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Allan Gray investment insights

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I feel like a kid at Christmas when I get my Allan Gray quarterly report - there's always so much insight they share, freely. Thank you, Allan Gray (disclaimer - I have a substantial amount invested with them).

2012 - 4th quarter report

"At year-end prices, based on bottom-up stock analysis, the reward on offer relative to the risk of loss in most JSE-listed stocks remains as unexciting as it was a year ago." (Ed: I concur, there are only a handful of stocks on the JSE I'm finding value in at the moment, and they're too illiquid for Allan Gray to gain a meaningful position in).

Allan Gray's valuation methodology

"Investors need to ask a lot of questions. Is the business sustainable? Is the demand for the product likely to shrink or grow? Will excess capital investment destroy returns? Are returns above or below normal? The goal should be to extract factual data to aid quantitative valuation.

"The most important variable in establishing the value of a company is the estimate of future cash flows. As it is not possible to forecast the future with any accuracy, we try instead to establish the average cash flows a business can sustain through the business cycle. We use this sustainable cash flow in normal conditions to determine the value. It is important not to think of current conditions as normal & just extrapolate these...That the market often extrapolates current conditions as normal, is what enables us to generate alpha".

"When the news is terrible it is likely you could be looking at a good investment opportunity. The reason is that investors may be extrapolating the current situation into the future. They may be right, buat at least it is in the price. And if things turn out to be even a little better, it is more than what is discounted in the share price."

Investment spending is a reason for GDP growth & stock market returns not being correlated

"GDP growth & stock market returns are not well correlated...One of the most important reasons for the low correlation...(is that)...investment spending can have the opposite impact on equity returns & GDP growth. When a business invests in new plant & machinery, it is reflected as GDP growth, so the greater the level of investment the faster GDP grows. Unfortunately, all these companies putting capital to work & investing, brings down the return on capital. Lower returns on capital mean lower profits & poor returns for equity investors...The current negativity towards the European & the US economies, and the subsequent lack of investment, may actually lead to higher returns on capital...The takeaway is not that you must look for weak economies for investment opportunities; rather it is the fundamentals & the entry price that matter."

Risks to iron ore are on the downside

"With the industry investing record amounts of capital (presumably as a result of the record profits), iron ore projects already under construction are forecast to add one-third to existing supply. At the same time, question marks remain over the sustainability of Chinese consumption. While we cannot predict the future, knowing where we are in the cycle gives us reason to be cautious and we believe the risks are now to the downside."

Platinum prices too low

"In contrast to iron ore, current platinum group metal prices are below those required to generate a fair return on capital...Whille we view this as unsustainable, we regard Impala Platinum & some of the juniors as more attractive than Amplats at current prices. Despite excellent cost control over the past 3 years, Amplats' unit costs remain above those of Impala. We have our doubts as to whether any further savings are achievable to change Amplats' relative position. We further have doubts about whether Amplats is investing sufficient capital to maintain & indeed grow production over the long term. In contrast, Impala is reinvesting a considerable portion of current profits in sinking new shafts, which should entrench its position as a low-cost producer over the longer term."

(Ed: There are a couple of risks which the Platinum miners are facing in the medium/long term - (1) scientific advancements are increasingly allowing platinum to be replaced by palladium in autocatalysts, and (2) over the long run the price of petroleum is increasing, and motor vehicles may be replaced by electric vehicles, which don't require autocatalysts. I too cant predict the future, but these are risks the platinum miners face, which cant be ignored. That being said, I do hold a small number of platinum shares, in the hope that short-term increases in demand will outweigh the medium-longterm influence - if prices spike sufficiently I'll sell them).

Dividend withholding tax

The Dividend Withholding tax is due to come into effect from 1 April 2012, replacing the Secondary Tax on Campanies. "DWT is a 10% tax levied on investors receiving dividends declared & paid by South African resident companies or foreign companies listed on the JSE. Although DWT is a tax borne by investors, it is the responsibility of the companies paying the dividends, or where relevant, certain 'withholding agents', to withhold the tax & pay it to the SA Revenue Service on behalf of the ultimate recipients."

"The new dividends tax is a final withholding tax set at 10% on dividends paid. The dividend income will still be exempt from normal tax in the beneficiary's hands because the dividends tax does not influence the normal tax rules. Ten percent will be the final tax payable on the dividend."

2011 - 3rd quarter report

The theme in Allan Gray's quarterly surrounds the high levels of company profit (compared to trend and the last 10 years) as a result of high commodity prices and consumer expenditure and the risk of a reversion to mean.

2011 - September

Allan Gray are skewing their Anglo American position towards the stub assets (excluding Anglo American Platinum & Kumba Iron Ore), maintaining their full offshore exposure in their balanced fund, their position in the Newgold ETF has been reduced in the Stable Fund, South African equity exposure has been slightly increased in the Optimal Fund (although they think that "the South African stock market is still not unequivocally cheap"), have kept the duration of the Bond Fund below the ALBI but "have taken advantage of the recent selloff to buy certain higher yield long-dated bonds", and the Money Market Fund has reduced duration to 67 days.

2011 - 2nd Quarter

here's a link to the Allan Gray quarterly commentary, which they published on their website on 29 July 2011. Here's the extracts which interested me:

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