Seven secrets from an investment master

Australian Foundation Investment Company chairman Bruce Teele and I sat down this week to yarn about his experiences, and right in the middle of the interview he dropped a clue as to one reason why Telstra shares have performed so well. But that takes us ahead of ourselves.

Teele has been a director of AFIC for 47 years, and at the age of 76 he is now about to retire. I wanted to yarn with him to gain some extra hints for readers and help for people with their portfolios by looking at the way he goes about making fundamental investment decisions.

As you will see in the video, Teele starts by telling the story of his predecessor, Staniforth Ricketson, who set up AFIC and was the senior partner in brokers JB Were for a generation or two. A young Bruce Teele “went to Mr Ricketson” suggesting that AFIC buy a particular stock. (To view more of my interview with Bruce Teele, click here or go to EurekaTV.

Know the board

Ricketson came back and asked Teele to look at who was on the board. Once they had seen who the directors were Ricketson said to Teele – “that’s why we don’t want to buy that stock”. So Teele says that when he is looking at a stock the first thing he does is to look at the board, and if he is not happy with that board he doesn’t look much further. The next thing is to talk to the CEO. Small investors can look at the structure of the board and who is on it, but usually don’t get a chance to talk to the CEO.

Listening to shareholders

Teele is encouraging Australian companies to go out and have shareholder meetings on an informal basis. The current formal shareholder meeting structures are not very productive because they involve decisions on salaries and other matters. But some companies are now having meetings purely for shareholders, with no decisions to be made – simply information sessions where shareholders can ask questions about the company.

One of the companies that has taken up Teele’s suggestion is Telstra, which now has had shareholder meetings around the country where smaller shareholders get the chance to evaluate CEO David Thodey. Clearly there are many reasons for the Telstra price rise, but shareholders getting the chance to meet Thodey would have helped

Succession planning

And Teele says that in evaluating the CEO he has a number of tests which would not normally be on your list to ask. For example, he asks where the chief executive gets his or her information from and watches closely to see how he handles and promotes his deputy. If the deputy is also strong, there is a succession plan in the company. Shareholders should press their company to hold briefings around the nation instead of spending so much time with the legacy institutions.

Self-managed funds now control about 30% of the superannuation market. Teele believes that the rise in self-managed funds is a wonderful development because smaller investors normally invest for the long term and are much more interested in long-term strategies than they are in the quick short-term outcomes that the institutions favour. In this context, one of Teele’s favourite stocks is Wesfarmers, because when the Wesfarmers CEO Richard Goyder talks to AFIC he often defers to his deputy, Terry Bowen. As a result, Teele and his people are able to assess management continuity, which is so important in long-term planning.

Past mistakes

One of the features of Wesfarmers is that it has not forgotten its history, and the company spends a lot of time to make sure that past mistakes are not forgotten. Teele believes that most Australian companies have lost the knowledge of their history, and in that sentiment I agree. Earlier this year I was at a dinner organised by BHP and found, to my horror, that I knew far more about the history of BHP and their good and bad decisions than the current management does. As a result, there is nothing to stop BHP from making the same mistakes again. I hasten to add that there is no sign that BHP is about to do that but, whether it be to this generation of managers or the ones that are to follow, the BHP history is not being passed down.

Like me, Teele believes that the current emphasis on yield is a passing phase. He has been a long campaigner for companies to pay higher dividends, but the current pressure is far more intense than anything we have seen in the past because interest rates on bank deposits and other interest-bearing securities have become so low.

Banks

The simple situation is that companies must reinvest in themselves and have long-term plans; dividends are important but so are retained earnings.

On this front, I asked Teele about the banks, especially as AFIC has 30% of its money in bank stocks. Teele is confident that the banks have sufficient retained earnings, but what he really likes about the Australian banks is that they have substantially curbed their high-risk trading and are being much more careful about their loans.

This week I dined with the executives of one of our top four banks on a Chatham House rules basis. What really impressed me was that the CFO of this bank volunteered that all the big bank disasters of the past have come via lending to high-risk property developments. As a result, the bank was now much more careful about such loans. Of course, that means that it is much harder to get supply of apartments and houses because developers have to find other forms of finance or have a very secure balance sheet. But in terms of the bank’s shareholders the amount of risk is being contained because the bank remembers its history. And that no doubt is why Bruce Teele is so confident about AFIC’s investment in banks.

Buy-back concerns

Teele gives us another warning of our chief executives. Beware of companies that engage in major buy-back exercises. Usually they undertake these buy-backs when the company is performing well and has lots of cash. All too often the buy-backs take place at the top of the market, and Teele recalls how before the global financial crisis that is exactly what the Australian banks did. They then had to replace the equity at much lower prices. Teele believes the right way to distribute cash is via dividends, preferably fully franked dividends. But he concedes that CSL is the exception. This company purchased its shares back at much lower prices than today’s value, and the stock has continued to increase in price, so it’s been very beneficial to shareholders. Of course CSL is continuing with its share buy-backs, so the risk becomes greater the higher the stock gets.

I asked Teele why Oil Search was so high in the AFIC portfolio (see A gas giant in the making). He came back instantly, because he was very impressed with the Oil Search management team led by managing director Peter Botten.

Investing back

In particular he was impressed by the amount of work they have done boosting Papua New Guinea with major investments in hospitals and other facilities. They didn’t just go there and take out the money.

He is also impressed because Oil Search can produce oil at half the cost than in Australia, and is set to have a major income stream. He has also questioned the Oil Search team about what they plan to do with that stream, and presumably is happy that a big portion of the money is going to flow to shareholders.

Teele believes that Australian institutions, in their quest for quick profits, have sold out a series of incredible valuable infrastructure companies in Australia including ConnectEast and the pipeline operations. The Canadians, who have a longer-term view, understood the value in these infrastructure investments.

Unfortunately it is going to take some time to create new infrastructure investments and there is clearly some risk in start-up infrastructure. In my view, the growth of self-managed funds has been necessary because our institutions did not take longer-term positions and thought too much about the short term. There is much to be done to get our Australian companies to start thinking the same way as their new breed of shareholders.