The share price of Perpetual Equity Investment Company (PIC), the listed investment company (LIC) managed by the team at Perpetual, has risen in recent months to more closely reflect the underlying value of its portfolio.
A large portion of PIC's returns have come from its biggest holding Woolworths. Investing in Woolworths when concerns over competition from Coles, owned by Wesfarmers, and Aldi were near their peak was something we agree with: we upgraded Woolworths to Buy in October 2015 before downgrading to Hold in August last year.
PIC shareholders have also been spared recent volatility thanks predominantly to its approximately 24% cash balance, while also being dramatically underweight the banks. Currently Westpac is the only bank in its portfolio, and even then it only represents a 2.2% weighting (a far cry from the 9.7% weighting for Woolworths).
Narrow discount to NTA
High cash balance
Downgraded to Hold
PIC's cash balance has been as low as 13% in the past but of course varies depending on the number of undervalued opportunities PIC's investment team identifies. Over the last twelve months this high cash balance has been a positive for PIC's returns but could easily lead to underperformance as well, especially in times when the index is inexorably rising.
The ability to vary its cash balance is only one of PIC's attractions. Perpetual’s investment philosophy is rooted in value investing which, as you might have guessed, we agree with. Its portfolio also has a wide mandate – PIC is benchmark unaware – which gives the investment team a great deal of flexibility to invest in undervalued stocks. Finally, NTA figures are reported daily so there's no guess work in valuing the portfolio.
At current prices, however, the discount to PIC's post-tax net tangible assets (NTA) per share is 6% and so we're downgrading to Hold. The discount to NTA will likely continue to stay low or even reduce further as long as PIC's returns remain adequate and its dividend continues to grow. Generally speaking, LIC investors pay greater attention to an LIC's dividend and so the higher the dividend yield, the smaller the discount to value. However, bear in mind that realised gains make up a high percentage of an LIC's dividend and so the returns of its underlying portfolio – and hence increases in its NTA – are just as important in affecting any discount (or premium) to NTA.
As we've noted previously, all things being equal, we like to see a discount that’s sufficient to make up for an LIC’s charges. So if you expect your investments to return 8% and an LIC charges 1% a year, then you’re losing one eighth of your return – that is 12.5% – and you’ll want to buy the LIC at a discount of this amount to get you back to square.
We may be prepared to relax this a little where we particularly like an LIC’s management and think they should outperform over time.
Note also that this is what we’d generally need to see clear value in an LIC – compared to making direct investments yourself – and therefore to make it an outright Buy. If you don’t want to pick your own investments then you will have to bear some costs, so it would make sense to only discount an LIC’s NTA by enough to overcome any extra costs above what a low-cost index tracker might charge. HOLD.
Note: We’re not going to put a price guide on the stock as its underlying value changes every day with the market.