ANDREW PAGE | The Strawman

· Podcast Episodes
Question Everything! Don't pretend you understand when you cleqarly don't. Andrew Page

Have you ever found yourself nodding along to someone's explanation of an investing concept or number, only to realize that you have no idea what they were talking about? It's eye-glazingly common in finance, where jargon and buzzwords are thrown around with abandon. Especially by men in fancy suits.

I'm joined in this episode by Andrew Page from the Strawman Investing Blog We're taking a closer look at 2 financial metrices - the price-earnings ratio (PE) and return on equity (ROE). Don't worry of these metrics are not clear when you're first starting out as an investor. It's more important that you are aware of the pitfalls and to need to keep asking questions.

Questions like:

  • Why is this number important?
  • What does this number or concept actually mean?
  • How does this fit into the bigger picture?
  • What assumptions are being made here?


PE ratio stands for "price-to-earnings ratio" and is a commonly used financial metric for evaluating company shares.

The PE ratio is calculated by dividing the current market price of a company's shares by its earnings per share (EPS) over the past 12 months. It can be used to assess how expensive or cheap a company is relative to its earnings.

A high PE ratio may suggest that a company's shares are overvalued, while a low PE ratio may suggest that it is undervalued. However, it's important to note that the PE ratio should not be used in isolation and should be considered alongside other financial metrics and factors.

It's also important to keep in mind that the PE ratio can vary widely depending on the industry and market conditions. For example, high-growth technology companies may have much higher PE ratios than more stable, established companies in other industries.

If you're using the share price, you need to make sure that the earnings you are using is the per share earnings. Otherwise it's the market cap divided by the total net profit. It's the same thing. It's just whether or not you work it out on a per share basis, it's at once. I mean, it's very popular. It's at once quite powerful, but full of pitfalls. It's one of those things I think every investor needs to go through the journey of understanding what it is, how you might use it, the limitations. It becomes a very useful heuristic once you are confident of certain things. If you are just going to apply it blindly, it's full of pitfalls.


ROE stands for "return on equity" and is a financial ratio that measures a company's profitability relative to the amount of shareholder equity.

The ROE is calculated by dividing a company's net income by its shareholder equity. The result is expressed as a percentage and indicates how much profit a company generated for each dollar of shareholder equity invested.

A high ROE generally suggests that a company is efficiently using its equity to generate profits, while a low ROE may indicate that a company is struggling to generate profits relative to the amount of shareholder equity invested.

However, like any financial ratio, the ROE should not be used in isolation and should be considered alongside other financial metrics and factors.

The name tells you what it is. It's the return relative to the equity. The equity is just the net assets. You get the balance sheet, you look at the total assets, you minus that total from that total liabilities. What do I own? What do I owe? And anyone who's got a home loan knows exactly what equity is. And so [ROE is} basically saying how profitable is this business? How efficient is this business at taking its equity, it's net assets and generating a profit.

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Phil (0s):

I've gone completely paperless. Apart from my, yeah. Isn't it brilliant? Apart from my share buying and stuff, I had this pile of paperwork there this morning. Oh God, when is it going to end? I mean, you know, you go paperless and then you, you know, you opt for email communications and then they send you a letter to confirm that you've opted isn't email communications? I know. It's bit crazy. Yeah.

Andrew (21s):

Yeah. It's like every time I do a trade, which isn't that often, I get a thousand notices and things from this and then, and just, I don't, and then as you say, the ironies is you, you say, I want electronic communications. And they send you a letter saying, okay. Yeah,

Phil (34s):


Chloe (38s):

Shares for beginners. Phil Muscatello and Fin Pods are authorized reps of Money Sherpa. The information in this podcast is general in nature and doesn't take into account your personal situation.

Andrew (50s):

Once it's on the share market and we have this daily quoted price and these char, all of that goes out the window. And all we care about is that everyone's gonna drive an electric car. So I'm buying lithium. Cause Gary at the pub last night said that that's the future. And like you would never buy a business like that. It's like, oh, it's okay. Cause I'm just buying $2,000 worth of shit. It's, it's pure madness. But, so think like a business person and don't imagine, I was gonna say, imagine you're buying a company. You are, you're literally buying, you're just buying it in, in small pieces. Think that way and you'll avoid a huge amount of error.

Phil (1m 22s):

Good day. And welcome back to Shares for Beginners. I'm Phil Muscatello. Today we're delving into metrics, the kind of numbers that sometimes make out beginner eyes glaze over when we look to value companies on the asx. Joining me today is Andrew Page from Strawman. Goodday. Andrew

Andrew (1m 38s):

Goodday Phil,

Phil (1m 39s):

Welcome back. It's been a long time. Yeah.

Andrew (1m 41s):

It's always, always fun, so Yeah, yeah, yeah. Thanks for having me. Look,

Phil (1m 44s):

I just, before we started, I just wanted to mention a friend of mine, Jed. Now I was walking through the streets of Redfern and Jed was coming towards me and he said, Phil, I've just been listening to you. I love the podcast. And yeah, cuz I told him about it. But now Jed, Jed was the proprietor of one of Sydney's premier dive bars, the doc. And I'd recommend the doc anyone to anyone who wants a fun night, especially Monday nights on sea shanty night. But anyway, so Jed's sold his share in the dock now and he's got himself a real job and he's got a baby coming along in a year's time and he's starting his investments. So I just wanted to say hi, Jed. Thanks for listening and good luck with everything.

Phil (2m 24s):

Best of

Andrew (2m 25s):

Luck with it all. It's a journey.

Phil (2m 28s):

It sure is. I'm sure you two are similar ages. Oh yeah. Maybe just a little bit further down the journey than he is.

Andrew (2m 34s):

Okay. Yeah. Well, just jumping into investing and fatherhood, that's, you know, it's two big things to bite.

Phil (2m 41s):

Yeah. But, but as I said to him, just, you know, start small, you know, like with a baby. Yeah. Like with a baby

Andrew (2m 48s):

Starts small

Phil (2m 49s):

Speaking of which baby giants. Tell us about the podcast. How's that going?

Andrew (2m 52s):

Yeah, so it's a, a pod I do once a week with Claude Walker from A Rich Life and Matt Joass from Maven Funds. And it's just a bit of a chat. We focus on small cap kind of stocks. Yeah. And

Phil (3m 3s):

That's, that's the area that you all like to work in, isn't it?

Andrew (3m 7s):

Yeah, we do. And it's just a, a bit of fun and I, I think even if it wasn't a podcast, we'd probably just get together and talk about that stuff anyway. In fact, that was probably the genesis of it. It's like, why don't we just record this and Yeah, yeah, yeah. You know, it's not a commercial endeavor, but it is a bit of fun and yeah. Hopefully people enjoy it. So

Phil (3m 22s):

On this podcast, we've covered the PE ratio before with Rudy from FN Arena on episode 188. So,

Andrew (3m 27s):

Oh, Rudy's great. Yeah,

Phil (3m 28s):

He is. He's a great character, isn't he? I'm gonna try and get him back on again. And this is a little refresher now. So let's just quickly just cover, we, not in incredible detail, but how is the PE ratio worked out?

Andrew (3m 40s):

It's actually given away in the name, the PE. The P is the price and the E is the earnings. So it's the price over the earnings. And it's

Phil (3m 50s):

Like the price is the share price,

Andrew (3m 52s):

Sorry, the share price that

Phil (3m 53s):

Particular time.

Andrew (3m 54s):

Well, you tend to do it in share price terms, so share price. If you're using the share price, you need to make sure that the earnings you are using is the per share earnings. Otherwise it's the market cap divided by the total net profit. It's the same thing. It's just whether or not you work it out on a per share basis. It's at once. I mean, it's very popular. It's at once quite powerful, but full of pitfalls.

Phil (4m 17s):

Well, that's what Rudy pointed out to, you know, different companies, different industries have different peer ratios applied to them as that metric, don't they? Yeah. It, it's

Andrew (4m 26s):

One of those things I think every investor needs to go through the journey of understanding what it is, how you might use it, the limitations. It becomes a very useful heuristic once you are confident of certain things. If you are just going to apply it blindly, it's full of pitfalls, you know, so Phil, there's a stock with a PE of eight. Well, it sounds cheap. Yeah.

Phil (4m 51s):

Because the lower the number that possibly is better is the better number.

Andrew (4m 56s):

Actually, you know, the way to, the best way to think about it is just to invert it so it's all consistent mathematically. So rather than the PE we could talk about what's called the earnings yield. So instead of price divided by earnings, it's earnings divided by price. Property investors will get this. Yeah. It's like, it's like the yield, you know? So it's like, for, I'm paying a dollar per share and for every share, the company is earning 10 cents in, in profit. So it's a 10% return. Now you've gotta be careful with it, not to you, because companies tend to keep some of the money that they make and they're, we'll get into why they might do that actually. So it's, but it is, it is, if you think about it in those terms, and you are running a business, well what earnings yield would you want?

Andrew (5m 38s):

And this is where the PE is different from some metrics where it's, there's not a number that's too high. Sometimes it's a bit too high, too low. You want that Goldilocks, in PEs you want to be as low as possible. And the, and the inverse, the earnings yield, you want to be as high as possible. You've got a business that earns a 12% earnings yield, mine earns are 6%, yours is more profitable. You know? So I think, I think that is, that is a really good way to to to think about it.

Phil (6m 5s):

And this is separate from the dividend, isn't it? The dividend is only part of the earnings, isn't it? And it's down. So,

Andrew (6m 10s):

So the, the company pays the dividend out of its earnings. And so you might, in my example, I've earned 10 cents per share. I might pay a 5 cent dividend. So the company's keeping 5 cents and they're paying out to you 5 cents. So your dividend yield is 5%. Yes. I mean, all of these, whether it's the pe, the dividend yield, the earnings yield, any kind of the, they're all trying to benchmark something or to relate one aspect of a company to another part of a company. Because it's just useless to say, Phil, I've got a company that makes a million dollars a year. Hmm. Maybe that's good if I'm running a lemonade stand. But if I'm running, you know, BHP, it's awful.

Andrew (6m 50s):

You know, you gotta standardize these kinds of, and that's what metrics are trying to do. And,

Phil (6m 56s):

And, and the PE ratio as well is one, it standardizes within an industry, doesn't it? Rather than, you don't, you don't look at a, a mining stock PE as opposed to a bank stock PE Yeah. Is that

Andrew (7m 7s):

Correct? Yeah. Well, it's the wrinkle in all of this. If, if that's what you want to call it, is that, look, let's start at the beginning. So the, the long, long-term average for the market tends to be, depending on which study you want to use around sort of 15, 16, 17. That's for the US market as well. And for our, it's been a bit distorted in this era of ultra low interest rates that we're sort of leaving now. But that's, that's and

Phil (7m 33s):

Dealing with

Andrew (7m 33s):

About what it is. And so you'll you'll say that, well, you know, on a very big arc, anything below that is quote unquote cheap. Anything above that is expensive. Hmm. So it's not so much, I mean, at the end of the day, it doesn't really matter what the industry or the business model is, it's just these are economic machines and I want the most efficient machine. Yeah, but you're right in the sense that it will differ within sectors because there are different growth outlooks within each sector. So let's say that your mining company, and they, it turns out that the mining PEs are pretty low at the moment. Well, you don't wanna compare it with the average PEs you're seeing in the tech sector or whatever. And it might be because everyone expects earnings to fall.

Andrew (8m 15s):

Cause there's at some point in the commodity cycle or something like that. Yeah. So it's not, you're right. I think when, when you're trying to benchmark, look at as similar a company or similar a sector as you can, it is, it is more relevant. But the key thing is the growth. There are, you can have a company on a PE of a hundred that is quote unquote cheaper than a company that's on a PE of five. Mm. Now how can that be? You know, one has got a very low earnings yield, if we wanna flip it over again, one's got a pretty decent one. The difference is, is that the one with a PE of a hundred, maybe it's tripling its profit each year. It's relatively small company. You know, it's Apple in the early days or Amazon in the early days.

Phil (8m 54s):

So it's looking at future growth. Is that what's happening? It's, well

Andrew (8m 57s):

Imagine if I said to you, I've got two businesses to sell you one's a PE of five, one's a PE of a hundred. And you go, well, okay, well the PE of five sounds better. But then when you started doing your due diligence, you realize, I'm trying to sell you a lemon here. That's probably going out of business. Yeah. In which case it's an awful, like, this is the other problem with pe well, not problem, but one thing you've gotta be aware of is they're generally backward looking. So I take last year's earnings per share. PE might be five on that basis, but if earnings are gonna drop 50% this year, and then the year after, and then the year after, you know, it might not actually be that great a deal. The one on a hundred, maybe that's going to be a thousand times bigger in, in 10 years time, in which case it's the, it's the bargain of the century.

Andrew (9m 38s):

So I think that's for me is the real lens to evaluate a PE is how does it contrast with the expected growth rate? And this is where you might want to get into what's called the PEG ratio, which uses PEs and divides by growth rates. It's, it's beyond the scope of this discussion now

Phil (9m 57s):

Where we've covered the peg ratio on a previous podcast as well. Oh,

Andrew (10m 0s):

Well, listeners should definitely go check it out because it's, it helps with that. But I guess, I guess one caution I would say with them all is that you've gotta take everything with a huge grain of salt.

Phil (10m 10s):

Well, especially if you're a beginner and you've got no idea what these numbers mean. Yep. I think what I try and do with this podcast is for people to listen and they're not gonna understand everything straight away, but if you keep on listening to the words Yep. It just becomes a little bit clear and you've got a little bit more knowledge with which you can approach the market. That's it.

Andrew (10m 29s):

And you know what, it's the same for everyone. It just, we've all gone through this process. I always encourage people to just ask the why again and again. Hmm. Too many things in our industry and many industries, they just get stated it's fact. Yeah. But it's, you gotta come at first principles here and, and sort of say, well, why is that a, a good number or a bad number? What does that mean? What is that telling me? And they're really basic questions. But people often feel as, oh, it's a dumb question. You know, and it's almost like, I shouldn't even question this.

Phil (11m 2s):

Yeah. There's a man in a fancy suit that's, you know, talking to me about it and he knows what's going on,

Andrew (11m 8s):

He knows what's going on. And it's, it's just sort of, all of them are useful heuristics. None of them will help you invest by themselves. I would never invest on the PE ratio alone or the dividend yield alone. I mean, I'd look at them, but I look at as many things as I can. So yeah, just stick with it and you'll, you'll find it less intimidating as you go on.

Phil (11m 24s):

So how do you like to use the PE to calculate a target price and intrinsic value?

Andrew (11m 28s):

Ah, so I'm a big fan of this. When, when you start going down the valuation route, you usually end up with what's called a discounted cash flow model. It's sort of the gold standard. And it actually comes back to, it's a very big conversation. Very deep conversation.

Phil (11m 44s):

It is, it is actually. But hang, just, let's start discounted cash flow means, yeah. It's a cash flow that's discounted for inflation against inflation.

Andrew (11m 51s):

Well, it's sort of, it comes back to the, the principle is, is what is a company really worth? That's a hard question. I mean, you know, what is it? Especially when it changes so much all the time up and down, you know, some, some would, the efficient market hypothesis would argue that actually no, that whatever the market is, that's what the company is worth. Cuz that's what market is saying it's worth. But you can approach it from a more mathematical standpoint. And, and the, it's based on this idea that the value of a company is equal to the all of the cash it will ever make. And the one adjustment we make to that is we, it's in the name we discount those future cash flows.

Andrew (12m 33s):

So if a company's gonna make a hundred dollars this year, that's good. If it's gonna make, also be making a hundred dollars in 10 years time, well that's also good. But a hundred dollars in 10 years is worth less than a hundred dollars now, hence the discount. So you've got discount it back. Yeah. So there's, it's brilliant and it's a, it's a wonderful intellectual framework. People will be listening to that going here, but how do I know what a company's gonna be earning next year, let alone the year after that, let alone in 10 years time? How far out do I go? Well, it's actually, it's in, it's, it's the entirety of the company's existence. Is this company gonna be around for a hundred years or four years? It's easy to define, diabolically, hard to calculate, but it's really, really, really, really useful in terms of understanding what value means.

Andrew (13m 18s):

And it's an alluring and a very rewarding, and I would encourage people to look into it. Where I'm going with all of this is that once you sort of go through all of that, I've found myself full circle. I started off not even caring about value. So shares going up or down, that was about the extent of my research. Then you start looking at PE ratios, then you get into the more discounted cash flow stuff. And now I've come full circle back to PE ratios because I've learned that over time it's the qualitative angles of a company that tend to be really important and they never fit into a formula. So qualitative, I mean the quality of management, the type of business model, the industrial headwind, oh, sorry, the industry headwinds or tailwinds that the comp, you know, all these things that kind of matter instinctively.

Andrew (14m 4s):

Yeah, a lot. So to answer your question, it's a long run up. Sorry. No, it's okay. Yeah. So let's go back to the formula. The PE equals the price over the earnings. If you remember your, your high school algebra, you can rearrange equations. So let's take the price part of that and solve for that. So, so when you rearrange the formula, PE equals price over earnings. Therefore price equals the PE of a company times its earnings per share. So I can use this if I have an estimate for what a company's per share earnings is going to be at a point in time, and I have an estimate for what the market, what pe the market will give that by definition I've got a target price.

Andrew (14m 49s):

And then I can discount that back. Let's say that in my hypothetical company, I believe that in three years time it'll have an eps, an earning special of $1. And I believe that the market will value that at a 15 times PE at that point in time. Well, one times 15 is 15 the share price under my assumptions. Now they're just as well, let's, let's use it, let's use the proper word, my guesses. You sound smarter when you say forecasts assumptions. Yeah, yeah, yeah. They're guesses. They're guesses. Yeah. They're all guesses. Yeah.

Phil (15m 22s):

Every time there's a forecast, every time you see an analyst forecast, when you see consensus, they're all guesses.

Andrew (15m 28s):

I forget who said, I'm gonna forget who made this quote, but it's forecasting is the art of saying what will happen and then explaining why it didn't. And I've always, I've always thought that was really good. So anyway, in my hypothetical example, I got, well, I think the share price under these two assumptions will be 15 bucks. And by the way, if my assumptions are right, well that by definition has to be the share price. So if today the share price is $15, well that's a pretty ordinary deal. I'm gonna buy it for 15 and wait three years and maybe sell it for 15. Then if it's $20, it doesn't make any sense. $10. Now I've got a 50% upside. So it, it helps me sort of put that line in the sand.

Andrew (16m 9s):

And the way the maths works is if, let's say you can work out an intrinsic value by also discounting that future price back. So let's say I want a 10% return, buy my shares today, 10% per annum Per annum. Yep. Per annum. And, and, and I want, I want to get that over the next three years. So I take my 15 and I divide that by one plus the return I want. So 1.1, I can't do this in my head, but 15 divided by 1.1. Yeah.

Phil (16m 38s):

The future value

Andrew (16m 39s):

And whatever that answer is, I'll divide that by 1.1 and then I'll divide that by 1.1. I'll do it three times the math nerds out there. It's 1.1 to the, to the end.

Phil (16m 48s):

And there's a calculator online.

Andrew (16m 50s):

There's a calculator online. I'll

Phil (16m 51s):

Do this for you. Yeah. But

Andrew (16m 52s):

It's really elegant way of working out a target price. Now the thing you've gotta be hyper careful of here and the saying whether, whatever valuation methodology you're using, the saying is garbage in, garbage out. You might think they're gonna earn a dollar a share. Maybe it's 20 cents a share, in which case your intrinsic value calculation is rubbish. So how do you do this? And you are, you can't get around the fact that I've gotta have a view on the future. And, you know, that's investing. Right? So this is where I, I think Ben Graham's, Warren Buffett's mentor said the three most important words in investing were margin of safety. And that is accounting for the chaotic nature of the universe and how unpredictable everything is.

Andrew (17m 36s):

You don't want base your investment on the idea of everything going perfectly in business is tough and business is messy, and the best operators, the best business and the best industry in the world. And you're, you're just gonna have crappy years cuz un unforeseen things happen. So I might think it's gonna earn a dollar per share, but maybe, maybe I should just assume 90 cents and I think 15 is reasonable and we can get to what you numbers you might think are reasonable later. But maybe I'll just, I'll knock that back a little bit as well. Now the more I do that, the lower the real value is, well, as per my calculation, that will come out, which, and obviously lower the better as we said at the, at the beginning with with pe.

Andrew (18m 20s):

But if you do it too low, you might, the market might not ever give you that chance. I would love to buy Woollies at $1 a share because I've put the biggest margins of safety in that you can imagine. But the reality is I'm just never gonna buy it cuz it's never gonna get to that level. Yeah, yeah, yeah, yeah. But that's, but it's a, it's a nice way of don't price for perfection. These are just guesses. Put out your best guess, adjust for the unknowns and the unknown unknowns. And it just helps you draw a line in the sand. And I think with valuation, people are too focused on coming up with a number. This is my valuation and I try to encourage people to do it 10 times. Here's my bull case, I think, no, I think this, this, this, they'll, they'll do much better than I I I've perhaps given them credit for.

Andrew (19m 4s):

And the market will be in a much better mood. So you can test a variety of assumptions and you obviously get a variety of valuations. But that process will at least know what your spread of options are and, and, and

Phil (19m 17s):

The spread of possible outcomes, the

Andrew (19m 18s):

Spread of possible outcomes. And then I can sort of use that to benchmark as the company progresses. I, on one scenario, I said they should be able to grow their earnings at 10% a year. They had a pretty ordinary, you know, maybe, maybe that was optimistic of me and I can sort of course correct along the way and it helps to have, you don't want to take your number too seriously.

Phil (19m 41s):


Andrew (19m 42s):

Yeah. But you don't want to just be buying on hope. Yeah. That's not, you need, you need to,

Phil (19m 48s):

You need something there to, to base your thesis on, don't you?

Andrew (19m 51s):

This is the problem with the, with the analysts, I would say in the main is that there's, they get sucked into the allure of false specificity. It's this, it's this false confidence that mathematics give you. I'm using very sophisticated maths and spreadsheets and just, it makes you feel very confident. So like

Phil (20m 7s):

When you see that view that says this stock is undervalued, it's worth $10 and it's currently trading at $6.

Andrew (20m 13s):

Except it'll be to 12 decimal places, $10 0.12, you know, it's, it's hyper specific. It's like best it's around $10, you know, and, and so you've gotta take it with a grain of salt and it it, it doesn't really matter to your investment returns. You may have calculated based on a desired 10% return if in the fullness of time it comes out at 8, 9, 10, 11. And directionally you are correct. Yeah, you're never gonna lose any sleep if this turns out to be HIH Insurance or Enron or something like that. Again, you know what, what does it really matter that your evaluation was the end result was zero. And what it does is you've got to have a bridge between what the company itself is going to do and what that means to me as a shareholder, I'm a fundamentals based investor.

Andrew (21m 0s):

I'm not relying on what whims of the market are going to be to determine my share. It'll be the, the operating performance of the business. And all of these techniques, all they do is they link the two. And it real, I've always found it really appealing because at the end of the day, if a business performs well, the share price will generally follow. Caveat there is provided it was priced sensibly in the first place. But, but that's really what you, what what you are trying to get at here. And it means that you cannot, you can worry far less about all this up and down daily volatility. And it's just, now my focus is the business. If this wasn't listed and I was just a billionaire and I was gonna buy this thing outright, what, what would I want to know?

Andrew (21m 43s):

How much money can I make out of this thing based on the cash flows I think this this economic machine can generate? What would I pay for that? And this is what does your head in a bit. It, it is entirely possible to do really badly in a really great company if you pay too much. I don't know. Let's pick a, pick an example. CSLs a great company. It's one of the best on the ASX I reckon. I don't own chairs in it by the way. It's a whole other story I did and didn't. Anyway, what's it worth a share at the moment? Geez. Haven't looked for a while. Oh,

Phil (22m 14s):

290 or something.

Andrew (22m 16s):

I'll tell you a story. I bought it at 40 bucks. Thought I was clever looking at a profit. That's a whole other lesson.

Phil (22m 23s):

But they, they haven't moved for a long time. They've been trading in this range

Andrew (22m 26s):

Sort of, well it's

Phil (22m 27s):

270 to 300 for a long time.

Andrew (22m 30s):

Let's say the market's roughly right now, is it a good company? Yes. Will it be around in 10 years? I'd say so will I be earning more money in 10 years time? I'd say so. Probably at a decent rate of growth. Mm. Would you pay $10,000 per share? I wouldn't because even if the business, even if the business does incredibly well, you are not gonna get anyone who's prepared to pay that much of a premium down the track for you to, to, to do well. So that's, that's the, that's the first thing. No matter how wonderful a business, you can overpay and if you overpay, you can do badly. You can also do well in pretty bad businesses. Your the, the example from before, let's say that it was a, a company that was going to go for two or three years and then go bankrupt.

Andrew (23m 11s):

Well, it's still gonna make some money over those three years, let's say on a discounted basis, it's gonna make a million dollars. Well, I'd pay 500,000 for it. Don't care that it doesn't. Cause I'm, I'm gonna put out my internal rate of return. Another, another calculation I'm gonna put out $500, $500,000 on on day one and after three years adjusting for the discount rate, I'm gonna get a million dollars back. This is the business that just went bankrupt. It's great. So, so valuation matters.

Phil (23m 41s):

It does, it does. I mean, I was talking to a friend the other day and he was talking about three companies in his son's portfolio and one of them was WiseTech, another one was zero. Yep. And the third one, and I can't remember the name of it, is it possibly Kadan? Kenan. Kaan. Anyway, whatever it is, you look at the three companies and I can't remember the wise tech situation, zero just burns through cash. Yes. Doesn't it? It just keeps on people invest and that money just gets spent on marketing to, to get market share. Yep. And it's only in Australia and New Zealand. Whereas this other small company is, which is a really good business, has got great numbers, great balance sheet in terms of it's got very little debt, you know, and it's paying a, a fully frank dividend and it's share price can't get arrested.

Phil (24m 30s):

It's she prices lately. I like that. Yeah. Can't get arrested.

Andrew (24m 33s):

Isn't that great though? Like small caps because they just, they sit under the radar for so long. They do long.

Phil (24m 38s):

Yeah. Yeah.

Andrew (24m 39s):

Zeros an actually fascinating case. The argument, as crazy as it sounds when you sort of say it like that, and I don't wanna defend, I don't know if shares in zero, but the rationale would be, the bulls would say is that yes, there's a lot of money going out the door now that in the future so much money is gonna come back that it still justifies the price. You and I start a business today, we spend the next three years putting a hundred thousand dollars into it. I mean it's money's just going out the door. But in that three years we build the next, I don't know, iPhone, you know, we say, well the the next latest and greatest computer chip technology. Yeah.

Phil (25m 14s):

As a pair, as a pair of geniuses. Yes. Yes,

Andrew (25m 17s):

We are, you know, it's only a matter of time. And, and so, and then in five years time, we, we've got, you know, a company worth billions. So it's sort of like anyone looking at that, our company, on year one, two or three, we go, this is rubbish based on the cash flows alone. So this, again, this is where it gets tricky. Now, whether the people are right or wrong with zero, well that's for you to determine as an investor. But the market is implicitly saying, given the cash flow scenario that no, we think that cash flow will come. It happened with Amazon. That's the archetypal scenario. I mean, Jeff, these are famously just, you know, just bled cash for ages, but then built one of the strongest moats in, in the planet's history. And, and we all know what happened with Amazon. But anyway, I dig, I digress.

Andrew (25m 58s):

But it's this, this is the, this is the thing that's can be frustrating, but it's just the reality of it is that there's always, I think we always wanna, here's a formula, put these numbers in, you'll find the numbers here on the balance sheet or the income statement. Yeah. And if it's below this buyer, don't say that's what we want to think. And if it was that easy, well we'd all be Warren Buffet. It's, it's not, there's always the, well here's the formula, here's the theory, but here's the buts, here's the maybes, here's the exceptions to the rule. Here's the, it depends. And that's who I think is frustrating. It's frustrating for me, it's frustrating for everyone. But, but, well,

Phil (26m 34s):

It's frustrating, but what I wanna point out to listeners is that you're taking a first look at the share market. You're gonna get pulled in by stories, by narratives. Analysts are gonna be telling your story. CEOs are gonna be telling your stories. Your mates are saying, oh, I've invested in this company and it does blah, blah blah. Yep. And you think, great, I wanna invest in the cure for cancer or the next big technology company, whatever. Don't we all? Yeah, yeah. That's right. But it,

Andrew (26m 60s):

It's all narrative driven. It's all narrative driven. It's all narrative driven.

Phil (27m 3s):

I just think it's important to understand that the behind us is all this numbers swirling around, which, you know, maybe you will never understand. Yeah.

Andrew (27m 10s):


Phil (27m 11s):

But, but just don't be pulled in by the narrative. That's

Andrew (27m 14s):

The, just you're trying to, I like to, I think I might have said this on the podcast last time with you, is that I, I feel as though you want to think and act like a detective. There's a, there's, there's a set of facts and stories out there and you want to build evidence. And in my toolkit, I've got a little bit of knowledge of how to use a few metrics. I've got a bit of knowledge of how that industry works and what the business model is. And you never, ever, ever get to a situation where there's only positives. I mean, the best companies in the world have hairs on, there's things about them that you would prefer weren't there. And it's hard

Phil (27m 52s):

Business, business. It's,

Andrew (27m 54s):

It is, it is. I mean, we, we all love these things. Or just, and the thing is, if there ever was a perfect company, it would be priced. So, in other words, you, you might not even do that well out of it cuz the market is so hyper aware of its quality that it is, it is priced accordingly. But you're trying to build up a body of evidence, I suppose, where you can make a compelling story where you are not just dependent on, on the, the twos and fros of the market. Again, it sounds so stupid, but, well not stupid, but over simplistic. But it's not. You've gotta keep coming back to the basics here You are literally buying a part ownership in a business. Now, I would wager that if you take anyone and you were to sort of say, you know, and they had the financial means to, to buy businesses outright.

Andrew (28m 41s):

And you said, do you wanna buy my business? They'd wanna look at how much money do you make? Who your customers, what do you do? What are the competitors like, all the things that just completely, you wouldn't necessarily come to you straight off the top of your head, but once you sat down with your other half at the dinner table that night saying, well is this offered to buy a company? And you know, you, you would, the questions would naturally come as to what, you know, how much, geez how much debt do they have there? And you know, all of these kinds of things. It, it, once it's on the share market and we have this daily quoted price and these charts, all of that goes out the window and all we care about is that everyone's gonna drive electric car. So I'm buying lithium cuz Gary at the pub last night said that that's the future.

Andrew (29m 22s):

Hmm. And like, you would never buy a business like that. It's like, oh, it's okay cause I'm just buying $2,000 worth of shares. It's, it's pure madness. But so think like a business person and don't imagine, I was gonna say, imagine you're buying a company. You are, you're literally buying, you're just buying it in, in small pieces. Think that way. And you'll avoid a huge amount of error.

Chloe (29m 43s):

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Phil (29m 55s):

Okay. So the next metric we're gonna talk about is return on equity ROE. Okay, what's this all mean?

Andrew (30m 6s):

You know, it it, the good thing of all these ratios is that the, the name tells you what it is. It's the return relative to the equity. The equity is just the net assets. You get the balance sheet, you look at the total assets, you minus that total li minus from that total liabilities. What do I own? What do I owe? And anyone who's got a home loan knows exactly what equity is. Right? And so I just, I again, back to this idea of all metrics are just trying to benchmark one aspect of a company, just something else. And so it's basically saying how much, how profitable is this business? How efficient is this business at taking its ac its equity, it's net assets and generating a profit.

Andrew (30m 48s):

So again, it's it's

Phil (30m 50s):

Looking at like a machine, isn't it?

Andrew (30m 51s):

They are economic machines. Yeah. I love that. Actually, I think I, they are, they're economic engines and some engines run really smooth and hot and some are not, you know, in need of di maintenance, spark plugs

Phil (31m 4s):

Need a bit of clean. So the injectors are a bit,

Andrew (31m 8s):

And this is, this is one of the dials on your dashboard, right? Yeah. You've got a company, you make a million dollars a year. I make a million dollars a year. It just so happens that I'm making my million dollars a year with 10 million in assets. I had to go somehow scrape to raise it from shareholders or borrow money from the bank debt or equity. I had to raise all $10 million, buy a bunch of, I don't know what I do, let's say factory parts and warehouses and stuff. And that investment. I've got a, I've made $1 million. That's pretty good. You know, it's a 10% return on, on equity through some financial genius. You've managed to make that $1 million profit on 2 million of equity. You're very capital light business.

Andrew (31m 49s):

You don't need factory parts. You've just, you know, the, the Phil Muscatellos putting his IP out there and people just snap me, you know, you, you basically pay for a webpage or something like that. Now we both made a million bucks, but which is the better business? Yeah. Yours is a much better business.

Phil (32m 5s):

That's much sweeter.

Andrew (32m 6s):

So you've got, what'd they say? Five, what'd they say? 2 million. So your return on equity is 50%. This is also one that can't be too high. Higher the better. I mean, at a point you think, is that too good to be true? And you know, but, but it is, it is a measure of efficiency, the efficiency with which I can generate a dollar of profit.

Phil (32m 32s):

So how, how can it be too high?

Andrew (32m 34s):

Well, it can't be too high if it's sustainable

Phil (32m 37s):

Because if it's, if it's available, someone else could take it up and do it as just as easily or

Andrew (32m 43s):

Well let's, let's say this, let's say that I managed to generate a hundred percent return on equity. I've got million dollars in net assets and I made a making a million dollars. You think that is fantastic And this is why you've always gotta dig behind the numbers. Maybe that year I sold off massive segment of the business. So the statutory profit that year was huge, but I've also sold half of my business. So it's is 100% return on equity. Good. Yeah. Can I do it next year? Not really. I've sold half the business and, and you gotta look at it the other, sometimes you get abnormally low ones cuz there might be write downs or something that, that impact it.

Andrew (33m 22s):

That's why it gets a lot of grief I think from investors when companies report adjusted and normalized figures. And you should be not cynical, but skeptical because there's a lot of shenanigans that goes on that companies always wanna present the best story. At the same time, there is a legitimacy to looking at things from a normalized perspective. Maybe you don't wanna take their word for what normalized is and come up with your own estimate of it. So in that case I might sort of say, well, my platform that I'm using or the numbers that I'm generating is a hundred percent, but really when I take off the one-off impact, this was the return on equity. So it can't be too high if it's sustained.

Andrew (34m 3s):

If you can get a hundred percent, you can do that every year. That's great. That's, that's not too high. But I just mean that when you see a very high number and really once you start seeing numbers above 20, 30, 40%, by the way, there's quite a number of companies that can consistently do that. Fantastic companies. But you just, you want to just sort of see, ask that question. Is it a sustainable return on equity? Yeah.

Phil (34m 26s):

What does this actual number mean? Yes. What's the number? What's behind those numbers? Yep. Okay. Yep. So how do you use return on equity then?

Andrew (34m 33s):

So return on equity is a great way, it ties back to the PE ratio actually. Because whether a PE is high or low, as I alluded to before, comes back to the kind of growth that it can generate very, very fast growing companies. You can pay very high PEs for and still get a bargain. So what you do with return on equity is you can work out what a re reasonable rate of growth is to expect. So let's go with Woolies cuz it's such an easy company to, everyone knows it. So they've actually consist, what, what

Phil (35m 6s):

Does it do?

Andrew (35m 7s):

Woolies, they do very well for a grocery store. That's what I'll say they do very well. We can talk about, actually we should get into them from a PE perspective too, but we'll start off with return and equity. So their, their return and equity is consistently above 20%. That is outstanding efficiency. A very, very well run opera and a mature business that's managed to do that consistently. So I think, I think that's pretty good. We also know that they pay out 70% of their profits is dividends. Mm. So this is where you get to the importance of it's not just the return on equity that matters, it's the return on incremental equity. So let me go back a step.

Andrew (35m 49s):

So they make whatever profit they make, 70% goes out the door to shareholders in cash. They don't have it anymore. The 30% that they've got, well we know that, let's say that we're, we're assuming they can continue to get a 20% return on equity. So I can take that retention rate in this case 30% times it by the return on equity, I'm gonna get about 6%. And that's probably a sustainable rate of earnings growth without the use of them taking on a bunch of debt or something. I mean, you might have the best business in the world, but it, you know, it's the old saying it takes money to make money, don't, can't conjure it out of thin air. So they've decided that they'll keep 30% of their profit and they will reinvest that in the business.

Andrew (36m 30s):

They'll open up a new supermarket, they'll put a new distribution center in whatever it is.

Phil (36m 35s):

Oh, technology. I know that they've invested so much in technology and their warehousing as well.

Andrew (36m 38s):

Yep. All for all for efficiency, for reasons right. To, to deliver better value, hopefully to customers and then ultimately to, to shareholders. So they, so if they're able to keep 30 cents in every dollar and if they're able to get a 20% return on that and you add it all together, it's sort of like, that sounds about right actually it's historically what they've sort of up upper end of what they've done, but around 6% seems reasonable. What it means though is that, so how do I use it? Well, in that example,

Phil (37m 9s):

Sorry, that 6% is growth.

Andrew (37m 10s):

No, the earnings per share growth that I could expect. Yep. If based on what they're keeping and based on the return, they're gonna get on that equity after the

Phil (37m 18s):

Dividends have gone out the door. Yep, yep. Yeah, you

Andrew (37m 20s):

Have to get into a bit of financial statement stuff because when you retain, retain profits is part of equity. In fact, another way to, we've, I've defined equity as assets minus liabilities, which is a hundred percent mathematically correct. But what is also equivalent and mathematically correct is to say it's the shareholder equity that was put into the business when it was started. Plus any retained profits. So if I'm retaining my money each year, that equity is getting bigger and bigger and bigger and bigger. Let's have a look at Woolies, right? So Woolies, I, let me just state for the record before anyone writes into you with a bunch of hate. I think it's a great business,

Phil (37m 55s):

Right? It

Andrew (37m 55s):

It's a great business. Yep. It'll be around for a long time. It's hard to disrupt groceries. Some have tried like milk run and others, which is a whole other segue we could get into. But, but they, they look historically it's sort of been around 5%, which is outstanding for a very mature business, right?

Phil (38m 17s):

5% earnings growth,

Andrew (38m 19s):

Earnings per share, earnings growth. I'm gonna assume that that's about true. And the ROE calculation, we just did kind of sanity checks that. So we said 6% they've done historically 5%. Now, again, I've, I've gotta guess at what the earnings, I've gotta, gotta make a guess. You could suck your thumb and go, I reckon it's gonna be 10%. But just because now maybe you're right and maybe I'm wrong, but if I go at least, well I reckon it's more mid-single digits based on these two things, at least I've got a bit of, again, that detective evidence sort of behind me. I also look at Woolies and I go, well historically, look over the last 10 years there's ups and downs if the share price, but the PE tends to be around 18 19.

Andrew (39m 0s):

And again, that contrasts with the, the longer term average of the market of sort of 15 16 trades at a bit of a premium and probably understandably so. That's cool. So let's tie this all together. So let's say that I think that they're earn, well they are earning a $1.36 of the most, most recent financial year, a dollar 36 per share. Per share. Yep. Yep. So a lot more in, in when you add it all up. But per share they're making about a dollar 36. Incidentally, they're trading at a PE of 30 something at the moment. So very well priced. So what's that mean? It means that the market expects some pretty good things.

Andrew (39m 42s):

Yeah. Now market might be right, your job as an investor to see if it's right or at least see if you can build some conviction around that. Anyway, I'm gonna, I'm gonna, I just, I just point that out there for, put that out there just to sort of set the scene. But I'm gonna say, and I just went to COMSEC and looked at the consensus forecast here. And in three years time, the boffins reckon the dollar 60 per share, take it with a big grain of salt. But just for the purposes of this, I'm gonna assume a PE of 18. Now maybe it's higher, but I, again, margin of safety, it's no one's gonna, I might be wrong, but no one's going to say I was reckless by using that forecast cuz it's about the average for Woolies. And if it's higher, who cares? It means my return will be better than I'm calculating.

Andrew (40m 23s):

So a dollar 60 times 18 gets me $28 80. That's what I think it will. If the sh if the earnings per share are a dollar 60, if the PE is 18, the share price will mathematically guaranteed be $28 80 and three years time. Now I want to account for that in today's dollars. So maybe I'm gonna discount that back. What, what figure do I use? Well, you use your rate of return that you want. So given that they pay a pretty good dividend, pretty reliable one, let's, let's call it 3%. It's not, at the moment it's less than that. But I'll assume I'll get a 3% dividend return. I want a 10% return as a shell. That's just me. You could pick whatever number you want, but I think that's, that's a pretty good line in the sand.

Andrew (41m 4s):

So it means I want a 7% capital growth. So if I take $28 80 and and discount it by 7% per year, so just 1.07, three times I get $23 and 50 cents. So I've just worked out an intrinsic value calculation for Woolworths. Now, is it right? Well if my assumptions are right, it's absolutely right. But again, don't get caught up in the false specificity. What I look at here is I go, well the markets, I'm just under those scenarios. It's gonna continue to grow at a decent rate. It's going to trade at its long-term average PE and that's, I'm buying it for 38 70 and I might be able to sell it for 2350 under these assumptions.

Andrew (41m 47s):

That's a pretty bad deal even for a wonderful company. So the question is, the first thing you go is, huh, what am I missing here? And this is what does your head in, because you, it's very natural, especially when you lack confidence and you're starting off is I'm wrong, the market's right, actually the market can be wrong all the time. And thank God for that because that's, that's our stock and trade. You want the market to be wrong. So I'm not saying the share price of Woolies is gonna crash. I don't say it can't go high, I could double from here. But I know that for me to do well as an investor, if I'm buying shares in Woolies today, and maybe someone who knows the company intimately well, so, well Andrew, what you're forgetting is this, this, this, and this.

Andrew (42m 27s):

And that's fine, right? You've answered the question. But those earnings per share have to be higher in three years time or the market and or the market needs to be trading in a much higher multiple at that point in time for me to do well. So if I've got great confidence in those things, then fine, fine. If I don't, and I personally don't, not cuz I'm definitely not gonna do, I just, you investing is not a hope, is not an investment strategy. I just feel as though this is an extraordinarily mature business. I mean, you can't, there's not that many places where Woolies doesn't exist where one could exist. There's only so much they can put their prices up each year. You know, all of these kinds of things. Again, great company, but it just, if, if, if I had come up with a valuation that was 10% or 15% either side of the market price, again, don't fall into the false specificity.

Andrew (43m 17s):

Probably it's reasonable and fair at this point in time, but I'm miles away from it. So it just sits there on a watch list. Now at one, I don't know when Phil, but at some point the market will throw its toys out of the cot and you'll get it really cheap and then then buy it, then buy it then. And then there'll, there'll come a point where the market goes the other way. Where it's sort of like you work out a valuation that's 30% higher than what the market's trading at. And again, what do I, what do I not see that the market sees? And maybe the market's just wrong or it's being too myopic and too short term fo which is usually the way they're like, oh, it's gonna be a bad quarter and everyone sells off. Not realizing this thing will last for another 50 years. And it's more about how it performs in aggregate.

Andrew (43m 58s):

But that's a lot of detail to do verbally. I hope I haven't lost anyone. No, that's okay. But it's, it's, it's just keep listening. Am I gonna understand everything, the idea, I mean I'll, I'll, I'll try and I'll try and tie it all up to make it easy. I've done two things with return and equity and PE to work out if in this case Woolies is good or not. I've looked at the return on equity to see what kind of, how efficient they can take their equity and turn it into profit. And I've just looked at, well, you know, 20 all of a sudden they know that it's, this is a good business or at least historically has been a good business cuz they've seen that history of high 20% plus return. Great tick. That's one of the ticks on my detective list. But it also means that, again, through that calculation, I think sort of mid-single digit growth is about what they'll do.

Andrew (44m 42s):

Sanity check. Have they, what have they done in the past? Yeah. About that tick. That seems pretty reasonable too. Then I've just taken the per share earnings and I've multiplied it by 1.063 times to get a forecast of earnings per share. Anyone can do this, right? Do it on your phone. And then I've just picked a out of thin air, a PE that I think is reasonable. We can argue it if that's reasonable. But again, this is the beauty. You can do the numbers that you think are right. And I've said 18 cause it's about the long, long-term average. If I wanted to be more conservative, I could lower it. If I wanted to be more ambitious, I could. But I've done that and all of a sudden I've now got a target price for where I think Woolies could be in three years. And the final step is I just discount it back by the rate of return I want. And I've now got a line in the sand.

Andrew (45m 22s):

Now, as I said before, do a few, see where the spread lies. But, but I've no longer just bought the company because quote unquote, they're a good company. I've, I've bought it. You've a

Phil (45m 33s):

Bit more reason to do it. Yep.

Andrew (45m 34s):

I've drawn, I've taken a view of business performance and I've translated that back to value. And it's, it's, it's always going to be wrong because you can't forecast perfectly. And also you and I might have the exact same inputs, but we could still come up with different valuations because you're a different person with different experiences and different life circumstances. I've said I'm discounting it back at 7%. You might go, well no, I'm, I'm a pretty high octane investor. I want only the, I want a 12% on your return. So even with the same numbers except for that last one, we'll come up with very different valuation. Now, who's right? Actually neither of us is wrong.

Andrew (46m 15s):

You are right in your context. I'm right in my context. You just need a bigger discount for you. Advice will

Phil (46m 20s):

Reveal itself in three years

Andrew (46m 22s):

Time. Sure. And, and, and you, in your, in your framework, the way I've laid it out, if you buy it and you get, you know, 8% return, well relative to your desired rate of return, it's a bit of a miss. Right? Relative to me. It's actually not too much of a miss. So, you know, it's, it's, it's just about what you want and, and how it relates to you. This is the, this is the nice thing about the market, right? Is, is that you, you often look at things, why is that happening? Why are people selling? And you've gotta remember that people are acting under all kinds of different incentive schemes and situations. The shares have gone down 2% today. The natural reaction is, oh my gosh, it's a disaster. Well, maybe they got reweighted in an index and some of the ETFs are readjusting.

Andrew (47m 7s):

Maybe one of the big substantial shareholders has gotten in trouble and needs to liquidate there. I know there, there's a bunch of plausible reasons as to why something can happen. Yeah.

Phil (47m 17s):

It's gonna affect the price,

Andrew (47m 19s):

Right? It gonna affect the price.

Phil (47m 20s):

Yeah. It doesn't have anything to do with the business.

Andrew (47m 22s):

Does it have anything to, or, or maybe it's even something more fundamental where Wooley's latest sales results are disappointing analysts had expected 5.8% sales growth that came in at 5.2. Now anyone listening to, they go, what's a big deal? But for analysts, they will

Phil (47m 36s):

Plug, lose, plug, plug these numbers into a spreadsheet.

Andrew (47m 39s):

Oh my gosh, it's a disaster sale recommendation. Boom, boom, boom, boom. And everyone, oh, now it's a good sales result. And bang, we all pile back in and it's madness. But that's what's going on. If you can sort of rise above the chaos and like when you're, anyone rides a motorcycle. So the idea is, is you keep your eyes on the horizon. You don't, you don't look at right in front of you when you're driving a bike. And that's the same with investing. Look out beyond that, any business is gonna have good years, bad years. And it's not, it's not about trying to have this hyper-specific forecast like analysts do is what's this company's per share earnings going to be at the next half year result. And you know, it's more about is this something that over the fullness of time is going to generate an attractive return on equity that is available at an attractive enough price that allows for a decent return while all accounting for the vicissitudes and, and volatility of market and business and life.

Andrew (48m 35s):

And it's, it's, it's about being one of my favorite sayings. It's about being generally right as opposed to specifically wrong. And yeah, it

Phil (48m 45s):

It, it's interesting that you talk about when the market throws its toys out of the cot. And a recent guest said to me, and it's something that's really stuck with me, is that earnings are far less volatile than share prices. Oh, yes. Which is really interesting way of looking at it, isn't it? That even though the market might be going through one of those periods that we all, we all know, yep. The earnings are not gonna be affected that much.

Andrew (49m 11s):

There's, there's a gentleman called Peter Thornhill. He wrote a book years ago called Motivated Money. It's more a pamphlet than a book. Not to be critical, it's just very high signal. But, but he, that's core, the core point I think he's making there, which is, and, and this, and Buffet makes this point too, is if the earnings per share drive continually higher, it's a wonderful win to have at your bank. Again, excluding the example of where you overpay ridiculous amounts, that is always going to work out pretty well for you. And when animals spirits are running hot, we will go above that, that earnings per share line. And when things are really in the doldrums, we'll fall well below it.

Andrew (49m 52s):

The funny thing is, is that we always say, I can't wait for the next market crash cause I'm gonna back up the truck. And then it happens and then we go, oh, it's really scary. I'm just gonna wait for it to get better. Oh, actually, here's, here's my favorite analogy for what you've just described. I'm not gonna attribute it to the right person cause I've gone blank, but the US fund manager gave the example of walking a dog and there's a man, and I'll, I'll, I'll make it an Australian example. He starts at Central Station in Sydney and he's walking to Circular Key and he's got this crazy dog and he's got this very long leash. Now he's walking from central to circular key,

Phil (50m 29s):

Straight up pit street,

Andrew (50m 30s):

Six kilometers an hour, just walking. That's what he's going to do. The dog is going to be going off and sniffing that pole and you know, racing after that possum or whatever it happens to be, but is darting all over the place. Now, logically, you know, if you ask where's the dog going? Well, the dog's going to circular key as well. He's on a, he's on a leash. But what, what a lot most people do in the market is they focus on the dog and they're trying to guess where the dog is going by looking at where he is scurrying off to along the way. Whereas the true investors look at the man, and the man is the earnings per share. The dog is the share price.

Andrew (51m 11s):

And they, they can differ. So, so maybe the man walks ahead for a bit and the dog decides to bolt back 20 yards or something to sniff another dog's backside, whatever it happens to be. Now you are watching that. You're think, oh, the dog's now going that way. Oh, now that I'm gonna extrapolate from there. It's like, no, watch the man watch the long-term earnings trajectory. That is the bedrock and anchor of all investing. I think if you can get that right, and again, generally right, you're

Phil (51m 37s):

Gonna do pretty some of the time. So,

Andrew (51m 39s):

And again, some of the time Right,

Phil (51m 40s):

I can get every call, right, are, yeah.

Andrew (51m 42s):

Well, but that's the, the thing is, is that frustrating thing about investing is that you can make money by doing dumb things and you can get punished for doing smart things. And it's, it's, it's, it's just, it's just how it is. The the, to help you work out that, have I made a mistake or not, you haven't made a mistake cuz the share price has gone down. You've made a mistake because the company isn't performing in the manner that you expected. That's a different story. In other words, you thought the man was heading to circular key turns out no, he is going to head off to Redfern. In which case, all you know, it's completely different focus on the man, not the dog.

Phil (52m 17s):

And you prefer to hunt small game, don't you? Yeah, yeah.

Andrew (52m 19s):

I much, much prefer it.

Phil (52m 20s):

So that, that brings me around to Strawman and, well, I'm just winding this up by just introducing that if people want to land on planet Andrew, it's Strawman Baby Giants podcast. Yep. Motley Fool Money podcast. Ozbiz. I think sometimes Yeah,

Andrew (52m 38s):

A bit of ozbiz. Yeah, yeah, yeah,

Phil (52m 39s):


Andrew (52m 39s):

Yeah. We're, we're a private online investment club. We're pretty small. We've pretty exclusive

Phil (52m 44s):

we get in twice a year.

Andrew (52m 47s):

Well, it sounds really snobby, but it's, we figured out that we only want the people who want to be there and we only want the people who are pretty serious. So we, we charge a pretty good premium for it. We've got about 600 paid members, but you're gonna open a free account if you wanna muck around and paper trade the market. We got a little portfolio tool there and some play money and you can trade the market and stuff. And that, that's, we've got about 20,000 people who, who do that. But yeah, come, come and check us out and the, you'll find us there. But, but we do tend to focus on small caps. Yeah. Yeah. And the reason that we do, I think, and it's not mandated, but that's where the members have sort of gravitated to, and that's where I gravitate to, is that they, a lot of people stay away from them because they're quote unquote risky.

Andrew (53m 26s):

And I think as a general rule that's true. Smaller companies, you more likely to be unprofitable more. They're in a growth phase, they're an earlier stage of, it's not bad to be unprofitable. All businesses are unprofitable at the beginning, but there's a lot of risk in, in that space. What people don't realize is that there's actually a lot of really great businesses in there that very profitable pay a dividend, been through all kinds of cycles, been

Phil (53m 52s):

Around for, I mean, I know one particular company was over a hundred years, you know, just a tiny one. A big what? Big river industries. Okay.

Andrew (53m 59s):


Phil (53m 59s):

Yep. As an example, no one would've heard

Andrew (54m 1s):

Of it, right? Yeah. And

Phil (54m 2s):

This is no recommendation to buy, by the way, you know, it,

Andrew (54m 4s):

It's, it's, they, are they more volatile? Yes, they are. But volatility is not risk. Risk is, is the chance of permanent loss of capital. Volatility to the true investor is a gift from heaven. You know, if you wanna buy things cheap, you need that vol, you need the stomach to sort of sit through all of that. And the other challenge with small cap investing is the liquidity is not always there. There is, I've got a stock that might trade five or $6,000 on the ASX a date. So it takes a while to build up a good position. And if anything was to go pair shaped, it'd be very hard to get out quickly. It's a bit of a lobster trap, but you, you have a lot of clear water because the fundies don't go there. The brokers don't go there and they don't go there because, well, if, if you've got a hundred million dollars that you are managing, there's just not enough shares on market for you to take a position, doesn't, you might love the business, you can't do it.

Andrew (54m 55s):

Now that, that takes away a big part of the competition. So now it's me and a bunch of other punters on there, so I don't have to be the smartest person in the world, but I don't wanna compete against the Harvard educated m i t guy at, you know, UBS that has a team of 400. And, you know, that, that's, that's hard. This is the, the lower grades, so to speak, but with incredible opportunity there. And so, yeah. Anyway, I I, I like the small cap space.

Phil (55m 21s):

There's only a couple of LICs that you'd really be competing about in the Yeah. In the bigger end of town, isn't it? Yeah, yeah, yeah.

Andrew (55m 27s):

There's, there's companies on there. Like, I've got a company at the moment, it's only 12 million in total. The market caps 12 million, they're doing about 110 million in sales, right? They're on track to launch a dividend next year. No one goes near it, right? It's just too illiquid. It's too hard. It's too under the radar, it's too small. And I'll be, it's

Phil (55m 46s):

Still ultimately a good business. I think it's, look,

Andrew (55m 48s):

If I was again, a billionaire and someone said, Hey, would you be interested in this business at this point? Yeah. The, the, the challenge with it is, is that you, again, aside from the volatility, you have to be a very patient investor. These are all the overnight success. What I hope that's 10 years in the making. You know, it's like if they continue to do half as well as they think they will in three or five years time, the market will discover them. The liquidity will come. And not only do you get the push in the earnings part, but remember the PE ratio, right? The price equals earnings per share times the, the, the pe There's gonna be a point where people are gonna go, whoa, there's two points. You get, you, you get the, the per share earnings growth that you hopefully envisage for the business, but you get the point where it goes from a PE of six to a PE of 20 as the market cottons onto it.

Andrew (56m 39s):

So you get this leverage gain, but it just takes years. So I've, I've done okay, but some of my best investments have, have been ones that did nothing for two years. And that's hard psychologically, but that's the price of being early. And it's nothing wrong with being early if the gains are big enough, right? And it's all right if I buy at a dollar and sell it $5 over five years and the share price didn't really move until year four. You what it feels like. You get this massive gain on the final year. But on an average basis, it still works out really well. Anyway, I could go on all day about small caps, but I, I, I, I think, I think they are unfairly tarnished by others that just sort of dismiss them as too volatile and too risky.

Andrew (57m 26s):

Even though that's generally true, there are plenty of diamonds in the rough and you get to invest in them with, with far less competition.

Phil (57m 34s):

Andrew Page, it's been great chatting with you again.

Andrew (57m 39s):

Thanks Phil.

Phil (57m 39s):

I think we've got at least three episodes outta this way.

Andrew (57m 41s):

Yeah, probably. You know, you know, you're gonna get a lot on.

Chloe (57m 45s):

Thanks for listening to Shares for Beginners. You can find more at If you enjoy listening, please take a moment to rate or review in your podcast player or tell a friend who might want to learn more about investing for their future.

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