Asset Management - Part 3
The last two articles have brought us to the point where we have a concise understanding of what we expect from an 'Asset Class share'. As noted in the previous article these expectations cover assets in general and not just shares.
Searching for lifetime, income producing assets is a boring and monotonous task … reliant on hard work and perseverance … not an ability to foretell the future. That said - let's now examine the guidelines for determining our benchmarks. As we are seeking 'Lifetime, income producing assets' we must consider the following 3 areas.
But before delving into each of these areas in detail, it is important to reiterate that the purpose of the Active Investing strategy, as it applies to either asset management or share trading, is to establish a minimal set of guidelines. Each of us has a different set of financial circumstances, financial goals and we are all of different ages. Therefore each of us must reduce the Active Investing guidelines to set of personal benchmarks, based on our individual circumstances.
This is the logic used by bargain hunting Traders who say 'The share price should go up' a lot. We can visually observe the inverse relationship between share price and dividend yield with the use of charts. Both of the following charts of Blackmores represent the same period in time.
The above dividend yield chart was generated using StockDoctor by Lincoln Indicators, a very powerful fundamental analysis program that is unique to Australia. Blackmores share price, shown in the first chart as an unbroken blue line, is steadily falling over time whilst the dividend yield, shown in the second chart as an unbroken blue line with small blue squares, is steadily rising. In next week's article we will continue to look at 'Income'.
- You want to own your assets forever…you never want to be forced to sell.
- You must very carefully assess the income producing capabilities of your assets
- You must purchase your assets at the lowest price possible
- Your assets must be able to withstand the passage of time.
Searching for lifetime, income producing assets is a boring and monotonous task … reliant on hard work and perseverance … not an ability to foretell the future. That said - let's now examine the guidelines for determining our benchmarks. As we are seeking 'Lifetime, income producing assets' we must consider the following 3 areas.
| Lifetime | Asset Class shares must represent Company's that will exist for our lifetime. |
| Income | Asset Class shares must have an acceptable dividend yield…or better. |
| Assets | Asset Class shares should be of quality and bought at the lowest possible price. |
Lifetime
If ever there was a gooey measurement, it's this one. In fact we are faced with a double gooey problem because firstly we have to quantify our own lifetime (you might want to consult your doctor on this one - but don't tell him why you want to know - he or she might throw you out - or worse, increase the bill as it may be tax deductible) and secondly how do we determine the life expectancy of a Publicly Listed Company? Our lifetime … the obvious guideline here is to find out what the average life expectancy of an adult Australian is and then subtract your own age from it. You may choose to go a step further and be gender specific. Your life expectancy will also vary dramatically depending on whether or not you smoke cigarettes, etc, etc, etc. Hence, for the purpose of establishing a minimum guideline let's use the broadly accepted male retirement age of 65 minus your current age. A Company's lifetime … there are several guidelines that we can combine in order to estimate a Company's life expectancy. We are definitely up to our armpits in goo on this one … the main problem being that we are required to make qualitative judgements about the stability of different commercial operating environments. In other words we must make an assessment of the longevity and stability of different industry sectors. Warren Buffet's choices in this regard are typified by some of the Companies that he has acquired in the past. He believes that men will always have to shave so he has bought shares in Gillette and he believes that everyone drinks Coca-Cola so he bought shares in Coca-Cola Ltd. He completely abstained from the 'Tech' doom on the simple basis that he perceived the operating environment to be subject to rapid change … not unlike the radio boom of the 1920's. Another guideline we can employ is the size of a Company in terms of its market capitalization. The simple logic here is that the bigger a Company is, the less likely it is to disappear off the face of the Earth. Mind you, past owners of HIH shares and Enron stock in the United States might disagree with this logic. But whilst size doesn't necessarily ensure survival, it is a statistically valid approach with the vast majority of delistings occurring among smaller capitalization companies. For asset class shares I would apply the simple cutoff of 100 Million dollars as a minimum as this level accurately describes the top 500 shares listed on the ASX. Of course we still need to assess each company on its own merits as there are always individual circumstances that can't be incorporated into global benchmarks as we have done previously. A typical example of this would be ANZ or Westpac. These banks would become likely takeover targets by the larger banks in the event of the dismantling of the 4-Pillar banking policy by the Federal Government. Therefore the 4-Pillar banking policy could have a direct effect on the life expectancy of these companies. As we have seen it's a very similar scenario for Media companies given changes to the rules on foreign ownership of media assets. So when it comes to assessing the life expectancy of a Company it will always depend on personal judgment.Income
Assessing 'Income' should prove a lot more straight forward than assessing 'Life expectancy', given its quantitative nature. But before we look at establishing a minimum benchmark for income, it is important to understand the inverse relationship between a companies share price and its 'Dividend yield' which is the amount of income generated per share, per annum. This is one of the more common tripwires where market participants confuse the science of share trading with the science of investing. In acquiring assets we are purchasing income streams whereas Traders buy and sell the price of the asset itself. It is normally wrong for a trader to buy a share with a falling price but, as asset managers, we want to buy an income stream for the lowest possible price. So as the annual dividend of a share remains constant at, let's say, $1 and the share price drops from $25 to $20, the income stream or dividend yield increases from 4% to 5%, making the share more attractive as an income producing asset. 'Buy low - sell high' doesn't apply here because we have no intention of ever selling our assets. And, although it may be said that this is bargain hunting, we are in search of undervalued companies and the income streams they represent. We are not searching for undervalued shares with the expectation that the market will inevitably come to its senses and push prices back up.This is the logic used by bargain hunting Traders who say 'The share price should go up' a lot. We can visually observe the inverse relationship between share price and dividend yield with the use of charts. Both of the following charts of Blackmores represent the same period in time.
The above dividend yield chart was generated using StockDoctor by Lincoln Indicators, a very powerful fundamental analysis program that is unique to Australia. Blackmores share price, shown in the first chart as an unbroken blue line, is steadily falling over time whilst the dividend yield, shown in the second chart as an unbroken blue line with small blue squares, is steadily rising. In next week's article we will continue to look at 'Income'.