Pete Wargent blogspot

Co-founder & CEO of AllenWargent property buyer's agents, offices in Brisbane (Riverside) & Sydney (Martin Place), and CEO of WargentAdvisory (providing subscription analysis, reports & services to institutional clients).

4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.

"Unfortunately so much commentary is self-serving or sensationalist. Pete Wargent shines through with his clear, sober & dispassionate analysis of the housing market, which is so valuable. Pete drills into the facts & unlocks the details that others gloss over in their rush to get a headline. On housing Pete is a must read, must follow - he is one of the better property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.

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Tuesday, 28 October 2014

Aren't LICs much too expensive?

High earnings ratios

A question I am asked fairly often is: "Aren't Listed Investment Companies (LICs) far too expensive?".

The answer is "not really" and the reasoning is a little technical, but easily enough explained.

LICs have often been trading at Price/Earnings (P/E) ratios of as high as 25 or above in Australia.

Now, sure, you wouldn't be able to make much of a case for investing in capital-intensive resources companies such as BHP Billiton or Rio Tinto if they were trading at such a high PE.

Indeed, even a PE of above 15 for the major banks, when considered in conjunction with price-to-book values, would be arguably too expensive to represent value, as considered here previously.

What actually are LICs?

But when you stop to consider what LICs actually are, being companies which invest in a wide range of other companies and trusts, then the answer becomes clearer.

For example, here is the FY2013 Income Statement for Argo (ARG) courtesy of the company's Annual Report:


The profit and loss account comprises revenues which are predominantly dividends harvested from other entities which have been invested in, premium income on exchange traded options written, interest income and some relatively small net gains on trading investments.

Administration costs are comparatively very, very low (a management expense ratio or MER of only 0.15 percent, meaning 0.15 percent of average assets, predominantly for director remuneration, office rent and share registry costs) allowing the company to record a net profit after tax of $175 million from income of only $191 million, equating to earnings per share (EPS) of 27.7 cents.

In 2014 profits surged by a further 12 percent to $196 million.

Most of the profits are distributed to shareholders, with fully franked dividends a priority. 

Argo has been consistently distributing around 26 cents per share to shareholders in recent years, which increased again to 28 cents in 2014.

It is fair to expect that LICs will trade at a small premium in order to reflect the reliability of their performance.

Argo has been returning capital growth and dividend income to shareholders consistently since 1946, and also has a proven track record of beating the All Ords returns with only a low management cost.

I like companies with such a track record of success over 60 or 70 years - it shows that their patient, value investment philosophy works because the thriving company has outlasted the working lifespan of individual portfolio managers!


A better way to value LICs?

Investors in LICs should try to look at things another way, that being to focus on the consistently growing dividend income. 

Here are ARG's interim and full dividends paid since 1986.


For 2014, ARG pays a total annual dividend of 28 cents per share.

I would suggest that a fair value in the current low interest rate environment could be somewhere around 25 times that dividend figure ($0.28 x 25 = $7.00), thereby equating to a yield of 4 percent.

Clearly if risk free returns elsewhere were higher than they are presently, one might take a different view on that.


The current share price of $7.85 may arguably be a little expensive, therefore, but it's nowhere near as overpriced as implied by the apparently 'high' P/E ratio, for the reasons explained previously.

Remember that an LIC benefits from the growth and dividend income of the ventures it invests in.

Unlike, say, a mining company, there after no hefty capital outlays and the business model is self-sustaining (indeed, some LICs should as Argo weight themselves towards an industrials allocation, companies which generally themselves are more sustainable and less capital intensive than the resources stocks equivalents).

With a net tangible asset backing of $7.46 per share in FY14 Argo has over the past year just about "priced for perfection" with only a small price premium, representing the comfort which some investors are taking in such well diversified products.

A couple of things to watch out your when choosing an LIC to invest in are:

(1) gearing - whether the company is using leverage to invest, and if so, how much?; and

(2) liquidity - how easily can you buy and sell parcels of shares given the volumes traded?).

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Disclaimer: I don't recommend individual stocks. Always consult a licensed professional before making investment decisions.