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Expert: Nathan Bell – The 2, 4, 6 rule of portfolio construction | InvestSMART

HOSTS Alec Renehan & Bryce Leske|9 September, 2022

Head of Research & Portfolio Management at InvestSmart, Nathan Bell discovered value investing after spending nine years as an accountant, including five at Deutsche Bank that ended in 2006, and has been with Intelligent Investor ever since. He is a CFA charter holder and his experience has guided our strong performance since 2011.

This episode is sponsored by InvestSmart

Alec mentions a previous episode featuring Domino’s Pizza CEO: Don Meij (ASX: DMP)

Book mentioned: The Essays of Warren Buffett: Lessons for Corporate America, by Warren Buffett & Lawrence Cunningham

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Bryce: [00:00:15] Welcome to another episode of Equity Mates, a podcast that follows our journey of investing. Whether you're an absolute beginner or approaching Warren Buffett status, our aim is to help break down your barriers from beginning to dividend. My name is Bryce and as always, I'm joined by my equity buddy, Ren. 

Alec: [00:00:29] Bryce excited for this episode. There's a lot going on in markets and we love the fact that we get to pick the brains of experts and trying to figure out what's going on. 

Bryce: [00:00:39] That's it. Well, speaking of experts, a reminder, before we start, we're not experts. We're not financial professionals. We are not licenced. We're here learning just like you. And nothing on this podcast should be taken as advice. Do not take financial advice from a podcast. But it is our pleasure to welcome Nathan Bell to Equity Mates. Nathan, how are you? 

Nathan Bell: [00:00:58] I'm well. 

Bryce: [00:00:58] So Nathan is head of research and portfolio management at InvestSmart. He discovered value investing after spending nine years as an accountant, including five at Deutsche Bank. That ended in 2006 and has been with Intelligent Investor ever since. He is a CFA charterholder and his experience has guided their strong performance at Invest Smart since 2011. So hoping to pick your brain. 

Speaker 1: [00:01:22] On advice. 

Alec: [00:01:22] Hoping to get some of that guidance today. Nathan. 

Nathan Bell: [00:01:26] The artist, I think I've done a lot better for our investors and I've done for myself. [00:01:28][2.7]

Alec: [00:01:32] Well, Nathan, before we get into all of that, we love to start these interviews by hearing about your first investment. We generally find there's a good lesson or story that comes out of it. So can you take us back and tell us the story of your first investment? [00:01:44][12.3]

Nathan Bell: [00:01:45] Yeah, I've got a classic Tabcorp when it first listed as an IPO, when the Government sold it off, I reckon it was maybe 1994 and I reckon that maybe the end of year 12 or start of university and I had a little bit of money from working at K-Mart during the school holidays and I remember I come from Mount Gambier and country South Australia and I always knew for some reason I want to be investor. I think it came down to the fact that my parents were divorced when I was young. We never had any money and I just wanted, I wanted something else. I just I was tired of always struggling and this stock market just seemed to be this place where all you had to do was have the right opinion and you had to have patience. And there was something about the grit and the patience that I just just I understood, just do my DNA. And it wasn't about being the smartest person. It was about being sensible and have common sense. But really that the idea of grinding it out and sort of something that for some reason appealed to me, but it didn't appeal to me when it came to my Aussie Rules footy career. So in the Border Watch was the local paper and I remember Tabcorp, the IPO and this guy I said I think it listed at a dollar 35 and he said look I think this stock is going to be worth $4 over time. And I thought I was a long term investor and after six months I got frustrated because the share price hadn't gone anywhere. And I gave up and I sold my stock and I made a classic profit of $0.01 fees. And I love that now. And I think that stock went on then. Actually, I'm not exactly sure because it's been in 70 reincarnations since that original flip it. I think that it was at least a four or five fold increase eventually, if not maybe even ten. And so I was an enormous lost opportunity and I really got lost in the wilderness for a long time after that, trying all sorts of different things like technical analysis and just a whole heap of wasted time. So it was a good experience in one sense. And I think one of the worst experiences some people can have is actually make a lot of money on a punt, particularly when they're young. And I think it's easy. And then when they've actually got some meaningful money behind and they end up losing it because they think they can just pick anything. And so there's good lessons there. But I wish I had probably learnt some better lessons about long term investing. [00:03:57][132.5]

Bryce: [00:03:58] So from that experience, Nathan, how would you describe your investment philosophy today? [00:04:03][5.0]

Nathan Bell: [00:04:04] So I've been a professional investor since 2006 and I call myself a value investor and there's always this, you know, whether it hits the guys at your right, whether you get these deep into it. But there's this idea that a value investor somehow is going to buy these cheap, ugly, cheap statistical businesses on high dividend yields and low price to earnings ratios. And somehow by buying cheap, you make all this money as people or the market recognises that actually it's a better business than what it's being priced at now. Warren Buffett, who's considered the greatest value investor in history, has actually been telling everyone who will listen for about 40 years that the best way to make money is to buy the best businesses and the ones that can reinvest their profits at the highest rate of return for the longest. And to me, that's what value investing really is, is the compromise between those two things, because essentially you've got to pick between a few key attributes, all of all businesses, and whether it's management, the growth in the company, the quality of the company, and then what the valuation is telling you. You never in a market where things are perfect. Occasionally you get into a GFC, but then even then you've got to make a choice to buy the absolute best businesses on the market. They're going to compound my wealth at 15% a year for the next 20 years. Or do I buy those really deeply discounted stocks that are been particularly impacted by whatever the current events of the day are, where you might be out to make ten times your money in a couple of years, but you know that once you've made that ten bagger, you then have to sell it and pay tax and then find the next stock. And by that time, all the great stocks have recovered to full prices again. So that's really what the balance is. I think value investing is all about. But to anyone young listening to me, yeah, the best advice I can give anyone is just find the best business you can find and put all your money in it and just. [00:05:55][111.4]

Speaker 1: [00:05:55] Let it grow and do. [00:05:56][0.7]

Nathan Bell: [00:05:56] Nothing and don't listen to anyone else. [00:05:58][1.6]

Speaker 1: [00:05:59] Yeah, it's not easy. [00:06:00][1.2]

Nathan Bell: [00:06:01] To get made. [00:06:01][0.3]

Speaker 1: [00:06:02] That's easy to be really is. [00:06:03][1.2]

Alec: [00:06:04] The challenge is just finding that the best business. Yeah. So anyway, we'll ask you that later. But Nathan, before we get there, I reckon if you surveyed all investing content across social media, podcasts or written stuff, even in, you know, the AFL, all of that 90% plus would be about what to buy. And there is very little discussed about actually how you build and then manage a portfolio of stocks. And so you're part of your role at Investsmart and Intelligent Investor is head of portfolio management. And so we're really interested to talk about that for a moment and talk about not just finding that stock, but then how you actually manage a portfolio of stocks. So to start broadly, do you have any key principles of portfolio management that you apply across across Investsmarts portfolios? [00:06:54][49.9]

Nathan Bell: [00:06:55] Yeah. Look, this is a fantastic topic and I'm glad you brought it up because it's sort of almost, I think, what most people consider one of the more boring topics of investing, and you really don't hear anything about it yet. It is to me the most critical part of putting a portfolio together, because the amount of money you invest in the stock compared to the overall size of the portfolio, to me that's where the rubber meets the road. It's where ego is involved. The confidence in your analysis, the trying to be balanced about the risks. Yet if you don't put enough into the great business and it goes up tenfold over a decade, you don't really make much money yet you put too much into a bad stock. It doesn't work out and you lose too much money. And there's no rules for this. And that's what makes it it's it's an art. It's not science, it's an art. But there are definitely a few rules that govern the way I manage the portfolios at Intelligent Investor. And this is a case of do what I say and not what I do, because personally I run a very concentrated portfolio and I don't recommend that for most people. I just don't think people can stomach the swings and being wrong. And I think you do need to be an expert and be on top of your stocks all the time if you're going to do that. But the one principle for me is always never put a lot of money in a lousy, low quality business where you can't stomach the losses. And the thing you have to remember with a professional portfolio is you're not investing for you personally. So what you know, what risk is in the demand volatility in the portfolio? For me, you might be very, very comfortable and it is. But to your net importer or your parents who can't afford to lose any money, who aren't working anymore and they're relying on that dividend income or those capital gains over time. You know, that's a very serious obligation. And it's a certain expectation that if you're very lucky and you run maybe a small portfolio, just friends and family that you might be able to impress on them, the understanding of volatility doesn't mean risk. And it's a very hard concept, I think, for people to understand because it's all well and good in a bull market. But as soon as you get into a bear market and the portfolio's going down and the people don't really understand the businesses that they own, they panic and sell out. So there's a certain amount of volatility I think our investors can handle, but there's a certain amount that they can't. So normally I, I sort of have in my head and the two for six principle, it doesn't work exactly like that. But the 6% is reserved for what I think are the cheap highest quality businesses. When I first buy them know the 4% I'd say is an average holding because we tend to run with about 25 stocks in the portfolio. But I find once you get into the twenties, the quality of the ideas are pretty poor. But I also find if you only have 15 stocks then if you've got about 7% invested in each one and some of those are going to be small caps, so they have a really bad result or they just don't work out and that's a big loss for people to take fairly quickly. So and I find the 25 is tends to be where the bounce lies and you remember you've probably best your top ten stocks are the ones that drive the performance of your portfolio. So as long as they're right, the rest takes care of itself. And you've probably got a bunch of stocks that you're slowly selling out of, plus another bunch of stocks where you're not quite sure yet, or maybe too risky for some reason, but could have big returns. So they're the smaller positions. So you tend to have sort of quite a long tail wear and. The top ten stocks are probably 50 to 60% of your portfolio, and then you've got the 30 or 40 in the smaller stuff. So if you're wrong or something goes wrong, you know, it's a manageable risk and you move on. [00:10:20][204.6]

Bryce: [00:10:20] MM Love that. [00:10:21][0.7]

Nathan Bell: [00:10:21] So the 2% is really safe for the more speculative stuff. I mean we are looking for the high quality stuff, but you just find smaller stocks sometimes that carry risks and maybe we'll talk about them later and we want something and there's no point putting half a percent or 1% in. And usually because if you work out, they're probably not going to do anything. Although, you know, we've been invested in Whitehaven Coal at a dollar, you know, 15 months ago and that's $8. So you only need 1.1% in that. But that's not usually how it works. I'd say the average is 4% and again if it's a new stock you probably want to build up your knowledge of it over time. So you might want to start smaller to begin with and then as you get more confident you might invest more. That's there's certainly no way to really feel like you own a stock until you actually own some of it. So one thing I'll do occasionally is just buy a very small bit of it and then just follow it and get to know it because you don't really understand the business, in my view, until you listen to the CEO speak three months, six months, 12 months, and then you really, really know what's going on. And you can really check whether this is BS and whether this is a guy who's really in it for the right reasons. And it just takes a bit of time sometimes to get that right. [00:11:30][69.0]

Bryce: [00:11:31] So I guess the follow on from that. So as a retail investor, we're sitting here and we happened to get a stock that ten bags or what not and it becomes a large portion of our portfolio and loving it. It looks great. Do you if that would have happened to you? You know, you've got the 6% rule there for the greats. Do you make sure that you don't allow stock to balloon too much or how do you let a stock run without that kind of cutting, cutting that opportunity? Sure. [00:11:56][25.2]

Nathan Bell: [00:11:56] Here. Peter Lynch, I'm sure you've heard this, always says, you know, don't cut the flowers and water the weed. So you really need to be careful in what you. And there's no doubt, I think it's a money management adage or maybe a trader adage that you want to let your profit to run. So and not also add on to that that when you get those stocks right and I hear this about says it all the time, right. So yeah, there's a lot of people who Cecil makes up 70 or 80% of their portfolio because it's just done so well since they got shares in the IPO in 1992 or whenever it was. And they say, you know, I'm not sure what to do with it. I know this is outrageous amount of my portfolio, but if I sell it now, I've got this enormous, enormous capital gains that's probably the equivalent of like paying 60% of the share price. Once I pay the tax and if the share price fell by 40%, I'd be buying more of the stock. So. So I actually think if you can handle it because every stock can fall by 50% or more at any time for some reason, and particularly Cecil, in the sense I think everyone thinks that's the safest piece of the market and arguably certainly one of them. But technology changes, world moves on. Sometimes they miss a particular product launch or a particular part of the health care economy and and solutions. And if I miss that and I know competitors are working on a lot of blood products, trying to catch up to say so if they work and prices come down for their production of whatever it is, if you can't stomach that 50% then and you can't sleep at night, then you've got too much. But in terms of the portfolio that entails, investor, we're only allowed to hold a maximum of 15% in any one stock at any time. And so let's say I put in that full whack of 6% at the start and you know it's up hundred and 50%, then I'm forced to start trimming that. But once, once we're getting to nine or 10% like that's, you take on a lot of reputation risk. I think as a fund manager and a lot of people I think are willing to admit that they'll make decisions based on reputation and business risk and career risk rather than just focussing fully on the investment. Because if, you know, we saw this years ago in the US as a bunch of hedge funds like Valeant Pharmaceuticals was one one of the best fund managers with the highest reputation ever in history, had 30% of their portfolio in value and blew up. You know, this is a business that had been around for, I think 40 or 50 years and Warren Buffett had recommended that to his clients when he decided to stop managing his own client's money. So it takes 40, 40 or 50 years to build the reputation of this business, and it took 5 minutes to lose it. So you're always trying to strike that balance between hanging onto your winners, because if you if you know you've got the great business, you know it inside out. You understand the risks. Once you sell it, you bring all these new risks into it. You've got to find a new stock. It won't be as good, it'll be more risky. And then you've got to pay the tax. So there's always cost to selling is great business. And I think it's a great question. And again, it's just shows you the art of investing and it's so personal, you know, for carrying 15% in one stock for you might be absolutely fine for someone else. They might think you're crazy, you know, 4% is a big position for them. So and as a mentor of mine always says, yeah, investing is such an individual. Your journey, but you've got to bring that individual journey to a bunch of mums and dads and and that's very different from managing your own portfolio. Mhm. [00:15:20][203.5]

Alec: [00:15:20] Well speaking of the portfolios you manage at Invest Smart, I believe you manage three, you might manage more. There's an ethical fund and equity growth fund and an equity income fund. How do you think about managing the different portfolios and are there different roles that you have to apply to each of them or do the principles sort of carry across them all? [00:15:42][21.8]

Nathan Bell: [00:15:43] So I start in my fantasy world where every stock is cheap and it's growing at 20% a year and it has a dividend yield of 5% fully franked, and therefore all three portfolios have the same. 20 or 25 stocks don't have to do anything. I would say starting from that base. So starting from that base, the one with the most freedom by far is the growth fund and and the ones with the, the big hurdles on them are the income fund because obviously you've got to have a competitive yield. And I'd say, as is more of a dividend growth fund necessarily than I think a classic income fund that a lot of people probably think where they're just trying to maximise the dividend yield in the franking credits that we still have to outperform the market by 1%, that's what we've told people. So we really need growth in that income portfolio. So it's such a classic stock for me. The one that went right across all three portfolios. And so just lastly, the ethical fund obviously has the filter on it. So no fossil fuel companies, no gambling, just just all the main things that people will understand. And there's nothing unique in our filter. But the perfect stock for us was a company called Pinnacle Funds Management, and I'd followed this company for a long time. I'd bought a little bit of it and it fitted perfectly for all three portfolios. It was a rapidly growing business. Now it's grown earnings and dividends at 50% a year for the last four years where you had insider owned management, which I love, is something that's really important to me, which you might get to later and a page, because one of these funds management business are going great. The profit margins are absolutely enormous because you don't have to pay anything for the next dollar of revenue. It all just goes straight to the bottom line so they can pay out all their profits as dividends and they were fully franked. So when we got the bear market three years ago and the stock fell to $2.50, I bought more of that stock and made it a four or 5% position across all three portfolios. Today that stock is trading about $11, but it was on it went to 20, come back to six, now it's back to 11. But the fully franked dividend yield at the moment, without the franking credits on that $2.50 purchase price is 14 and a half per cent. [00:17:51][128.4]

Speaker 1: [00:17:52] Well now. [00:17:53][0.7]

Nathan Bell: [00:17:53] Like that, that to me is dividend investing. I just want a portfolio full of 25 pinnacles in all three. But I know with the income fund I have to at least be competitive with the yield of the ASX, which at the moment is about 5%, but it's been juiced up by the iron ore miners. So, you know, on an underlying basis, assuming the iron ore price comes down and dividends get cut a bit more, you know, maybe it subsides 4.3%. So I can't go out there and say this is an income fund with a yield of 2% because otherwise it's just like the growth fund. In saying that I will decide that the distribution did get cut quite drastically for 12 months during the COVID bear market because a whole bunch of companies we owned and bought, which were the best, you know, the airports, the casinos, but they all cut their dividends during that period. So so they're all bouncing back now, which is fine, but I really want to keep the portfolio as simple as possible. And that's the biggest lesson I'd say to anyone listening is keep your investing simple, because every time in my life where I've tried to make it, you know, chase returns or diversify overseas or whatever, it's been definitely some gains at times, but the thing that works best is keep it simple. So I just try as much as I can to have a cool bunch of great companies across all three portfolios, and that makes it a lot easier. [00:19:08][75.4]

Bryce: [00:19:09] So Nathan, before we turn our attention to earnings season, are we just going to take a quick break to hear from some of our sponsors? Tonight, an earnings season where in the thick of it here in Australia, it's been going on for about a month now over in the States. What have you learnt so far about what the companies have been reporting or some of the guidance that they've been delivering and anything that you'll be keeping an eye on going into the next reporting season? [00:19:36][26.9]

Nathan Bell: [00:19:36] Look, the thing is, there's been a lot of lack of guidance which you probably expect from people because the earnings are looking backwards right over the past 12 months and the last 12 months is not going to be indicative of what it's going to be like most likely for the next 12 to 18 months, where interest rates are finally going to start having an impact on the economy. Because keep in mind that most of the world's on fixed interest rates on their mortgage rates. So America doesn't have variable interest rates, so they're putting up their interest rates. Australia at the moment I think about 45% of all loans are still on fixed mortgage rates. So it's going to be at least another year before we see higher interest rates across the board really start to impact the economy. So you've got a lot of companies that were huge beneficiaries of COVID who are now starting to show much slower revenue growth as was expected. And there's still some companies that are hurting from the post-COVID hangover, and that's going to be a slow return. And airports are a good example. I mentioned the casinos. So it's really been all over the shop because you can't even say, look, this is all the technology companies have been going great because if you look at zero and the share price has come way down, he got crazy to start with, but people are worried about slowing UK subscribers, which is a huge part of the value that people have priced in. Then you look at Wise Tech yesterday just produced this absolute bonanza of a result and you certainly wonder why I didn't buy it earlier. And so you can't even say it's like by sector almost, right? It's just it's just depends on the business. It's so unique to the business because of the unique cross-currents of events we've got right across the board from the war train and staff shortages and all the rest of it. But the one thing you can certainly say is costs are going up, profit margins are getting squeezed, and valuations are still enormously high. And just to give one example which caught my attention is Fisher Paykel Healthcare, which is another one of the many stories I can tell you about bailing out way too early for stupidly thinking it was expensive at $3.50 and the $35 and probably up to five bucks of dividends went to $40 and reported at $2, 20 and so on at $3.50 oh oh many years ago, because the price to earnings ratio of like 22 looked a bit expensive. And again, it's just it's just don't fall for these PE ratios and all this sort of stuff. Just find the great businesses that are growing and hang onto them. And it's it's all in the hanging onto them is where the money's made over a long period of time. But the earnings have really come back and know I think earnings per share might be likely to be $0.35 this year. Wait out 92 or something the before because it's Fisher Paykel healthcare. You might know they have a sleep apnoea business, they also have an oxygen therapy business. So they used all these humidifiers and whatnot in the hospitals. And for people who need oxygen care and this sort of range of therapies, I use it for improving, you know, for COVID. They just bought all the hospital said, look, we need it all and we need it now. So I think Fisher Paykel got something like five or six years or more of hardware sales into the hospitals in 12 months. And and clearly that was unsustainable. But the interesting thing to me is the earnings look like they're going to be lucky to be about $0.35 next year. And yet the share prices only come down to about $19. That's trading on a price to earnings ratio of about 55. Now, clearly, everyone's expecting the earnings growth to come back as they use more consumables because they've got sort of over that, if you like, in the recent years. But to me, it just shows you how people are really clamouring into what they think is safe. You know, these growth stocks that haven't failed yet or more insensitive to the economic environment and what it's doing is is producing a bifurcated market where you've got these very, very increasingly smaller group of high quality businesses that people are paying enormous multiples for. And then you've got this sort of the reprobates, which is, you know, the cyclical stocks or coal stocks or, you know, all these companies have been demonised for some reason and people don't want to own them because we're potentially going into a recession. In fact, the US and Europe might already be in it, and so they're trading at low valuations. So again, you've got this conundrum of do Vizag now while everyone else is still zigging, sort of repeating the crazy behaviour of the previous bull market that we all thought ended eight months ago, because they're all just going into these same highs, high risk stocks and a lot of them with no earnings and things. Or do you buy these sort of lower quality, low, statistically cheap stocks where if they work out, I'm actually gonna get a really nice return over next few years. But they are risky and not as reliable as the others. So at. So to sum up the current environment and reporting system. [00:24:19][282.6]

Alec: [00:24:20] Well, we won't ask you to answer that question of of which category you go into, but we will ask you. One thing that I guess annoys us a little bit here is the amount of jargon in the investing world. And one that has got my attention recently is how we call it both reporting season and earnings season and manager for the same thing. So settle the debate for us or reporting seasonal earnings season. Which one is. [00:24:46][25.3]

Nathan Bell: [00:24:46] The longer it goes on and you particularly see this in long bull markets it becomes more less of earnings season the more reporting season, because the abuse of ape numbers and all these new metrics, we get classic bull market peak stuff, you know, and you see it always happens. And like they say, that one rings a bell at the top of a bull market. But you can see all the evidence, the you know, the butchered earnings and they've beaten numbers. And we don't have this a lot in Australia. But in America, if anyone's ever looking at us, stocks don't just look at the cash profits or the reported earnings. Go and have a look at how much stock compensation is getting paid to these technology companies and make sure you include that. It's just phenomenal. Well, we're not talking, you know, 5% different apps for some business. We're talking 30%, 50%. And these are enormous amounts of money that are essentially being given away because I don't want to pay cash to all these new starts and I've got to encourage these people to come to their tech company because there's so many choices. It's an enormous cost. But I think Warren Buffett used to say in his book, you know, we were particularly critical of App Store, which is an accounting number, rather than the free cash flow number, which is more important. And just who does not think he sets up a lot? Who does he thinks pays the expenses, the fairies? [00:26:00][73.7]

Alec: [00:26:02] Well, I think that that actually leads nicely onto our next question. Well, Bryce and I are really interested in this concept of what matters and what doesn't. And whenever we have CEOs joining us on the show, we like to ask them what metrics matter and what metrics don't in their industry. We both come from a retail background and, you know, metrics like same store sales or sales per square foot were really important. But a lot of people outside the retail industry didn't really think about them a lot. So when you're analysing a company, we want to ask you that same question. What matters and what doesn't? You've said that a bit. Duh, doesn't matter. Is there anything else there that you really look towards or anything that you think people speak a lot about that perhaps isn't that important? [00:26:45][43.1]

Nathan Bell: [00:26:45] Yeah, I think the number one for me is the price to earnings ratio, which we still use as a shorthand to give people the impression of what expectations are built into the share price. It's actually funny, I think when you start to learn about investing, the price to earnings ratio is actually somewhat confusing because it actually should be the opposite way around, which is called the earnings yield. I think that actually makes a lot more sense to people. That's basically the profits divided by the share price. So it's like saying, if I bought a company today for a dollar and I bought the whole thing and it's got profits of $0.05, then the price to earnings ratio is 20. It's, it's the market value divided by the profits. But the other way around is actually well, the earnings growth is 5%, so basically your return should be 5% plus whatever growth. And I think intuitively that actually makes a lot more sense. But for some reason Australia adopted this and acronyms and whatever it's called in many, many years ago was never changed. So it actually confuses people. I think people understand interest rates just, you know, genetically through mortgages and borrowing money and that type of thing. And then but I think the damage it does is it teaches people to think in statistical turns as to what's cheap and expensive. And that's where you get to this rap about, you know, value investing and growth investing. And, you know, and the biggest mistake people can make is just buying that low quality stuff, trading at a discount and just missing out on the incredible growth and of the great businesses. And what really does matter, I think is an important one. Sort of tied to that is the return on equity is very useful because it's more of a concept than the actual number. The actual number does matter because as Charlie Munger says, the longer you own a business, the more likely your return is going to be a return on equity figure. So it doesn't matter really how much you pay for that business. If you own it long enough, that's what your returns are going to be. So you want to own the businesses producing high return on equity. And that's why the risk meds in the Seychelles and the Domino's Pizzas trade at such big valuations because they can just continue to invest and grow their businesses, those high rates for a long time. But the statistical cheap stuff, sometimes it's alluring because it feels cheap and safe, but they're the worst quality businesses. But what you have to remember is, is that that return on equity for the great business works for decades and the cheap business. The longer you own it, the more likely something is to go wrong. So the best avoided. But there are times when you go through those big falls and sometimes they just worth it because the returns are so high and they can come so quickly. [00:29:10][144.3]

Bryce: [00:29:12] So Nathan, it's that part of the interview that we really look forward to and it's picking your brains on a. Couple of specific stocks that you're covering. So we've asked if you could bring two or three companies to sort of unpack and explain the thesis, why you're interested in them, how it kind of matches your investment philosophy as well. So over to you for the first one. Yeah. What is it? Why you like it? And perhaps a bear case as well. [00:29:38][26.1]

Alec: [00:29:38] Yeah. Yeah. One of the. What are the. [00:29:39][1.2]

Speaker 1: [00:29:39] What are the risks. [00:29:40][0.3]

Nathan Bell: [00:29:41] There's always plenty of them. The I'll give you a stock. I actually really didn't want to talk about it because I think my name's becoming associated with this stock. And it is risky in some senses, but it's just it just has its potential is huge. And I don't know many other companies like this. [00:29:57][16.2]

Speaker 1: [00:29:57] And you. [00:29:59][1.3]

Bryce: [00:29:59] Say you don't want to talk about it, but then you say it's potentially. [00:30:01][2.2]

Speaker 1: [00:30:01] Huge where all is. Well. [00:30:05][3.8]

Nathan Bell: [00:30:06] The problem is, is it's actually not a lot of great things to choose from at the moment because the good stuff is really expensive, which leaves you with the mediocre stuff. And I don't really want to be on record talking about the mediocre low top and some idiot echo. So again, like professional reputation, like this is real, right? So this company I'm associated with is, is frontier digital ventures. And the background to it is, is it's a it operates in emerging markets about sort of 18 different countries. It's a small stock. It's only about $350 million market cap. The guy who runs it is a guy called Sean DeGregorio, and his background was from about 2000 to 2009 as one of the senior executives at RealEstate.com.au. And then he got poached from there to come and fix up a company that was called AI property, which was a similar business, but in Southeast Asia. And he won back that stock. So I think he came in and it was like $0.72 or something and he sold it back to recruit, funnily enough, at about seven bucks or something like that. So this guy has tremendous reputation. He knows these businesses inside out. And what he did was he decided to take the money that he'd made through property and start his own business called Frontier Digital Ventures. Now, it's a searching classic for online classifieds, for property and cars. And we know that these are amongst the greatest businesses ever created. Look, you've only got to look at our results on Rightmove in the UK. Once you're at the dominant property classifieds business in the country, it is the closest thing to a licence to print money. But the trick with this business, because there's always a catch, is that it operates like the gem. Actually, the portfolio at the moment is the main which is in Pakistan. So who wants you know, who wants to invest in Pakistan? At the moment we're in Sri Lanka is just, you know, social unrest and this is a little bit disrupt tiny bit of Sri Lankan business in Frontier and also Myanmar where the army has taken over recently and again, civil unrest. So no one wants to you know, no one wants this exposure in the best of times yet alone when interest rates are going around, up, around the world and now sovereign countries like Pakistan are running out of foreign exchange and there's a big risk to their currency. But the valuation of this stock is it's probably trading. You know, I think this business could in four years, maybe could do $200 million in revenue. The business at the moment, I mean, it's got to is it worth market value? About 350 million. There's $30 million of cash on the balance sheet. So there's no financial risk in that sense. So you potentially paying about a bit over one and a half times revenue. Now, recently I really group and these sort of companies are trading at 15 times revenue now for BIS for frontier to trade at 15 times revenue. That means it needs to have the profit margins that an ARIA group has. Now, I believe they'll get there over time. And one of the reasons I believe they'll get there is because they're not only just doing the advertising like ARIA Group relies on, they're also doing that transactions. So they're taking a lot more of the money involved in the property sector in addition to what leads up to a property transaction in that sense. So insurance or if a developer is trying to sell 20 units in a building, then in Pakistan they take an 11% clip on each sale. So which sounds like an enormous number. But the problem is they have to use a lot of staff to earn that money. So now I'd much rather earn two or 3% so doing a lot less. And but it just goes to show you that that market is actually, you know, some multiple, I think five or seven times bigger than the eight or many more times bigger than the advertising market, which interestingly our rights group are now actually just starting to scratch and tell people that's where the growth is coming from. So this is the business I just no one wants to own. This environment looks extraordinarily cheap, but it's just got yuck written all over it from like PayPal and and you're going to have to go through 18 months of paying because it's a small stock. There's a lot of small fund managers that are losing money at the moment or their returns are really poor. So they're suffering outflows so that when they have to sell the stock, obviously the share price falls quite a lot. And just, you know, the risk in Pakistan with the currency and these sort of things are real. But I just try to stay. For the next five or ten years because like at the moment, that's the main that's the main investment alone is worth $300 million. So that's basically all of that's what's a frontier. So basically getting the other 17 countries for free, assuming that the Pakistan currency doesn't collapse and which is where most of the worry is at the moment. But in future, the Latin American business is where the real value is. And to give you some sort of gauge as to what the foundation thinks he can build here, he says in his presentations that he's aiming to build a three and a half to $5 billion business, and at the moment it's 350 million. So even if you lose the main and obviously it's painful, but it's not really where the future value is. So you could still make many times your money, but you really have to earn this. I've been invested at $0.50 a share since 2016, so I've done it for six years and it hasn't even doubled. You know, it's back to back to $0.83 loss yesterday. And over that time you think you could have bought Google, right. And made three or four times your money with the safest the best business in the world. So has it been a good risk return? Absolutely not. But I'm trying to stay focussed on the next five years, but it's certainly the stock that's of most interest to me. [00:35:24][317.8]

Alec: [00:35:24] Yeah, that's fascinating. That's why I love having these conversations because I'd never heard of Frontier Digital Ventures and it's just a fascinating company doing really interesting work. And I think that's that is just a good reminder. I love investing because you just you just learn about these things that you wouldn't otherwise know about, like looking through their portfolio, you know, they're touching all corners of the world with some of these businesses they run. So, so. Nathan And that's one we could talk about it more, but we're, we're excited to get to a second company that's on your mind, on your watch list, maybe in your portfolio. What's another one that stands out for you at the moment? [00:36:02][37.7]

Nathan Bell: [00:36:02] I should just quickly say the worst thing about Frontier is all my friends and family in it. My reputation with online site doesn't work at if we skip into Pakistan anyway, so get a job there. It's a me. So the second stop for me would be I think stock together is mesh in my if it used to be called MOAS but it's financial now so hasn't been around very long I think it listed in 2017 so is a company that's basically a mini Macquarie. So most people are familiar with Macquarie. It's an investment bank that's become extremely large funds management business and is really a key stock in most retirees portfolios. So these companies to be called malls and it came from a conversation that a guy called Andrew Pridham, who's also the president of the Sydney Swans, had with a guy called Ken Mollison. And it's worth actually going to read a couple of interviews about him because it's really interesting. He started a small investment bank in America and he really liked Andrew and said, let's start up in Australia. So I think that was 2009 and in 2017 the company IPO and I think it was only like a dollar 50 or maybe a couple of bucks a share and Andrew Pridham has had to young offsite. As I can tell you a funny story that's not a lot is not that story's not for live. [00:37:18][75.8]

Speaker 1: [00:37:19] Camera and I actually. [00:37:22][3.0]

Nathan Bell: [00:37:22] Have a relationship with one of the guys back in Adelaide in college, but that's a story for another time anyway. These two guys have done very well, so really it's been the three of them driving this business. And Andrew sort of step back a little bit recently and he's letting these two younger guys take over. And the key to the business is if one is just small and if you look at the sort of investment banking funds management businesses, it's a really reliable business model. Like some of the most fantastic business in the world are the Brookfield's and KKR. And these guys, you can grow very big over a very long period of time, whereas Macquarie sort of, you know, very mature business and you can't expect too much growth. Emma Financial is really tiny second innings and an interesting thing about it is the sort of the longer it goes on the safer it gets because this is a business where you really rely on the individuals working in the business. This isn't CECL where you've got the number one blood products business in the world and you've got decades of research and development and, you know, billions, billions of dollars behind you. And it's really hard to take you on. This is a business just where the value of the business is in the people working there. And because they've been quite successful and they're getting more successful now, they're starting to attract more, more people. And it is all about talent in that sense, in sort of investment banking and funds management. And the good thing is they really incentivise people will with owning shares in the business and that the idea that the founders and the ideas and the people that work in the business owned shares is really, really important to me. And in fact, it's almost probably the most important thing I hate to see in these situations where you see companies that they bring in a new CEO and they take Mike Smith of ANZ all those years ago, we're going to go and dominate Asia even though it's already full of banks and they waste all this money on acquisitions and then all of a sudden they all blow up as they're always going to. And then the CEO lays with a big golden handshake. And then the new CEO comes in and they pay him just as much money to fix the mess. And almost behind it started many years ago. And as a shareholder, you've made no money. So we really want the opposite of that. And and that's just attracting more and more talent goes on. And because it's not, they can find these niches across all sorts of industries of where to make money. Now, obviously, things have been very good for investment banks and fund managers more recently. So the earnings per share are about between 40 and $0.44 at the moment. The share price has come back from 10 to 6. And this is another one. I just I can't stress the importance of portfolio allocation now, because in that bear market a few years ago, I stuck with five at most of our money there and it's done nothing. And I put some money into MF, which went from a low of like a dollar 29 to $10. And yeah, and I'm sitting here going FTV was supposed to be the one and I should be sitting in the apartment looking over Bondi Beach now instead of living in inner Sydney. And that's the difference a portfolio allocation makes. So don't skip over that part ever. But, you know, most probably trading at about 15 times earnings now, which I actually think is alright long term. But you just got to remember that those earnings are really currently boosted by a lot of increase in values and things like hotels, which you've probably seen across the papers the last year, has been a feeding frenzy for any pub on the East Coast. So that's been really helpful for then there's the earnings. Investment banking have been great as lots of merger and acquisition activity and asset price have been going up. So really everything's been running as well as it possibly could. But these are cyclical businesses and their fortunes are tied to market activity and asset prices. So that M&A activity is going to slow down, obviously, and that's what the market's trying to price in. I'd love another crack at this below $4, and I'm really hopeful we get a another proper bear market next year as interest rates really actually start to impact the economy and financial markets. But it just ticks all the boxes. I like I really like finding small businesses with the potential to become much larger businesses over decades. And that's what I really enjoy about the job. Yeah, it's not going to happen tomorrow. And, you know, these these sort of stocks can fall 50% many times over those periods. But when you find those, those founder led businesses, they just tend to work out much better. And there's just more and more statistical evidence every year that satellite businesses work out much better. And I've got a chart I use in my presentations about shows from 1990. The difference between the stocks in the S&P 500, which is the major American index, how they perform versus the rest of the S&P 500. And I've only got the chart up to 2014 and the red lines look ridiculous. But keep in mind that from 2014 to 22 was a a tech boom. And all those big tech companies are run by their founders, basically, all of them anyway. So you imagine what that chart looks today. It is literally off the charts in that sense. And we don't we don't have as many in 14 Australia, but we have plenty of good ones. [00:42:14][292.0]

Bryce: [00:42:14] Love it. Nathan Well we unfortunately are getting close to the end of the interview, so a massive thank you to yourself and also investment for sponsoring this episode. Certainly taken a lot of actionable insights from it. Now if you would like more info on what investment are doing, head to invest smart dotcom dot org. You will check a link in our show notes, but we always finish with three questions for all of our guests. So Ren take it away. [00:42:38][23.5]

Alec: [00:42:38] So Nathan, the first one is, do you have any books that you consider a must read? [00:42:42][4.0]

Nathan Bell: [00:42:43] Look, I'm sure everyone on this show has come and told you all the ones I need to read. But the one thing I'd say, if you're if you're really serious about learning more about investing and you've got a bit of time to put into it, just don't skip Warren Buffett's particularly the early letters to Buffett Berkshire Hathaway shareholders and just just pick one a week or one a month to get through. And there's a period of about 20 years where there's absolutely no substitute for that for any one book. But again, if you've just read Chapters eight and 20 of Intel's investor, you've read your Peter Lynch book and you've read some. Buffett Yeah, that that's really all you need to know. And if anything in past theories becomes more complicated, and I think from all those books I read, I actually ended up focussing too much on risk and didn't focus enough on the imagination side of what the great businesses could become over ten or 15 years. And that's where the money is made. I think one important lesson is when you come in as a new investor, you really worry about losing money and particularly the professional like you ran all these seasoned guys and you don't want to lose any money. And so you really focus on the risk. But I think you take that to find the real money is my in understanding what a great business is, why it can continue to be a great business for the next ten or 20 years and really thinking broadly about new ways it could make money or how it could develop. Because if you can have that insight now, that's that's a very valuable insight. And that's the difference between living in inner city Sydney and looking over Bondi Beach every morning. [00:44:09][86.0]

Alec: [00:44:11] So Nathan, the second question we like to ask is. Forget valuation, forget what is trading out at the moment. Forget the company as an investment, just purely on the the company, what it does and who runs it. What's the best company you've ever come across? [00:44:26][14.8]

Nathan Bell: [00:44:27] How? So I'll just stick to Australia because it's more useful. But you know, probably Domino's is just about be up there. It's been quite it's been incredible. It's incredibly well run. If you just read the detail for anyone listening who wants to read, I should probably be stroking my own quarterly letters. But a next mentor of mine I used to work with, he runs selective funds and his quarterlies run about 100 pages long. So they they're in debt, to say the least. But if you really want to learn the insights of the great business in Australia, just go back and read those. It's the best thing on anyway. Do the best thing you could read full stop because they're ASX listed stocks and the detail that goes into it is quite incredible. And Domino's, it just continues to grow in new countries. It's it does such a great job in marrying technology with the reality of actually delivering physically a pizza and all the way it's developed management over years so they can actually expand to such a wide range of countries and keep the wheels on, you know, without falling off and blowing up. A lot of money has made them by far the number one person that head Domino's Company wants to run their different countries. [00:45:41][74.3]

Alec: [00:45:42] Mhm. [00:45:42][0.0]

Nathan Bell: [00:45:43] Yeah. That's how important. That's so important. Out to the actual top, Domino's Headstock. It's incredible. It's a great story too because they found it done. They started delivering pizzas and now he drives Lamborghinis around the yesterday. [00:45:54][11.2]

Alec: [00:45:55] Yeah, yeah, yeah. Well we've had Don my on the show before so we'll include the link to that interview in the show notes. But yeah, it is a pretty incredible story. Who knew that pizzas would be the best growth stock of the 20 tens? But Nathan, final question. We always like to finish with this. If you think back to your earlier self starting out in markets, subscribing to that Tabcorp IPO when it happened, what advice would you give to your younger self? [00:46:23][27.9]

Nathan Bell: [00:46:23] Yeah, look, there's a few bits. One, I should have bought that house in contrary. Let's see Mount Gambier when I was 21. [00:46:28][4.4]

Speaker 1: [00:46:29] And. [00:46:29][0.0]

Nathan Bell: [00:46:29] That would actually have me sitting overlooking Bondi Beach at the moment that that one decision alone. So if you can actually get onto the property market at some point, it is a good idea. But obviously we never thought interest rates would go to zero and see the growth that we have said. And that was one critical mistake I made and the other one was not just putting all my money into CSL. The view that that's probably the most practical one I think for most people is just find that great business and obviously it takes a bit of work to work out what a good business is and it doesn't it doesn't take that much work. I mean, you followed intelligent investor for six months and read a few books on whatever and you'll understand what a good business is versus a rubbish business. And then you just add a few things you about understanding a bit about valuation, those sort of expectations and things. And then and it's really do your own work and don't listen to anyone else. That's one of the pitfalls I made. I think that there's, you know, a risk become such a big issue in the business. When I started early that it took over from thinking creatively about what these great businesses could become, because the best way to reduce risk is to buy the great businesses. And you just be amazed at how much money you can make on the market over time. And and you can tell about the frustration in my voice. You know, Frontier was at three bucks. I would be so frustrated. Yeah, but you really what people underestimate is that compounding and you only get that compounding in the great businesses. And yes, every now and then you'll get a Whitehaven Coal at $1 where you can see it's actually going to make as much money in one year as its total market cap. And it's fine to jump on those, but they're pretty rare. So again, try and get a house or apartment, just get that taken care of and find the best business in the world. Now, I mean, you not even back then, you just you had to buy six stocks, but you don't have to anymore. It's very easy to buy international stocks. So as much higher quality businesses over there, much more of them. But also the earlier you can find them, the better. You know, if Frontier ends up being the next area group, then finding it today is so much better than finding it in five years when everybody knows it's the next REIT group. That's really the key with investing, I think, is to see the value before the market's priced it in. 

Bryce: [00:48:36] Well, Nathan, it's been fascinating speaking with you today. Thank you so much for sharing your time. Love the breakdown of portfolio management and the two for six rule. I'll certainly be looking at how my portfolio stacks up against that. Definitely won't match two for six, that's for sure. But I'm sure our audience took a lot of, as I said, actionable insights from that. So we do really appreciate it and look forward to having you back on at another point in the future. Thank you very much. 

Nathan Bell: [00:49:02] It sounds like your portfolio looks like my personal one. Thanks a lot. 

Alec: [00:49:07] That nice? Thanks, Nathan.

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Meet your hosts

  • Alec Renehan

    Alec Renehan

    Alec developed an interest in investing after realising he was spending all that he was earning. Investing became his form of 'forced saving'. While his first investment, Slater and Gordon (SGH), was a resounding failure, he learnt a lot from that experience. He hopes to share those lessons amongst others through the podcast and help people realise that if he can make money investing, anyone can.
  • Bryce Leske

    Bryce Leske

    Bryce has had an interest in the stock market since his parents encouraged him to save 50c a fortnight from the age of 5. Once he had saved $500 he bought his first stock - BKI - a Listed Investment Company (LIC), and since then hasn't stopped. He hopes that Equity Mates can help make investing understandable and accessible. He loves the Essendon Football Club, and lives in Sydney.

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