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Initial Portfolio Construction

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Stanley Munodawafa

on 22 August 2014

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Transcript of Initial Portfolio Construction

The aim of this portfolio is to generate good returns from dividend income in the short to medium term however in the long-term capital growth is more important.
Investment Objective
Initial Portfolio Construction
Both top down and bottom up approach.
Top down approach is paramount for a clear sign of the macroeconomic environment. HOWEVER
Forecasting does not form part of my valuation techniques
Investment process
Moderately aggressive

Moderately aggressive investors are long-term investors who want good real growth in their capital. A fair amount of risk is acceptable. They are generally willing to trade some risk for greater long-term returns and typically will have a longer investment objective.
Risk Profile
The essential element when constructing a portfolio is research.
Determining the intrinsic value of a company is key.
Look at undervalued shares which pay out a competitive dividend yield in line with market interest rates or above and have growth prospects.
It is critical to be defensive by diversifying a portfolio.
Understanding the importance margin of safety in trying to search for value.
For long-term growth investment objective patience is critical.
Investment Philosophy
The company is in an expansionary phase and has achieved over 90% relevant interest in the Country Road Limited.
This deal eliminates uncertainty regarding Solomon Lew
Beyond Australia the company is strengthening its roots in Africa.
Growth prospects for Woolworths remain high as the company’s Return on Equity (ROE) has almost doubled since 2009 from 26.3% to 55.9%
Woolworth’s service offering is clothing sales which have been SA’s best performing consumer category according to the EY/Bureau for Economic Research (BER) retail survey.
Why buy Woolworths?
Standard bank is a universal bank providing financial services mainly focusing on :Personal and Business Banking, Corporate and Investment Banking.
ROA is a is a useful metric for valuing capital intensive companies such as banks.
ROA tells you what earnings were generated from invested capital (Investopedia).
Value = Assets x long-term ROA x long-term price-to-earnings multiple
Woolworth's is a South African retail chain store which mainly focuses on the provision of retail and financial services to upper and middle-income groups, mainly in South Africa but also in Africa, Australia and New Zealand.
Higher P/E ratio than the FTSE/JSE all share index because earnings have decreased while share price increased.
Woolworths has higher dividend
Yield compared to Shoprite
Standard Bank is on 13 times earnings multiple, a solid dividend yield paying out 3.62%
Historically Standard Bank has experienced a steady growth in its share price but has managed to outperform the FTSE/JSE Financial 15 .
But Capitec has a high ROA and ROE
Then why buy Standard Bank ?
Paradigm Shift in the banking sector.
Regulation has increased as a result of GFC 2008
Banks now have to take less risk meaning few returns.
Specialises in unsecured lending and the target market is the low income earning group
Capitec is looking to attract high net worth clients, probably the higher LSM 6 upwards to 9 by providing Mortgage loans in partnership with SA Home loans. they will be able to cross-sell products.
Impala Platinum Holdings Limited is in the business of mining, refining and marketing of platinum group metals (PGMs), as well as nickel, copper and cobalt.
commodity stocks are cyclical short term earnings are unpredictable and the very best time to buy is when their future seems uncertain.
P/E ratios may not be the best gauge because when there is a downward trend earning decline.
long term average for price to book value for Impala platinum 2.96 times
Impala platinum is a company that has a good cost control despite the fact that unit labour unit costs were uncompetitive due to inflation wage increases, lower productivities and above inflation power costs
Why buy Impala ?
.South Africa produces almost 75% of the world mined platinum
5 month strike that has been ongoing until the end of June it is evident that obviously there is an under supply of platinum and precious metals.
The automotive, jewellery and industrial are the main drivers for demand of platinum though demand for platinum.
Rand/US dollar exchange rate is an important driver of returns since the majority of platinum refined in South Africa is exported
Vodacom is an African mobile and communications company providing a wide range of services, including mobile voice, messaging, and data services to customers
P/E ratios seem fairly priced compared to the JSE All Share Index (ALSI).
Relatively high dividend yield of 6.49% which is better than the bond markets which are low following the persistent low interest environment.
Why buy Vodacom ?
Operators have two sources of revenue
retail subscribers
interconnect revenue.
The Independent Communications Authority of South Africa (Icasa)reduced from interconnection rates R0.40 to R0.20
Distribution of profits will be affected
The key strengths of Vodacom can leverage on advanced growing technology and economies of scale.
Industry is capital intensive lower tariffs might see smaller operators experiencing congestion and hence the need to invest infrastructure.
Voice services still contribute a huge percentage of the industry profits however there is an increase data usage.
Source (Vodacom Integrated Report 2014)
BHP Billiton, a leading global resources company among the world’s top producers of major commodities, including iron ore, metallurgical and energy coal, conventional and unconventional oil and gas, copper, aluminum, manganese, uranium, nickel and silver.
Mines earnings are erratic this makes it difficult to value mining stocks using P/E ratios.
Some of the reasons for higher P/E ratios are that earnings have been declining due to falling commodity prices.
The increase in the price to book ratio over the last decade can be at least partially explained by the increase in return on equity over the same period

Why buy BHP?
Well diversified with operations in many countries in the world
Australia which is well endowed with Metallurgical coal (HIGH Quality) Competitive advantage Close to the market that demands more (Asian Market)
Metal commodity prices have been falling mainly because supply has been growing faster than demand China Slow down
Increased stability in the European sovereign debt markets and improving private sector in the USA will begin to push the demand for commodities in the long term.
Energy commodities such as crude oil are rising and may continue to rise because geopolitical tensions.
BHP is highly exposed to exchange rate risk because of its operations in different countries however because most of the commodities are sold in US dollars
Operating costs and costs of acquiring equipment locally are influenced by local currencies. In the context of South Africa the Rand has been weaker against the dollar therefore profitable for BHP
Richemont owns several of the world's leading companies in the field of luxury goods, with particular strengths in jewellery, luxury watches and writing instruments.
Richemont looks favourable with a much lower P/E ratio compared to Reinet however the dividend yield does not look attractive as it is relatively low at 1.62.
Luxury goods are cyclical therefore P/E ratios are not sufficient rather look at Foward P/E because luxury goods companies are ussually not very capital/debt-intensive.
The advantage of not being capital intensive is that the cash flow can be used to pay down debt, make acquisitions.
Why buy Richemont?
Consumption of luxury goods is driven by social, cultural factors.
Cartier one of the brands owned by the company which sell watches and jewellery is a strong preference for the Asian markets.
Cultural dynamics play a significant role in especially in Chinese market where gift giving has been strong. (One child Policy).
In the short to medium term sensitive news coming from china will impact the share price because markets tend to overact but patience is critical when investing for the long term.
The number of emerging-market consumers travelling to Europe to buy the latest fashions, be it designer apparel, high-end jewellery or premium cosmetics is of paramount importance because of tax).
Taxes on luxury goods in emerging markets can be high ranging between 1% and 50% depending on the luxury product.(China Tax guide 2013).
According to the Credit Suisse global Wealth report 2013 the increase in wealth growth rates have been driven by emerging markets hence there is more room for luxury products.
British American Tobacco (BAT) is a UK company based in London. The company operates in 180 countries, is the third largest in the global tobacco market and controls 11% of the international cigarette market.
BAT has favourable valuation metrics compared to SAB Miller
The relationship between Price to Book value and ROE for these two companies is interesting and form part of the basis why I prefer BAT to SAB miller.
SAB High P/bv Low ROE


Why buy BAT ?
The tobacco industry faces a lot of regulation regarding health issues.
There are also challenges of building a brand in a market which restricts or ban advertising .
This is Positive for BAT
There are barriers to entry in this industry.
Taxes on cigarettes assist in raising the barriers to entry therefore there is less competition on prices.
Cigarettes are inelastic as tobacco products are habit forming and brand loyalty is high.
Consumption declines in developed markets are more than offset by a rise in consumption of conventional cigarettes in emerging markets therefore revenue may be decreasing but there is still room for some moderate growth in tobacco sales.
The company’s pay-out ratio is 67%
BAT substantially has the ability to pay all of its earnings to shareholders and still grow without need for retained earnings.
Given the following multiples a negative P/E of -2.29, a low dividend yield as well as negative return on equity the company is cheap.
The negative multiples are a result of the losses the bank has been making.
I will not buy ABIL but I will keep a close eye on the how the company will turn around.
The bank needs to raise capital either through rights issue or disposal of its subsidiary Ellerines more importantly the sale of this Ellerines is most likely to be a hot sale which would be costly for the company.
Pinnacle is under-priced given that the P/E ratio of 6.47 is quite low relative the ALSI index .
D/Y is attractive at the moment however investigations are going further hence it is difficult to establish the risk involved regarding the bribery case at hand
I will not buy this stock at the moment.

The company has a very high P/E Ratio of 87.81 and this not favourable given that the dividend yield is very low.
Dividends per share have increased however the dividend yield is relatively very low whilst the retention rate is quite high
Naspers expensive therefore at the moment will not hold any position in it.

Thank you !!!!!!!
Asset Allocation
Standard Bank Key Highlights
Between in 2005 and 2011 Expanding in Emerging markets.
Noticed its strengths and repositioned for growth in Africa.
While reducing their appetite for developed countries emerging markets.
Sub Saharan Africa continues to grow at higher rate than other regions mainly because the continent is well endowed with natural resources and there has been increasing trade flows.
The largest in terms asset size of the big 4 banks in South Africa,
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