noticed, too, that when I’m looking for audit reports that the half yearly report can be a lot different to the annual report. Could you just maybe tell us what the differences are, and maybe give us an indication of what we can rely on in the half year report in terms of audit quality.

James Oliver [1:55:01]: So, all listed companies have to do half year reports and typically in Australia, as we know, that’s it December and the full year is 30th of June, not all companies, but that’s the general trend. So the half year report is what we call a limited assurance opinion, it’s based on review procedures, not audit procedures. So, in layman’s terms, the auditor does just a bit less than it does for the full year audit. And so what you get is an opinion that says nothing has come to our attention, that will indicate that the financial report isn’t in line with the corps act, etcetera. So, it’s saying nothing has come to our attention, it’s not saying that the auditor believes that it IS in line, it’s just not NOT in line.

So, the full year is an audit and we call that reasonable assurance and the auditor states categorically what his opinion is, so it’s a different standard of assurance, the half year is less, the full year is more. So, it’s a difficult question to answer as to what the investor needs to think about in that respect. Typically, though, I could say that most major material matters would be discussed quite fulsomely at the half year. So, and if going concern issues or valuation issues, it’s just that the extent of testing by that auditor to validate all of the books and records is less at half year.

Tony Kynaston [1:56:59]: I’ve seen cases where have an annual report will have a material concern qualification in it. But then by the half year it’s gone. What does that mean James? Is that mean that the auditors now think the company’s full of sunshine and roses or something else has happened? Or what does it mean?

James Oliver [1:57:18]: No, I think, my best guess as to what it would mean, in the cases you’ve seen, Tony, is that no company, and no Board of Directors wanted to see a qualification and a set of accounts that they’re signing off. And so, there’d typically be a lot of strong action to fix whatever needs fixing, between the full year and half year, that’s certainly one reason that you might see that trend. But there’s no requirement for the auditor at the half year to sort of refer to the full year and say, by the way, this has changed, and therefore, we haven’t flagged this as an issue. So, I can’t see any real other reason for that trend, necessarily.

Tony Kynaston [1:58:15]: Could a board decide to solve its qualified audit problem by booting the auditors and replacing before the half year result?

James Oliver [1:58:26]: Well, what I’ll just say to that is the investor should probably seek to understand whether it’s raising a question at the AGM or through some other means, why an auditor changes, and it could be just part of everyday good governance and a competitive process that goes on. But yeah, that could be a potential flag just to raise questions as to why has this auditor changed? And did he just not like that the opinion of that auditor. You’d very much hope that’s not the case.

Tony Kynaston [1:59:16]: But there are some rules around how long an auditor can do auditing for a company aren’t there and whether the other arm of the consulting firm you work for can do business with the company?

James Oliver [1:59:28]: Look, there are various rules in Australia and there are also various rules globally and they are a little bit different. It’s a topic of conversation with regulators and governments around the world. So in Australia, there is mandatory rotation of audit partners so, for example, in the listed space, you can’t be the audit partner of the same company for more than five years, it can be the same company, and you transition that over to a new audit partner. Some jurisdictions, not in Australia, not yet at least, force mandatory tendering of the audit firm and that mandatory tendering doesn’t necessarily mean that the incumbent won’t be appointed again but there has been a competitive process that’s been undertaken. And then some go further enforce mandatory rotation.

So, you get a certain period as the auditor and after that you just can’t re-tender for that. And there’s lots of arguments either way, pros and cons of the different approaches, maybe not worth going too far into those here. But I think from a conflicts perspective, that there are pretty strong processes and governance steps that we have to go through as auditors, particularly where there’s a full service firm behind us doing various different things, but it’s rightfully an area that gets regulators interested. And, I think the perception of those conflicts is as important as whether or not there is a real conflict just to maintain that confidence in the audit process. And so, it’ll continue to be debated hotly.

Tony Kynaston [2:01:37]: As investors, is it something we should be aware of, if we look at the history of a company that’s had the same auditors for 10 years, is that an issue, do you think?

James Oliver [2:01:46]: I think it’s probably other things that the investors can spend their time on? It would be my sense; I’d leave that to the regulator for it’s a very highly regulated profession, the audit profession. And that like I said, there’s pros and cons. There are some companies, some on the ASX that have had the same auditor for over 100 years. Does it mean that they’re getting some sort of compromised audit? I doubt it, I don’t believe so. But the counter argument, Tony, is that the auditor, the audit firm  has built a lot of knowledge about those businesses and particularly very large businesses can be very complex to get your head around and to see every nook and cranny where there could be an issue. So again, I’m not going to express strong views either way, but there are definitely counter arguments to that 10 years or more being a concern, as an audit firm being in place.

Tony Kynaston [2:03:06]: I think I’ve come to the end of my questions, Cam, but before we cut the interview, you could just dish some dirt for us, James and tell us what companies to avoid or tell us where the skeletons are buried in some of the big companies out there?

James Oliver [2:03:20]: I definitely can’t do that unfortunately, Tony and the information’s out there. One of the questions, Tony, I know that you’ve asked before at one of the dinners was whether or not an investor can download information on mass about the nature of any audit qualifications, or of such things. I’m not aware that those databases can exist but it certainly if there’s an enterprising soul out there who can use technology in some natural language processing, looking for keywords, etc. I’m sure you can scan the ASX or scan the asset database of companies for issues. I’m sure there’s someone who can put their mind to that but it doesn’t exist as far as I’m aware.

Tony Kynaston [2:04:15]: If we were going to do a natural language search, are we looking for ‘material uncertainty’? What are the words we’re looking for?

James Oliver [2:04:25]: So, ‘material uncertainty’, I think is a good one,  I’d do the ‘except for’, is another one and then ‘disclaimer of opinion’.

Tony Kynaston [2:04:38]: Good.

James Oliver [2:04:39]: You might want to ’emphasis of matter’ as well.

Cameron Reily [2:04:41]: Thanks, James. Last question before we go, why did you leave the chef business and is it okay if I call this episode The Naked Auditor.

James Oliver [2:05:01]: It’s not a problem, for many years since that chef you allude to came on the scene I’ve had that from all sorts of avenues in my life including, calling up the electricity company to pay a bill and they make some joke about the naked chef and…

Cameron Reily [2:05:21]: You must be sick of it.

James Oliver [2:05:23]: All good Cam.

Cameron Reily [2:05:24]: Well, thanks very much mate, hope Melbourne stays out of lock down and hope to see you at our next Melbourne dinner.

James Oliver [2:05:34]: I appreciate that. Thanks.

What? A free weekly investing newsletter? Oh yes please.

Every Monday we publish a newsletter with updates on our podcast and portfolio activity. Sign up now to get your copy completely free!