Letters of the Week

BHP’s true value. Beach Energy. Theory vs reality in equity returns.

Value investing
Now Roger Montgomery has me really confused (Blue chip escape). I bought his book, Value.able, and embarked on his investment philosophy of buying into businesses at prices below their intrinsic value – value investing. BHP and Rio are both 14% below intrinsic value, (Skaffold, May 17), and yet Roger is selling them! If he believes his own book, he should be buying them. At least he is honest enough to let us know he is being contrary to his book's investment principles. I want to be first in line when he hands out refunds!

– R Marlborough

Roger Montogomery’s response: BHP is indeed at a discount to its current estimated intrinsic value. In the future, however, valuations change. When Warren Buffett said, in 1987, “the speed at which a business success is recognised, furthermore, is not that important as long as the company's intrinsic value is increasing at a satisfactory rate”, he alerted me to the importance of mapping future intrinsic values, and so I introduced the concept to Australian investors, in my book and here at Eureka Report. Prior to this, I can find no evidence of the concept being implemented as part of an investment strategy.

The impact of this revelation is that investors must have an eye to future valuations rising at a 'satisfactory clip'. If iron ore prices fall and/or demand declines (remember ’if’), BHP's margins will be under pressure and therefore its prospects for increasing intrinsic value. We don't want to buy or own businesses whose intrinsic values may decline – even if they are cheap today when compared to current estimates.

Any substantial decline in iron ore prices would have significant adverse repercussions for intrinsic values in the future. Remember that future intrinsic values are based on forecasts and I simply believe that, in the absence of a strong conviction that iron ore prices will really stay at $140/t, pride prevents those who have put buy recommendations on BHP changing their recommendations and earnings forecasts. If they did change their forecasts for future profit, you would see intrinsic values forecasts change immediately.

The alternative is that I am comprehensively wrong and iron ore prices stay where they are, or go up and Chinese demand rebounds. Under that scenario, BHP's share price would rise to its current forecast intrinsic value estimates.

You must, of course, seek and take personal professional advice before engaging in any changes to your strategy or portfolio, or trading in any securities.

Beach weather?

I read Robert Gottliebsen's congratulations to his partner for his prescience last December in warning investors about grim times ahead (A call ahead of its time). But he made no mention of the current performance of Beach (BPT) which Eureka Report at the same time listed as one of the hottest stocks for 2012. It would be good to get an updated assessment.

– J Tulloh

Editor’s response: Beach Energy remains a stock closely watched by Eureka Report, and one that is regularly reported on by Tim Treadgold, who is interested in the group’s shale assets. Tim most recently wrote on Beach Energy on March 5.

Rough retirement wicket

Congratulations A Abbott on your letter (Letters of the week, May 16), I could not have put it better myself. James Kirby must be in another world to most – if you have even $10,000 to put into super as you approach retirement age, you are on a better wicket than the vast majority. Come on Eureka Report, report to us, the silent majority, not the pampered few!

– A Maree

Theory versus practice

The May 11 article by Scott Francis just doesn't ring true. Equities returns can be accurately tracked by the performance of a number of large and respected LICs. My portfolio, for example, has AFI shares bought in July 2006, which show a loss of 10.39% of capital in six years and returns of 4.7% p.a., including franking credits. My Whitefield (WHF) shares since August 2007 have a capital loss of 43.2%! Returns including franking are 5.1% p.a. The advisers’ beloved banks show NAB shares from November 2009 to present have a capital loss of 18.9%, which wipes out all dividends including franking (return 0%). Westpac from May 2010 to end of 2011 has a return of -2%. My losses on Leighton, Hastie, Panoramic Resources, Westfield and even Perpetual don't bear telling, they are so bad. These are not hypothetical; they are real experiences of a self-funded retiree.

– Name withheld