Ask Colin

Why don't you use a scan based on PE ratio, Dividend Yield and Price/NTA to find value stocks among resources and trusts?

Trusts are quite different incorporated vehicles than companies. Companies typically pay out part of their earnings and retain the rest in the business to generate growth. The parameters I use for the scans assume this kind of industrial company that has a maintainable earnings stream.

However, a trust is quite different. It is set up as an income distribution vehicle. Trusts have to pay out all of their earnings each year or else they are taxed on them. Enterprises that are conducted as trusts are set up in this way so that the earnings get passed through to investors without being taxed. The important thing is that there are no retained earnings; hence not the same growth as a company and the parameters used for companies will not apply. You will notice that trusts usually have higher yields than companies for this reason.

I see no reason why you could not scan trusts, but the threshold levels are going to be different. I do not generally invest in trusts and have not done any work on them, so cannot give any guidelines in this area.

Resources companies are different again. If they are explorers, I have no idea how to value them. It is all pure speculation. If they are producers, then the key difference to industrial companies is that they are exploiting a wasting asset, unless they have a huge resource with a lifetime of decades to centuries perhaps. So, the assumption of maintainable earnings that underlies the PE/DY/P:NTA scan do not apply. Instead these companies would have to be valued using something like a discounted cash flow model or a dividend discount model. Again, I do not generally invest in these companies and have not done enough work to feel that I can give any guidelines in this area. When I do invest in them, it tends to be pure technical analysis approach.

In conclusion, let me say that it amazes me that I get asked this question so often. I teach a perfectly good method for making money in industrial shares. Like any approach it works best at the hard core of solid companies. However, there are always people wanting to push the envelope out to the marginal cases, where the techniques may have limited utility - like trying to solve the difficult problems, when there are plenty of easy problems to solve. Maybe it is pride. Humility works better in markets. I have a general philosophy of trying to find ways to make money with high probability. Low probability speculation has no appeal except to the gambler in us. I invest as a business. I don't gamble.


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