Facts and Figureheads

These are dangerous days for Qantas as fuel prices soar, offshore outsourcing sparks industrial unrest, and terrorism clouds travel forecasts. But Qantas has something every company desires: a highly regarded chief executive. Five years into the top job, Geoff Dixon cushions the airline from reality. Dixon, it is said, has done wonders in what should be a dog of a business.

The airline business has little in its favour, yet Dixon makes the sun shine and investors largely ignore the negative signals accumulating for Qantas, focusing instead on the sterling job Dixon has done with a difficult assignment.

Is Dixon that good? The stock has quietly slipped from about $4.00 to $3.20 since February. Yet Dixon remains broadly supported in the market. Many believe Qantas remains a good long-term investment as a global stock on the ASX.

A closer look at the numbers shows that Qantas has lifted profits from $419 million to $760 million a year during Dixon's tenure. But Qantas under Dixon had accumulated borrowings, additional share capital and retained profits of $5.5 billion. On the $5.5 billion that Dixon accumulated, Qantas earned an additional $110 million last year. Had he put the money into a bank account earning interest of 5.75% he'd have made $136 million.

Dixon is good, but he's not that good. In fact, it's fair to say that were it not for the boon of franked dividends, many investors would have sold out of Qantas by now.

Numbers-plus

If investing was all about numbers it would be very easy indeed. The best companies would have the best numbers; the best numbers would instantly indicate the best stocks. A computer program could solve the mysteries of sharemarket investing.

But it’s not like that. Companies are run by highly persuasive, impressive and often charismatic people such as Geoff Dixon. Any analysis of listed company numbers will always be highly influenced by the cult of leadership. Unfortunately, the numbers don't speak for themselves. The chief executive gets to interpret the company numbers first and that makes all the difference.

To try and divine the true dynamics of sharemarket companies, we have to find the numbers that tell us most about management ability and fuse that intelligence with informed character assessment.

It's the lure of charisma that makes the market overrate or underrate stocks. Big names like Dixon get over-rated. Names that barely register on the radar such as Dick McIlwain at Unitab or Alan Wilson at Reece get underrated.

Consider the story of Newcrest Gold. Australia’s biggest gold miner is sitting exquisitely positioned atop a commodities boom. It’s also a takeover target. But has it been a good investment? Not at all. With a return on equity of 13% Newcrest is currently trading at about $20.50 down from a top of $27.00. Moreover, the Newcrest price was falling long before the commodity price of gold began to drop earlier this month. Newcrest has been beset by production problems; a higher gold price could not save a company that failed to exploit boom conditions.

It's no coincidence that last month Newcrest dispensed with the services of its long-running managing director, Tony Palmer. Palmer could not impress the market even though he was literally sitting on a gold mine. What might Reece's Alan Wilson, who has turned out a return on equity (ROE) of 31% in a flat construction sector, have been able to do given a similar opportunity.

A strong company leader throws many of our textbook assumptions out the window. Qantas should have keeled over and died like Belgium's Sabena Airlines five years ago, but Dixon's strong (though not remarkable) talents kept the stock alive as a credible choice for local investors.

Exceptional leaders take ownership of the business and make it sing. The business may not make sense. Who would recommend a coal and retailing operation '” Wesfarmers '” without understanding the company was led by Michael Chaney, for many years the most admired chief executive in Australia?

Who would invest in a company that sold sofas, televisions and computer equipment? It's a family concern run by a husband and wife. The husband runs a sizeable share portfolio through the company accounts. Welcome to Harvey Norman.

Or what about an insurance company in an era when local investors are still recovering from the HIH insurance scandal and are fretful about climate change? QBE's Frank O'Halloran has defied the doomsayers so long the market could be forgiven for thinking O'Halloran is faultless.

MHow they've performed
Qantas (Geoff Dixon)	2001	2002	2003	2004	2005
ROE (%)	17.6	12.9	10.3	14.8	15.6
ROE Distributed as dividends (%)	12.5	10.3	8.7	8.2	8.5
Payout ratio	71.02	79.84	84.47	55.41	54.49
ABC Learning (Eddie Groves)	2002	2003	2004	2005	2006 f
ROE (%)	48.3	26.1	19.2	15.4	11.6
ROE Distributed as dividends (%)	33.3	10.8	7.9	6.6	5
Payout ratio (%)	68.94	41.38	41.15	42.86	43.10
Macquarie (Allan Moss)	2002	2003	2004	2005	2006 f
ROE (%)	20.4	27.1	28	33.3	31
ROE Distributed as dividends (%)	15.1	24.6	8.2	15.6	16.5
Payout ratio (%)	74.02	90.77	29.29	46.85	53.23
Flight Centre (Graham Turner)	2002	2003	2004	2005	2006 f
ROE (%)	49.5	32.6	29.5	28.1	24.6
ROE Distributed as dividends (%)	29.5	19.5	16.3	32.6	17.3
Payout ratio (%)	59.60	59.82	55.25	116.01	70.33
Leighton (Wal King)	2001	2002	2003	2004	2005
ROE (%)	26	27.9	23	19.5	30
ROE Distributed as dividends (%)	17.6	19.7	19	20.4	20.3
Payout ratio (%)	67.69	70.61	82.61	104.62	67.67
Computershare (Chris Morris)	2001	2002	2003	2004	2005
ROE (%)	20.36	21.9	15.8	27.7	26.4
ROE Distributed as dividends (%)	2	5	8	10	11.6
Payout ratio (%)	9.82	22.83	50.63	36.10	43.94
Sigma (Elmo de Alwis)	2002	2003	2004	2005	2006 f
ROE (%)	11.5	15.3	19.8	22.9	15.5
ROE Distributed as dividends (%)	7.8	10.2	11	14.2	20.1
Payout ratio (%)	67.83	66.67	55.56	62.01	129.68
Unitab (Dick McIlwain)	2002	2003	2004	2005	2006 f
ROE (%)	47.3	68.4	70.5	76.5	95.3
ROE Distributed as dividends (%)	39.4	52.6	64.4	71.9	93.6
Payout ratio (%)	83.30	76.90	91.35	93.99	98.22
Toll Holdings (Paul Little)	2001	2002	2003	2004	2005
ROE (%)	33.5	33.4	28	29.4	28.5
ROE Distributed as dividends (%)	15.9	14.3	10.5	11.2	12.4
Payout ratio (%)	47.46	42.81	37.50	38.10	43.51
Reece (Alan Wilson)	2001	2002	2003	2004	2005
ROE (%)	20.8	28.1	24.8	29.6	31.5
ROE Distributed as dividends (%)	10.2	13.6	5.3	13.2	15.7
Payout ratio (%)	49.04	48.40	21.37	44.59	49.84
ARB * (Roger Brown)	2002	2003	2004	2005	2006 f
ROE (%)	39.4	38.4	38.7	40.4	31.4
ROE Distributed as dividends (%)	21.5	19.6	20.4	49.9	19.9
Payout ratio (%) * 2005 Special dividend	54.57	51.04	52.71	123.51	63.38
Rural Press (John B Fairfax)	2001	2002	2003	2004	2005
ROE (%)	7.4	18.7	11.4	15.3	19.1
ROE Distributed as dividends (%)	8.4	3.2	12.7	12.1	16.8
Payout ratio (%)	113.51	17.11	111.40	79.08	87.96
Cabcharge (Reg Kermonde)	2001	2002	2003	2004	2005
ROE (%)	18.2	20.4	24.8	25.8	28.1
ROE Distributed as dividends (%)	13.9	16.2	16.9	18.2	19.2
Payout ratio (%)	76.37	79.41	68.15	70.54	68.33
QBE Insurance (Frank O'Halloran)	2001	2002	2003	2004	2005
ROE (%)	14.6	14.1	21.7	25.7	27.2
ROE Distributed as dividends (%)	9.4	10.3	9.4	9.2	13.6
Payout ratio (%)	64.38	73.05	43.32	35.80	50.00
Fantastic Furniture (Julian Tertini)	2002	2003	2004	2005	2006 f
ROE (%)	63.2	73.2	80.5	67.5	44.8
ROE Distributed as dividends (%)	25.3	36.1	41.8	39.9	37.5
Payout ratio (%(	40.03	49.32	51.93	59.11	83.71
Sonic Healthcare (Colin Goldschmidt)	2001	2002	2003	2004	2005
ROE(%)	15.7	14.1	14.9	16.9	20.3
ROE Distributed as dividends (%)	12.3	10.3	11	12	14.6
Payout ratio (%)	78.34	73.05	73.83	71.01	71.92
Bendigo Bank (Rob Hunt)	2001	2002	2003	2004	2005
ROE (%)	17.2	16	16.4	16.3	17.6
ROE Distributed as dividends (%)	20.8	11.5	10.7	11	11.7
Payout ratio (%)	120.93	71.88	65.24	67.48	66.48
JB Hi-Fi (Richard Uechtritz)	2003	2004	2005
ROE (%)	28.8	45.3	49.3
ROE Distributed as dividends (%)	0	44.8	21.6
Payout ratio (%)	0.00	98.90	43.81
ANZ Bank (John McFarlane)	2002	2003	2004	2005	2006 f
ROE (%)	28.6	24.9	25.7	23.1	24.9
ROE Distributed as dividends (%)	19.6	9	16.9	15.8	17.8
Payout ratio (%)	68.53	36.14	65.76	68.40	71.49
Great Southern (John Young)	2002	2003	2004	2005	2006 f
ROE (%)	18.1	25.1	35.9	27.1	21.2
ROE Distributed as dividends (%)	30.2	10.6	8.4	8.4	8.5
Payout ratio (%)	166.85	42.23	23.40	31.00	40.09
David Jones (Mark McInnes)	2002	2003	2004	2005	2006
ROE (%)	10.2	10.9	-3.6	21.1	24.3
ROE Distributed as dividends (%)	11	9.8	8.8	13.1	18.1
Payout ratio (%)	107.84	89.91	–244.44	62.09	74.49

How do we usefully analyse company leaders? How do we get a valid measure of the value they create in the companies they lead?

Net profit is useful, as are price/earnings multiples. Better still is ROE and dividend payout ratio. ROE is a measure of the how much the company has made from the money you invested. Dividend payout ratio is a measure of how much of that money the company is prepared to hand back to you.

Roger Montgomery, managing director of Clime Asset Management, a specialist in return on equity valuation, says: "A business that can generate a high rate of return on equity is worth more than a business that cannot, all things being equal. This is logical. If you could give $1 to someone who could generate a consistent 20% a year, they would be worth more in present value terms than someone who could only generate a consistent 10%."

But the successful formula must be a blend of those key numbers and getting 'the number' of the chief executive. If that sounds like the sort of wooly intangible that you might expect to hear from a new-age academic, listen to this quote on the art of selecting the best company leaders: "They love their business, they think like owners, and they exude integrity and ability." That’s from Warren Buffett, the world’s greatest investor.

The danger on the ASX is not that we generally underestimate our company leaders, it’s that we overestimate the chosen few. It’s a danger because obviously if you give too much power, too much applause, too much money to any one individual they can lose their grip on reality.

Dixon is a subtle example of an overrated executive from the top levels of the market. There are more obvious stories. David Vaux at healthcare operator DCA, who watched his stock plunge 20% after delivering his first-ever negative news to the market. At DCA, the numbers were good but the chief executive's reputation was extraordinary; when Vaux announced his first profit downgrade investors were sorely disappointed.

Michael Malone, the mathematician who seemed to offer a glimmer of hope in the luckless technology sector as managing director of iiNet also turned out to be all-too-human. When iiNet relisted last week after an extended voluntary suspension the stock dropped 50%.

If you overrate an individual you overrate the stock and sooner or later that will lose you money.

Take Eddie Groves at ABC Learning Centres. How durable is that model of a corporatised childcare chain and can it be exported overseas? Ignore the ABC Learning share price for a moment (and that's not easy given it has roared from $5.45 to $7.60 in 12 months). Now look at the profits. ABC Learning almost doubled from $21 million to $38 million in 2005. In the year to June 2006, analysts estimate the profits will jump to $90 million.

But the concern at ABC Learning is the haunting words of Benjamin Graham (Buffett's mentor) who warned the price will always follow value. Groves is expanding ABC Learning Centres offshore. To do so he's issuing huge licks of capital. As the capital expands faster than the profits at ABC Learning Centres, the ROE is dropping (from 15% in 2004 to 11% in 2005); it means money invested in Groves is earning less than it used to when the company was smaller. Put simply, Eddie Groves is not as good value an investment as he used to be.

Graham Turner at Flight Centre struggles with the same problems but the market has already punished Flight Centre as its ROE slid from dizzy heights to merely acceptable levels in recent years. The Brisbane-based travel agent managed a return on equity of 64% in the late 1990s. By 2006 the number had dropped to 24% and the stock had nosedived from $14 to $9.85.

But that’s not to say the cult of personality is a negative. When the right executive is sitting in the right chair it is beyond doubt the company will thrive. The sheer presence of John McFarlane in the chief executive's chair has lifted the bank from the torpor of Don Mercer's era when the bank's strategy appeared to drift.

It's worth noting that McFarlane has taken ownership of the business in the fullest sense: with about 1.8 million shares he is its biggest individual shareholder. McFarlane's ANZ is a top performer on the key ratios of ROE and dividend payout ratio. The big bank average this year is 20% but ANZ sails ahead with 24% and McFarlane directs a payout ratio of 71% with a keen eye on the franking credits much appreciated by ASX investors.

The wider issue is whether other chief executives piggyback on the cult of personality and get paid for looking like a superstar when they're not. At PaperlinX, the office supplies manufacturer Tom Park went through revolving doors at Goodman Fielder and Southcorp before settling into PaperlinX. At one stage, Park was one of the most highly paid executives in Australia. Since Park was appointed to PaperlinX the stock has gone from $4.14 to $3.00. For the record, the PaperlinX return on equity is an unimpressive 5%.

As Montgomery of Clime Asset Management points out, when the very best managers such as Allan Moss at Macquarie Bank get everything right they can build empires, issue huge amounts of capital year after year and still keep ROE buoyed at levels of more than 25%. Says Montgomery: "Any business that can only manage a mediocre return on equity should refrain from retaining profit and distribute it as dividends to shareholders."