asset class shares 1010

8/8/2019 Asset Class Shares 1010

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Managing

Asset Class Sharesby Alan Hull

Disclaimer

This document was prepared by Alan Hull an authorized representative of Gryphon Learning, holder of AustralianFinancial Services License No. 246606 and registered training organization provider No. 21327. It is published in goodfaith based on the facts known at the time of preparation and does not purport to contain all relevant information inrespect of the securities to which it relates (Securities).

Alan Hull has prepared this document for multiple distribution and without consideration to the investment objectives,financial situation or particular needs (Objectives) of any individual investor. Accordingly, any advice given is not arecommendation that a particular course of action is suitable for any particular person and is not suitable to be acted on asinvestment advice. Readers must assess whether the advice is appropriate to their Objectives before making an

investment decision on the basis of this document.

Neither Gryphon Learning Pty Ltd nor Alan Hull warrant or represent the accuracy of the contents of the document. Anypersons relying on the information do so at their own risk. Except to the extent that liability under any law cannot beexcluded, Gryphon Learning Pty Ltd and Alan Hull disclaim liability for all loss or damage arising as a result of anopinion, advice, recommendation, representation or information expressly or impliedly published in or in relation to thisdocument notwithstanding any error or omission including negligence.

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assistance of a securities adviser, whether the advice is appropriate in the light of the particular investment needs,objectives and financial circumstances of the prospective investor.

Copyright Alan Hull 2010

This document is copyright. This document, in part or whole, may not be reproduced or transmitted in any form or by anymeans, electronic, mechanical, photocopying, recording, scanning or otherwise without prior written permission. Furtherenquiries can be made to Alan Hull, the author, on 061-03-9778 7061.

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Contents........

Introduction to Asset Class Shares 3

Lifetime 3

Income 4

Assets 7

Markets Searches 8

How to manage your Asset Class Shares 9

Capital Allocation 11

Risk Management 12

Buying asset class shares 12

Research 13

Wait for the market to come to you 18

Reviewing your asset class shares 19

Yearly Review 19

Yield remains attractive 19

What not to do 20

Fundamentally sound and good future prospects 21

Switch from an asset class share to a rising share 22

Capital Allocation 23


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Introduction to Asset Class Shares

We can refer to shares that represent companies which we deem to be 'Lifetime, income- producing Assets' as 'Asset Class Shares'. To seek out 'Asset Class Shares' we must firstestablish a set of specific benchmarks to work with. Understand from the outset that there areno right or wrong benchmarks and the selection criteria that we use is very much a matter of

personal opinion.

Hence whilst there is a degree of mystery surrounding the apparent genius of the likes ofWarren Buffet and Ben Graham, they in their turn use or used a discrete set of pre-definedbenchmarks to seek out asset class shares and not a crystal ball. Searching for lifetime, income producing assets is a boring and monotonous task, reliant on hard worknot an ability toforetell the future.

That said - let's now examine the guidelines for determining our benchmarks. As we areseeking 'Lifetime, income producing assets' we must consider the following 3 areas;

Lifetime - Asset Class shares represent Companies that will exist for our lifetime(Ideallywe never want to sell our income stocks so they must last a lifetime)

Income - Asset Class shares must have an acceptable dividend yieldor better(we are acquiring asset class shares for their income, not their capital growth)

Assets - Asset Class shares should be of quality and bought at a reasonable price(hence we want to acquire asset class shares when the Stockmarket is depressed)

But before delving into each of these areas in detail, it is important to reiterate that each of ushas a different set of financial circumstances, financial goals and we are all of different ages.Therefore the guidelines proffered here are not set in stone and should be tailored to eachindividuals needs and situation in life.

Lifetime

In order to make a judgment as to whether a company will last our lifetime, we must firstly

quantify our own life expectancy and, secondly, determine the life expectancy of the PubliclyListed Company in question. Of course human life expectancy is well beyond the scope of thisdiscussion and so we will quickly move on to the question of a Companys lifetime expectancy.

There are several guidelines that we can combine in order to estimate a Company's lifeexpectancy. The main problem is that we are required to make qualitative judgments about thestability of different commercial operating environments. Ie., we must make an assessment ofthe longevity and stability of different industry sectors.

Warren Buffet's choices in this regard are typified by some of the Companies that he hasacquired in the past. He believes that men will always have to shave so he has bought shares inGillette whereas he completely abstained from the 'Tech' boom on the simple basis that heperceived the operating environment to be subject to rapid changea sensible assessment.


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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 theface of the Earth. Mind you, owners of HIH shares and Enron in the States might disagree withthis logic.

But whilst size doesn't necessarily ensure survival, it is a statistically valid approach with thevast majority of delistings occurring among smaller capitalization companies. For asset class

shares we will apply a cutoff of 100 Million dollars as a minimum as this level fairly accuratelydefines 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 individualcircumstances that can't be incorporated into global benchmarks. A typical example of thiswould be ANZ or Westpac. These banks would become likely takeover targets by the largerbanks 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. It would be a very similar scenario for Media companies in the event of changes tothe restrictions of foreign ownership of media assets. So when it comes to assessing the lifeexpectancy of a Company it will always depend on personal judgment.

Income

Before we look at establishing a minimum benchmark for income, it is important to understandthe inverse relationship between a companies share price and its 'Dividend yield' which is theamount of income generated per share, per annum.

This is one of the more common tripwires where market participants confuse the science ofshare trading with the science of investing. In acquiring assets we are purchasing incomestreams whereas Traders buy and sell the share price for profit (or loss).

It is normally wrong for a trader to buy a share with a falling price but, as asset managers, wewant to buy an income stream for the lowest possible price. So as the annual dividend of a shareremains constant at, let's say, $1 and the share price drops from $25 to $20, the income streamor 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 (at least at the outset) ofever selling our assets. And, although we are bargain hunting as the Stockmarket declines, weare in search of undervalued companies and the income streams they represent.

We are not searching for undervalued shares with the expectation that the market willinevitably come to its senses and push prices back up. This is the logic used by bargain huntingTraders who use the word 'Should' a lot when talking about share price movements.

We can visually observe the inverse relationship between share price and dividend yield withthe use of charts. Both of the following charts of Blackmores (see next page) represent the sametime period where one chart is of the share price whilst the other is its dividend yield.


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The above dividend yield chart was generated using StockDoctor by Lincoln Indicators, a veryhandy fundamental analysis program, unique to Australia. (www.stockdoctor.com.au) Thischart not only shows Blackmores dividend yield but also includes the average dividend yieldfor both the relevant sector and index.

Blackmores share price, shown in the first chart as an unbroken blue line, is steadily fallingover time whilst the dividend yield, shown in the second chart as an unbroken blue line withsmall blue squares, is steadily rising.


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As the average dividend yield of the entire Stockmarket has a very strong tendency to trackofficial interest rates, our expectations in terms of income must remain flexible and in keepingwith the Reserve Bank of Australia's official cash interest rate. As the average dividend yield isusually just below the official cash interest rate it would be prudent to set our minimumbenchmark at the RBA's official rate which can be found at www.rba.gov.au

This will ensure that our income stream is always above the official cash rate and we're always

ahead of the curve. What's more, this benchmark doesn't take into consideration any frankingcredits, ie. tax credits, that we may also be entitled to.

Be aware that whatever benchmark we choose to employ is only our starting point and shouldreflect our tolerance towards minimum income. The income streams from these assets willgrow in magnitude and proportionality with respect to the prices we originally paid for them.

For example, if you paid $6.50 for CBA shares in 1991 then the annual dividend ofapproximately $2.60 per share (at the time of writing) represents an annual income stream of

40% with respect to your original purchase price whilst it only equates to a dividend yield of6.5% with respect to the current share price. So if we were to apply the benchmark of 4.75% tothe dividend yield chart of Blackmores we can see that it exceeds our expectations in terms ofminimum income requirements. (the RBA interest rate was 4.75% during the relevant period)

But, taking the example of Blackmores a step further, the dilemma we now face is 'Do we buytoday or, given that the share price is falling (see previous page), do we wait for a possiblyhigher income yield in the future?'. The answer iswe buy if the current dividend yield isabove our threshold and we continue to accumulate shares into the future if the share pricecontinues to fall. Whereas traders will cry foul because we're averaging down our purchaseprice, a no-no when tradingwe are in fact averaging up the dividend yield or income stream.

It is also interesting to note that when we are accumulating shares in a particular company,while the share price continues to fall, we could in fact be losing money. In other words if we

add the dividend payments to our capital losses, the result is a negative one. But given ourtimeframe of 'Lifetime', these losses are just the short term impact of an imperfect market entry.Fund managers will often use similar reasoning as an excuse for losses but it is only a validexcuse if their timeframe is the same as ours and they are accumulating income streams.


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On a final note on income, it is always wise to ensure that the 'Dividend per share' or DPS is notof an abnormal nature and is in keeping with the normal dividend payment pattern of thecompany. In other words, check that the company has not paid out an extraordinarily largedividend because it's income has been abnormally inflated due to a unique circumstance such asthe selling of a major asset. An example of this is when Mayne Nickless sold its interest inOptus which led to a bonus payment to shareholders of an extra $1 per share.

Assets

This section covers two very important areasthe first being the issue of 'Quality' and thesecond being 'Value for money'. Of course by quality I am referring to the quality of thecompany that the shares represent where an assessment can be made using fundamentalanalysis. To this end I will, once again, enlist the help of StockDoctor by only considering StarStocks (Companies deemed to be of low risk and good future prospects by StockDoctor) aspossible asset class shares.

But no matter how good the quality of a company, I always like to pay as little as possible formy assets. So in order to know that I'm getting a bargain, or at least value for money, I mustensure that the P/E and P/A ratios are within acceptable benchmarks. But before we explore thequestion of acceptable benchmarks we should first clarify what these ratios are.

'P/E Ratio' is an abbreviation for Price/earnings ratio and defines the relationship between acompanys market capitalization and its annual net earnings after tax. A low P/E ratio indicatesthat the earnings of a company are proportionally high with respect to its share price whereasthe opposite is true for a high P/E ratio. Whenever the share price of a company changes or a

new financial report is issued by the company, the P/E ratio will change.

Example

A company has a total market capitalization of $10 Million.

Its annual net earnings after tax are $1 Million.

Therefore it has a P/E ratio of 10 ($10 Million / $1 Million)

'P/A Ratio' is an abbreviation for Price/asset ratio and defines the relationship between acompanys market capitalization and its net tangible assets.

Example

A company has a total market capitalization of $10 Million.

Its total net tangible assets (ie. property, plant and equipment, etc) are $2.5 Million

Therefore it has a P/A ratio of 4 ($10 Million / $2.5 Million)

A low P/A ratio indicates that the asset backing of a company is proportionally high withrespect to its share price whereas the opposite is true for a high P/A ratio. Interestingly, it is

possible to find companies with P/A ratios of less than one which means that a $1 sharerepresents more than $1 of value in net tangible assets. This situation occurs when the futureprospects of a company are poor and the marketplace is more focused on earnings rather thanasset backing.


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To ensure that this situation doesn't occur we need to look for companies with both a low P/Aratio, indicating substantial asset backing, and a low P/E ratio, indicating good earnings. Ourminimum benchmarks will be a price/earnings ratio of 15 or less and a price/asset ratio of 5 orless. These minimum levels for earnings and asset backing will reasonably ensure that we aregetting value for money when we go shopping for asset class shares.

Market Searches

The following is a summary of the benchmarks that we have developed for our asset classshares; (This list excludes any discretionary guidelines such as life expectancy)

Market capitalization of at least 100 Million dollars

Dividend yield greater than the RBA target cash rate

Fundamentally sound - companies must currently be StockDoctor Star Stocks

The P/E ratio must be less than 15 and the P/A ratio must be less than 5

Using these benchmarks we can, with the help of StockDoctor, create a short list of potentialasset class shares. Note that this list is a starting point for further research and doesnt take intoaccount such factors as the abnormal sale of assets such as property and/or plant, etc.

Asset Class Shares from 2002

The following list includes 10 possibilities from a time when global markets were severelydepressed in 2002. The number of possibilities is typically very small because our benchmarks

are tough and, whats more, we haven't even begun to examine this list with respect to 'LifeExpectancy'. The reality is that you should only expect to uncover a handful of idealopportunities over a period of several years. But when you do, it pays to have the confidence toact swiftlylest you suffer the regret of not buying CBA shares for $6.50 all over again.

___________________________________________________________________________________________________________________________________

Company Name Code P/A Ratio P/E Ratio Dividend yield%

Alinta Gas ALN 2.52 12.78 5.28AV Jennings Homes AVJ 1.24 6.90 10.11

Blackmores Laboratories BKL 4.92 13.39 5.43Bristile BRS 2.28 10.57 5.73Casinos Austria Int. CAI 2.79 6.67 6.00Centennial Coal Company CEY 1.39 9.58 5.09Crane Group CRG 1.51 12.33 5.99Joe White Maltings WJM 1.45 8.00 5.58Simsmetal SMS 2.60 14.14 5.18Stockland Trust Group SGP 1.36 14.38 6.70____________________________________________________________________________

(Note that the RBAs target cash rate during 2002 when this list as generated was 4.75%)

An 'Asset Class Shares' list appears every week in the ActVest Newsletter. This list is generated

using StockDoctor's StockFilter function and the above parameters.


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How to manage your Asset Class Shares

So now its time to get down to the nitty gritty of how to manage our asset class shares. As partof this explanation I will be reiterating some of the key concepts made in the previous section.And Ill start with the point that we are searching for attractive income streams as opposed tocapital gains. This is the flipside of what we do as traders and as the market is falling and prices

are dropping, dividend yields start to rise. So Buy and Hold investors like Warren Buffettcome out of hidingready and willing to spend some money.

Warren is looking for high income streams from well established businesses like when hebought $5 Billion worth of preferred stock in General Electric with a guaranteed 10% annualdistribution. But given that the price of GE continued to fall after Warren made his move (hebought in during the 2008 calendar year), some market commentators have scoffed at what theysaw as poor timing.


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But, to the contrary, Warren is perfectly happy with his 10%pa income stream (and whowouldnt be) and if the price of GE stock remains low then Warren will probably try to strikeanother and probably even better deal for some more preferred stock. Afterall hes buying arising income stream, not a falling share price and we should be following his example bylooking for similar opportunities on this side of the Pacific Ocean.

So now I would like to draw your attention to second last page of the ActVestNewsletter Data

Tables where youll find a list of potential asset class shares. Below is the list from mid-2010

____________________________________________________________________________

Asset Class SharesThe following table of potential 'Asset Class Shares' was generated using StockDoctor's searchfunction, StockFilter, with the following set of parameters. (www.stockdoctor.com.au)


Dividend yield greater than the official RBA cash rate target (www.rba.gov.au)

Fundamentally soundCompanies must currently be StockDoctor Star Stocks

The P/E ratio must be less than 15 and the P/A ratio must be less than 5

Asset Class Shares Reserve Bank of Australia's cash rate = 4.50%___________________________________________________________________________________________________________________________________

Code Company Name P/A Ratio P/E Ratio Dividend yield%

DJS David Jones Limited 3.18 13.53 6.70%TGA Thorn Group Limited 2.35 7.97 5.27%

PLEASE NOTE The management of Asset Class shares is explained in detail in theActive Investing course notes from page 34 to 43, inclusive. Furtherrelevant information can also be found on pages 45 and 46 of theAdvanced Tactics Manual. The latest versions of these documents canbe found at www.actvest.com below the newsletters and data tables.

IMPORTANT The figures shown in the above table are calculated using ASX dataand are post abnormals. For this reason discrepancies may be apparentwhen comparing these figures to other sources of fundamental data.

This table is intended as a starting point for further research anddoesn't include any unsearched fields such as franking credits, etc.

____________________________________________________________________________


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Whilst the list from mid-2010 isnt exactly overflowing with possibilities I would now like toremind of how many possibilities there were in late 2002 when we suffered a mini-Bear marketand the list was far more extensive.

At this time there was plenty of opportunity and some very attractive yields, not to mentionfranking credits which arent shown here. So when global markets stumble and fall we canusually expect the list of asset class shares to swell in response. So armed with this list of

potential asset class shares, we now need to delve deeper into some of the more practicalconsiderations. These include how much capital you wish to allocate to income stocks versustrading stocks, risk management and how to go about buying asset class shares.

Capital Allocation

This is most definitely a question that I cant provide a general answer to as we are all in verydifferent situations. So we must each decide for ourselves how much of our total capital wewant to allocate to asset class shares versus trading shares. Once weve made up our minds then

we need to split our money into 2 separate pools and treat them as being mutually exclusive.

Asset class shares require very little management and generally only need to bereviewed once a year while trading shares are the ones on the ActVest newsletterrising equity list and the BCR share list that are normally managed on a weekly basis

Typically the younger you are then the more inclined you will be to actively manageyour shares hence shares that you trade will be more attractive to you at this time

As the intention is to hold asset class shares indefinitely then you must assume thatyou wont have ready access to the capital which you allocate to them (fixed assets)

while shares that you trade can be sold quickly and turned to cash (liquid assets)

Of course whatever mix you choose can change over time and so I wouldnt dwell on it toomuch. Also the amount of money you have to play with will have some bearing as well.


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Risk Management

Whilst capital allocation is open to individual interpretation, the question of risk managementisnt and with asset class shares it differs somewhat from that of trading stocks. The keydifference being that asset class shares, given their buy and hold nature, cant employ a stoploss. And unfortunately there is always the chance that a stock that can look very attractive onpaper, can turn out to be a complete dud. Just ask anyone who bought HIH back in the 1990s.

So because we cant apply a stop loss to our income stocks, the only protection we have isdiversification. Hence I never allocate more than 10% of my total capital to one individualposition and at the annual review of my asset class shares, I will sell down any position that hasreached 15% of total capital back to at least 10% of total capital. Also be mindful of your sectorexposure which I recommend be limited to 25% of total capital. Thus many long term investorshave, and I suspect will again, be caught out with far too much exposure to the banking sector.

Buying Asset Class Shares

The secret here is to always remember that youre buying the income or dividend yield and notthe share price. Lets assume youve done your research and the yield is very attractive so youbuy. But a little while later the share price drops and the yield goes up. For a share trader this isbad but if youre buying for yield then you simply buy some more. This is called dollar costaveraging and you can do it with one provisoyou still have some money in reserve to spend.

So I always recommend that you acquire asset class shares in several parcels over time andpreferably when the general outlook is very bleak. An example of this would be if I had $1M

and I wanted to build a $400K income portfolio. Then I would allocate $40K per share and Iwould break this down into 4x $10K parcels that I would then spend monthly or even quarterly.

Please remember that theres no need to hurry when it comes to purchasing asset class sharesand I personally wont start acquiring income stocks until Im convinced the broad market is ina well established downtrend. Hence, in the case of the All Ords, pictured below, it isconsolidating and I wouldnt buy income stocks until it develops into a downtrend as shown


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The trick here is to pre-empt a major market decline so we have plenty of time to shop aroundand do our research before committing to what will hopefully be a very long term investment.Mind you, I review my income stocks every year and if they dont measure up then I willcontemplate getting rid of them. Unfortunately in this modern era of investing, the businessenvironment is changing very rapidly and a Companys fundamentals and circumstances candeteriorate very rapidly as a result.

Research

So now to the asset class share list again where you will find a list of suggested stocks thatshould then be researched further. Also note that when these companies drop off the list that itis not a signal to sell them. If they do disappear then it is probably a good idea to stop buyingthem but the criteria for selling is a different matter entirelyan issue well cover in greaterdetail a little later on. Anyway, here again is the asset class share list from about mid-2010____________________________________________________________________________

Asset Class SharesThe following table of potential 'Asset Class Shares' was generated using StockDoctor's searchfunction, StockFilter, with the following set of parameters. (www.stockdoctor.com.au)


Dividend yield greater than the official RBA cash rate target (www.rba.gov.au)

Fundamentally soundCompanies must currently be StockDoctor Star Stocks The P/E ratio must be less than 15 and the P/A ratio must be less than 5

Asset Class Shares Reserve Bank of Australia's cash rate = 4.50%___________________________________________________________________________________________________________________________________

Code Company Name P/A Ratio P/E Ratio Dividend yield%

DJS David Jones Limited 3.18 13.53 6.70%TGA Thorn Group Limited 2.35 7.97 5.27%

____________________________________________________________________________

Note that the dividend yield must be greater than the current Reserve Bank of Australia target

cash rate which is subject to change on a month by month basis. Hence we always show the

latest RBA cash rate with the weekly results and update our search criteria accordingly.

As a working example, I thought we would take a closer look at Thorn Group who is the parentcompany of Radio Rentals. And let me say that based on its business model, I dont think there

could be a more defensive stock. Radio Rentals usually thrive during tough times as people willfavour renting over outright ownership of many everyday household appliances. Furthermore,40% of Radio Rentals client base are on some form of welfare and they are hardly likely to beimpacted by a downturn in the broader economy. In fact their numbers will probably increase.


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But enough comments from me as this is the part where I defer to the expert commentary fromStockDoctor, a fundamental analysis program that we have been using to create the ActVestnewsletter for over 10 years. For more information on StockDoctor please visit the website atwww.stockdoctor.com.au and whilst it may help you get a discount, there is no need tomention that you are one of my subscribers as we do not receive commissions for referrals.

This is what StockDoctor said about Thorn Group in mid-2010 the facts and figures.

These are the Companys principal activities.

Thorn Group Limited (TGA, formerly RR Australia Limited) is an operator in the Australianelectrical and household appliances rental market, particularly the SME sector and government.The company offers a wide range of audio visual products, kitchen and laundry appliances and

computers along with a new range of furniture and gym equipment on a rental basis or apurchase option.

Rent, Try, Buy (RTB):either an 18 or 36 month rental contract, which includes an option to buy a similar product after36 months for $1. Alternatively, the customer can make an offer to purchase the product beingrented at the expiry of the rental term which the company can either accept or reject.

Rent, Try, Buy! Plus:

is available on a selected range of products and is similar to the 18 month RTB, except thecustomer pays a premium for additional flexibility which includes the ability for them to returnthe product any time after 6 months without incurring an early termination fee and the customercan also recommence the rental at any time within the next 12 months.


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Big Brown Box:As at November 2008, the company launched Big Brown Box, a new online electrical store thataims to provide Australian consumers with a retail experience. Big Brown Box would provideconsumers with the opportunity to research and compare products at a time convenient to themand then make a purchase.

And finally, here are Michael Fellers (a Lincoln Analysts) comments.

We attended a presentation held by the company at the recent Goldman Sachs JBWere MicroCap Conference 2010.

John Hughes, TGAs managing director, is the type of down-to-earth individual you wouldexpect to be managing a company thats been making whitegoods and appliances moreaffordable for over 70 years. Still, while TGAs core business Radio Rentals has a very oldand staid business model, the company continues to innovate and TGAs strong top andbottom-line growth in recent years can be expected to continue in the longer-term.

Beyond the companys excellent annual results, longer-term growth can be expected for TGAregardless of wider economic conditions. It is estimated that some 40% of Radio Rentalscustomers receive welfare benefits so a drop in overall economic conditions will not necessarilyaffect this demographic and indeed, it can be argued, that a drop in employment, credit ordisposable income levels will create more customers for Radio Rentals.

Rising property prices leading to an increase in renting, market uncertainty and a trend towardsa more mobile workforce also contribute to further growth potential. For this reason a numberof Radio Rentals stores are being made over from upscale St Vincent de Paul shops as

Hughes expressed it, to retail spaces that will attract an aspirational demographic.

Whitegoods, televisions and personal computers generate approximately 20% of sales each forRadio Rentals, with furniture largely making up the rest. Aspirational consumers are morelikely to buy electronics from Radio Rentals than other product categories, especially if itmeans new, latest equipment can be had without being purchased. The end of analoguetelevision broadcasting in 2013 is another key driver.

TGAs other experiment in serving this market, however, has disappointed. BigBrownBox.com

continues to operate and will become the exclusive retailer for the new Acer build-you-owncomputer in Australia, but the division still remains a dream unfulfilled. TGAs BusinessServices division, which provides equipment finance and leases goods to the SME market, onthe other hand appears to have better prospects. The failure of SME financiers like CIT andothers since the credit crunch is furthermore TGAs advantage. The company's personal lendingdivision, Cash First, also has strong potential and readily meets the governments newconsumer credit code.

As TGA moves into a more upscale market firms like Flexirent and Thinksmart will begin to

bring competitive pressure, but it has its defensive Radio Rentals business to fall back on. Theintroduction of new one-person branches to service remote and regional areas also opens up themodel to areas that were previously underserviced by Radio Rentals. The story behind TGAslatest results is compelling and the company remains well positioned for further expansion.


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You can see from this sample of information from StockDoctor why Im such a big fan of it.Anyway I personally believe that given its financials and their business model that ThornGroup are a potential asset class share that I would be keeping a close eye on. Now lets moveon to the example of David Jones (DJS) where I have a very different opinion;

These are the facts and figures for David Jones (DJS) from mid-2010.

Heres the Companys principal activities.

David Jones Limited (DJS) is a leading upmarket retailer with stores throughout Australia. TheGroup operates 35 department stores and 2 warehouse outlets. DJS and American Express injoint venture run a David Jones branded credit card.

Department Stores:

Retail stores focusing on the premium end of the market in terms of the brands and products.To facilitate store differentiation, DJS is focused on increasing the number of lines that areexclusive to David Jones.

Distribution Agreements:The company continually adds well known brands to the portfolio. Recent additions includeTigerlily, Simone, Prle, Sara, Luxaflex, Mambo, Saba, FCUK and Witchery. In July 08 DJSannounced that it added 50 new brands to its portfolio on a department store exclusive basis.

Strategic Plan:In March 08 DJS released it FY09-FY12 strategic plan, highlighting seven sources it will focuson to drive Profit and cash flow growth. Including opening new stores, launching new DavidJones branded AMEX card, improving gross margins and improving capital efficiency.


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Credit Card Business:In February 08 David Jones announced that it has selected American Express as its partner for along term strategic alliance that will see the launch of a David Jones branded credit card inAustralia.

And lastly, here are Angela Ignacios (another Lincoln Analysts) comments .

DJS has regained its status as a Consistently Healthy Star Stock following analysis of thecompany's latest interim results.

The company remains in a Satisfactory financial health position. With all key ratios coming inas either Strong or Satisfactory, DJS is exposed to manageable levels of financial risk andtherefore satisfies Golden Rule No. 1 - Financial Health.

Net operating profit before tax and significant items has risen by 10.4% from $129.968 millionin the previous corresponding period to $143.497 million on the back of higher sales and

improved margins. The company reported that despite a very competitive environment in 1H10marked by heavy promotional activity by retailers, gross profit margin hit an all-time high of40.0% and EBIT margin was up 90 bp to 13.5%.

Pre abnormal Earnings per Share (EPS) rose from 17.70 cents to 19.40 cents. This translatesinto EPS Growth of 9.60%. Return on Assets (ROA) has increased from 23.96% to 24.93%. AsROA and EPS growth are above our target of 8% and have increased, DJS is able to satisfyGolden Rule No. 2 - Management Assessment.

The company also satisfies Golden Rule No. 6 with a market capitalisation of $2,583 million.There is sufficient liquidity for both retail and institutional investors with the 22 day averagedaily dollars traded at $11.214 million.

The company last closed at $5.13 at a PE of 16.03 times, which when compared to the sectoraverage of 13.17 times, suggests the company is potentially overvalued at current prices. This issupported by the PEG of 1.67. We will be resuming coverage on DJS and a Lincoln Valuationis forthcoming.

DJS declared an interim dividend of 12 cents per ordinary share, fully franked (an all-timehigh) for the six months ended 23 January 2010 resulting in a dividend yield of 5.65%.

The outlook for DJS remains positive with the company's key new store & refurbishment projects on track. The Bourke Street store is scheduled to be completed in 1Q11 with majorEBIT benefit to flow through in FY12. Kotara will be completed in Nov 2010 and Claremont isdue to open in March 2011. On the expense side, cost of doing business can be reduced furtherwith 58 Cost Efficiency projects on track over FY10-FY12.

Management has reaffirmed its 5%-10% Profit After Tax (PAT) growth guidance for 2H10 and

FY10, although they remain very cautious about cycling the Government Stimulus in 4Q10.They also reaffirmed its PAT guidance for FY11 of 5%-10% PAT growth. It was notedhowever that to achieve the top end of this guidance, the retail recovery will have to be in fullswing.


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Now to my opinionand I dont believe that given the nature of its business that David Jonesis a defensive stock. Unlike Thorn Group who can be expected to thrive during a downturn inthe broader economy, I see David Jones as an upmarket retailer who is not an essential serviceprovider (or what I like to call a toilet paper company). Hence I would put Thorn Group on myincome stock watch list but I would be far less interested in David Jones.

Certainly as at mid-2010, David Jones is domestically focused and its high dividend yield and

100% franking credit are both a plus. However I believe its price:earnings ratio is on the highside and will probably get even higher as revenues fall away in a slowing economy, which iswhat you would be anticipating.

But this is just my opinion and as you can see, choosing asset class shares is not an exactscience. Nor is anticipating the direction of the broad economy.

Furthermore you may decide to do a lot more research than what Ive shown you here but atleast you now have a good idea of what were looking for in an asset class share. Of course the

weekly list that we provide in the ActVestnewsletter data tables is a safe and sensible startingpoint that will ensure that youre in the right ballpark.

Wait for the market to come to you

So I like Thorn Group and I would keep a close eye on this share but I wouldnt necessarilyrace out and buy it straight away. As I have already said, when buying asset class shares there isabsolutely no need to be in a hurry as we should have plenty of time to sit back and wait for themarket to come to us.

Remember that we are buying a rising income stream which means that we want the share priceto be falling and in mid-2010 that certainly wasnt the case for TGA


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Whilst TGAs price chart would suggest that its beginning to struggle (a possible double top?),it certainly hasnt begun to trend down. So its too early to be buying TGA but we can alwaysbe shopping around and compiling a list of possibilities. Of course, if Thorn Group does fail totrend down as we hope it will, then we will simply move on to the next possibility.

Reviewing your asset class shares

Now to the final piece of the jigsaw puzzle which is when to review your asset class shares andwhat you should be looking for. There are several things you need to consider but uppermost inyour mind should be whether or not each of your income producing assets are producing anadequate amount of incomeand will keep doing so. But there are other considerations as welland it will probably be best if we tackle them all, one at a time

Yearly ReviewThis first point is fairly obvious and easy.I recommend that you review your asset class share portfolio on an annual basis. But I would also recommend that while youre at it, you also

review your capital/asset allocation to ensure that you are not too heavily weighted in any particular asset class. This is an exercise that all investors should also perform on an annualbasis and one that, I believe, becomes far more critical if we are in or approaching retirement.

This is because an imbalance in our asset allocation can expose us to the totally unnecessaryrisk of a catastrophic event occurring within a single asset class, such as shares for instance. Solets assume you have your money spread across the following asset classes;

A sensible set of guidelines for the average baby-boomer would be;

Have enough cash to live on for at least 2 years in case of a general downturn Shares shouldnt exceed property assets (very pertinent during a market boom) Retain your business interests if possible, also in case of a general downturn Make sure your assets are legally protected, especially if you are in business Establish/manage financial structures to minimise tax and reduce legal exposure

Where possible I believe its a good idea to retain one's business interests into retirement as thisis a good hedge for times when both Property and Stockmarket assets dip at the same time.

Yield remains attractive

As already stated, this is central to the review of our asset class share portfolioare our assetsproducing adequate income and are they likely to keep doing so? But please ensure that youmake this assessment based on your initial purchase price, incremented using the cost of livingvia a suitable benchmark such as the annual CPI figureand not the current share price.


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And being such an important part of the annual review process, it is probably best if Idemonstrate how this is done with a working example. So lets take the fairly straight forwardcase of CBA shares which well assume you hypothetically purchased back around 1991/92 atthe bargain basement price of just $6.50. The question being; what is your $6.50 worth today?

Now (at the time of writing) approximately 20 years on, your original $6.50 is now worth a lotmore largely due to the impact of inflation. In other words $6.50 back in 1991/92 had a lot

more purchasing power than it has today. However we can calculate the equivalent value of$6.50 from 1991/92 by indexing it using a hypothetical (but indicative) annual CPI of 4%...

1991 $6.50

1992 $6.50 x 1.04 = $6.76

1993 $6.76 x 1.04 = $7.03

1994 $7.03 x 1.04 = $7.31

2010 $13.17 x 1.04 = $13.69

So there you have it; $6.50 in 1991 is equivalent in purchasing power to $13.69 today. So nowwe can compare CBAs current dividend payment to the current value of your original purchaseprice of $6.50 where CBAs annual dividend in 2010 is $2.90

$2.90 / $13.69 = 21% annual return on your original investment And reversing out the 100% franking credit = 21% / 0.7 = 30%pa

Based on these numbers I would suggest that CBA shares purchased in 1991/92 are now a verynicely matured income producing asset. But there are a couple of other key points you alsowant to consider when assessing a shares income

Is there an investment I can move my money into that has a better yield? Is the annual return on my investment increasing or decreasing each year? Was there any abnormals included in the annual distribution to shareholders?

(for instance, did the company sell off any major assets creating one-off profit?) Is the value of the share dropping over time and therefore offsetting the income?

If these questions dont raise any concerns and the yield is attractive then I would suggest thatthe share is generating an acceptable income stream, for now. And so once again I reiterate theneed to perform this review at least once a year and not put your asset class shares in the bottomdraw. With the business cycle getting shorter and shorter I think those days are definitely over.

What not to do

Do not fall for the trap of using the current dividend yield because it is based on the currentshare price which is not actually relevant to this assessment. Take the example of AV Jenningswhich was a very attractive asset class share back in 2002. Please see the report on AVJennings (generated using StockDoctor) at the top of the next page.


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Whilst it is an extreme example, the case of AV Jennings illustrates the point well. Looking at

the first column for AV Jennings (Sep 02) you will see that, based on the share price at thetime, the dividend yield was 13.41% with 100% franking creditsvery attractive in anyonesview. But one & a half years later on (March 04) and the dividend yield has dropped offdramatically to just 4.80% which would suggest that the actual dividend has more than halved.

But in fact the dividend payments to investors remained virtually unchanged whilst the shareprice rose from about 80 cents to over $2, making the yield drop dramatically. So the dividendyield can be very deceiving and you should always look at the dividend payment itself and, asstated earlier, compare it to your initial purchase price indexed using the cost of living (ie. the

annual CPI). Of course with the doubling of AV Jennings share price its fundamentals becamesomewhat overstretched but that is actually an issue that I believe should be handled separately.

Fundamentally sound and good future prospects

And so if we go back to the above report on AV Jennings, you can see that as the share pricerose dramatically, the fundamentals tapered off nearly as fast. I draw your attention to the rowmarked financial health which went from Strong in Sep 02 to Marginal by Sep 05. At thistime the P/E ratio was 36 and the earnings per share was well into negative territory.

Hence, whilst fundamental analysis isnt an exact science and so I am not prepared to give setbenchmarks for when to sell, the alarms bells were certainly ringing loudly for AV Jennings.And as you can see, a companys financial ratios can and will change, and must be monitored.


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Another related consideration is the assessment of a companys future prospects. Imagineowning a company that made buggy whips when cars were first introduced into everyday life.Whilst a buggy whip company could have had very good fundamentals and an attractivedividend, its days were certainly numbered and I suspect its share price would have been slowlyfalling as a result (a point I mentioned earlierfalling share price offsetting dividend income).

Thus Im somewhat skeptical about Telstra and its aging copper wire network. And you can see

what Im talking about in the following chart where Telstra is in a very long term downtrend.This is not really a situation I want even with my asset class shares and therefore we should bemindful of the long term price trend even though we own the share for income purposes.

Switch from an asset class share to a rising share

Returning to the example of AV Jennings, there is another option for those who purchased AVJback in late 2002 and that was to switch it from being an income producing asset to a tradingproposition. This would have meant applying a stop loss strategy and managing the share priceas opposed to the income stream it provided via its dividend payments. The decision at the timewould have been triggered by the sharp rise in its share price and the potential capital growth.


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I personally would have been tempted to take this approach because a share price that doublesin the space of just one year will inevitably lead to overstretched fundamentals. Furthermoreyou would have been forced to sell down anyway to maintain a safe level of capital allocation.

Capital Allocation

This follows on from our earlier discussion on asset class shares and risk management. As ouronly means of protection against catastrophic risk is diversification (given we dont use stoplosses to manage income stocks) then we must continually rebalance our portfolio. I personallylike to ensure that each income stock remains close to about 10% of the total portfolio value.

Thus when I initially purchase asset class shares I only spend a maximum of 10% of totalcapital and when I do my annual review I will sell down any position that has exceeded 15% oftotal capital. And three guesses what I sell it back to10% of my current total capital or thetotal portfolio value, whatever you like to call it.

But there is also the question of sector allocation which I previously said I like to maintain at a

maximum of no more than about 25% per sector. Hence if my sector exposure exceeds 30% oftotal capital then I will sell it back to 20% of total capital. Please note of course that thesebenchmarks are not set in stone but are a sensible set of guidelines that are open to a degree ofindividual interpretation. Thus an investor with a very large amount of capital may be inclinedto use even more conservative benchmarks.

Without knowing your individual situation, I believe we have come as far as we possibly canwith this discussion and its key aspects. However on a final note I will say that there is a time totrade markets and a time to accumulate asset class shares. And to ultimately succeed as anactive investor, you must apply the right approach at the right timeand in the right way.

asset class shares 1010

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