Managing a Share Portfolio

This report is about investing directly in Australian shares for profit, not about using the Share Market as a Casino. There are any number of books and systems that purport to show the road to quick and easy riches. Almost invariably, the riches flow only to the promoters.

Investing for Profit in Australian Shares

Thousands of books and millions of pages have been written about investing in shares, from popular books aimed at the general public to academic tomes written by Doctors of Philosophy. Statistics have been poked and prodded, ideas espoused and debunked, all to confirm what is really obvious. This Report focuses on the five basic principles used by investors serious about managing and growing their wealth.

There is no attempt to favour one company or type of company over another, although, by definition, more will be invested in large companies than small companies because that is how the index works. Efficient Market Theory says that the market is always well informed in setting the price of individual stocks. Supporters of this theory believe that the market is almost always right and that it is impossible to do better and very costly to try. Recently this theory has been seriously challenged both on a theoretical basis and after new, long term analysis of share market data from the United States. There is also ample evidence in Australia, where the market is not as large, diverse and well informed as some international markets, that the market can be beaten - but it is not easy. Over time, the Australian share market, as represented by the index has been a very good investment.

Special Points of Interest

Analysis

of almost seven decades of Australian share market performance shows average per annum performance of around 11%. This confirms the importance of patience, diversification and time in the share market; The importance of understanding and applying basic principles to recognise when shares in good companies are reasonably priced. And being disciplined to sell when those shares become expensive; Why planning to be wrong is an important part of being a seriously successful investor.

Using Fund Managers

Using fund managers can be a good approach to share investment but management expenses can be high. Also, money tends to be managed by people - not companies - and significant changes in personnel are rarely reported to investors. Many investors spread their investment across too many fund managers and can end up paying dearly for an average return. For larger investors, perhaps the major problem with using managed funds is the lack of control over the level and nature of the income received and the tax implications of decisions taken by managers. When buying into a managed fund, investors are invariably buying into a pre-existing Capital Gains Tax liability. Sometimes this Capital Gain is crystallised soon after investment and a portion of the investors capital is paid back in the form of taxable income.

The Lessons of Experience and Research

The continuing lesson from examining how the great names in investment and fund management have been consistently so successful over decades of often great industrial, financial and economic change is their disciplined approach using five basic principals. Dont expect to get rich quickly but dont be surprised if you do; Buy shares in good, investment grade companies; Try not to pay too much - be happy to wait - and be happy to sell if the stock becomes expensive; Plan on being wrong sometimes - manage your risk; Work hard and hire good help the less work you want to do, the better the help you need.

Personal Funds Management for Profit

Your Own Portfolio, Managed Funds or Investing in the Index. In the main this report is about investing in your own portfolio rather than in the market overall or by using fund managers. Employing any of these approaches is far better than not investing. Often a combination of approaches should provide a better quality result.

Investing in Your Own Portfolio

Buying shares is different to investing in the market index by definition. It would be a miracle if the returns received over short or long periods were the same. The risk when investing in your own portfolio is higher than when investing in the index or through most managed funds. Individual companies can go out of business and all of the money can be lost. (Ask investors in HIH or Babcock & Brown). Investors who dont obey the basic rules or are driven by greed into speculation can be very badly damaged. Many who played the market with technology stocks found their portfolios down by more than 80%. In the late 2000s, those who were overexposed to property investments also would have seen their portfolio performance lag. This is a far worse performance than an investment in the broad market index could ever return just because of the increased diversity it provides.

Investing in the Index

There are investment funds that aim to almost exactly replicate the performance of the share market index. There is little or no management involved in this type of investment and the costs are very low. Investing in the index is a legitimate approach. The investment is in the broad economy as represented by the major businesses listed on the share market.

Managing your own share portfolio also requires more administration than using index funds or fund managers. The rewards are in having more control over investments; the opportunity to get a better after-tax result by managing income and capital gains more efficiently; and the interest there is in the investment process. These rewards have some costs in time and involvement.

telecommunications, information technology and healthcare are the significant parts of the economy. Over this period the average return for long-term investors has been 11% per year. Had these investors kept their money in loans to others (eg in the bank) they would have made less than 7% per year. And the return from shares is more favourably taxed with the dividend income mostly in the form of franked dividends where 30% tax has already been paid and tax is only paid on only half of capital gains. Based on todays tax laws the after tax return from shares would have been around double the return from money in mortgages or at the bank. Chart 1 also tells us why people shouldnt put all their money into the Share Market. The returns can be negative. There is, of course, also risk in lending money - the people you lend it to may not pay it back. In fact, a lot of money has been lost over the last ten years due to the failure of mortgage intermediaries through either bad management or fraud. But the negative return from the share market goes away with time and after ten years all index investors in the past have at least had their money back. The message is that if you want to spend the money within the next four years and you want to be 90% certain that it is going to be there, then dont invest it in the share market keep it in the bank or in some form of term deposit. This area of discussion is called Asset Allocation and is more fully explored in other reports from Prescott Securities.

Why Invest in Shares

People with money have two major alternatives: You can choose to invest in assets like shares and properties. By being a part-owner, you receive a share of the earnings and capital growth; or You can choose to lend money to others like banks and other financial institutions or through mortgages. By lending your money rather than investing it, you will receive interest.

Chart 1 shows the returns, from capital growth and dividends, received by people who invested in Australian shares over a period of sixty years. The chart shows all the rates of return they experienced after one year, two years all the way up to 20 years. There is a separate line for each quarter over that period. In other words, the chart includes a line showing the returns for investments made in September 1936, December 1936, March 1937 and each quarter after that. This is a very large series of data, including periods of war, booms and recessions as well as a period of substantial structural change. During this period Australia moved from being a rural and colonial economy, through the growth of protected manufacturing industry in the 1950s and 1960s, to becoming one of worlds great mineral exporters, through industrial restructuring to the present where mining, financial services,

Chart 1 - Rewards from Long Term Investing

Source: Prescott Securities Ltd.

The good news from Chart 1 is that having a bad year in the first year does not mean that you are destined to do poorly from investing in shares. And unfortunately, a great first year does not mean you will always be a top performing investor. The blue line in Chart 1 shows the returns experienced by those who invested at the end of September 1973, just prior to the oil crisis. This was the worst time to invest in the last sixty years (worse than September 1987) and the portfolio would have lost almost 45% of its value over the next twelve months. Fortunately, the year from September 1974 was pretty good and most of the loss was recovered. And by the end of the third year the portfolio was back into profit. These investors later participated in the strong market returns of the late 1970s. After seven years they had experienced compound returns of around 16% per annum. The red line shows the return for investors at one of the great investment dates of the last Century, the end of June 1967. The economy was running strongly after the slow down in the early 1960s, inflation and interest rates were low and the future looked terrific. After one year the portfolio value was 73% higher than at the start. Unfortunately, it didnt continue. Seven years later these investors also hit the oil crisis that brought their performance back to the pack. The message is that when investing in the index or managed funds it is the time in the market that matters, not the timing of the market.

Why Do Shares Go Up in Value (or When Will the Music Stop?)

The more profit a company earns the more valuable it is. The amount of profit a company earns can be divided amongst all of the shares to calculate the Earnings Per Share. If the amount earned per share increases over time then the value of the share to investors will increase over time. What is also important is the amount that investors are prepared to pay for earnings. Investors have long used the ratio of Price per Share/ Earnings per Share (the PE Ratio) as an indication of whether a share is cheap or expensive. The amount that investors are prepared to pay for shares seems to be influenced by two key factors: The level of interest rates (ie what they can earn by not investing in shares); and Sentiment. When interest rates are high it is more attractive to keep money in safe loans rather than be subjected to the risks of investing. The price of shares will be lower than at times when interest rates are low. The level of interest rates is largely influenced by the rate of inflation. Consequently, over quite a long time period there has been an inverse relationship between PE Ratios and the Rate of Inflation, as shown in Chart 2. This relationship led to a drop in the attractiveness of shares in the early 1970s as inflation went up to quite high levels. There was a return to higher levels of pricing through the 1990s as inflation fell to more normal, long term levels.

Share Prices and Inflation Chart 2 - Share Prices and Inflation

-2.0
Inflation (Inverted) (LHS) Price/Earnings Ratio (RHS)

24

0.0

22

20 2.0 18 4.0 16 6.0

14

8.0

12

10.0

10

8 12.0 6 14.0 4 16.0

18.0

Source: Iress & RBA

Year

Price/Earnings Ratio

Inflation

The two factors that seem to drive sentiment surrounding an individual share or the market as a whole are price movements in the recent past and the level of confidence in the future. If prices have been increasing then investors will feel confident about investing in shares. Prices will keep rising until they reach an unsustainable level. When share prices are falling, confidence will be lower and prices will continue to fall until the underlying value becomes so attractive as to cause a turn in pricing. Riding the wave of investor sentiment is called Momentum Investing. This can be a lucrative but dangerous style of investing and critics often call it the Greater Fool Theory. The Greater Fool Theory is that it is OK to pay a high price for a share that is rising in price because there is always a greater fool who will pay you more. This is the foundation of most day trading and works well until the music stops. The experience of traders in technology stocks during 2000 bears witness to this. Long Term Investors will do best if they buy shares in good quality companies when sentiment is poor and hold the stock until sentiment improves. If a stock becomes very popular it sometimes makes sense to sell and move to another investment. To do this successfully is hard work. You must recognise the fundamental quality of a company and also have a way of knowing when the shares are reasonably priced.

If you wanted to estimate future cash flows you would start with the Dividend Yield and in order to estimate the future dividends and the direction of the share price, you would need to know the level of Earnings Growth. In order to make some judgement about the future price of a share you would need to decide whether the current Price/Earnings Ratio (PE) would be maintained in the future and you would certainly need to know what it is now. With the basic components of Dividend Yield, Earnings Growth and the current PE, you have all the building blocks that would be necessary to calculate the value of a share based on the net present value of all future cash flows. Another approach to using this data is to create a Value Score for each share based on the equation below which was used by the famous US investor, Peter Lynch. Value Score = Dividend Yield + Earnings Growth Price/Earnings Ratio What this equation is saying is that shares with a high dividend yield and/or high earnings growth that are selling at a low price are more attractive to buy than other shares. This seems like a reasonable proposition.

Getting the Information

In choosing to focus on the Yield, Earnings Growth and the Price/Earnings Ratio we know we are evaluating shares based on the basic components of success. The raw historic information is readily available and you will always know the current price. The question is whether the historic data is good enough or whether the process can be improved by using research? Historic data will tell you the results a business has achieved under past management - very valuable information. Unless something changes this is a pretty good indication of what will happen in the future. At Prescott Securities we believe it is possible to improve on the historic data and the information we use is outlined below.

Comparing Likely Returns from Different Share Investments

The theory is that the true value of a share is the discounted present value of all cash flows that will flow from that investment in the future. This means that if you could estimate the dividends you will receive from a share each year in the future for a very long time and the price at which you will eventually sell it, you could then reduce all of these amounts to a current value. To do this, the estimates would need to be discounted by the current risk free return you might get, say from a cash management trust, plus a premium for risk. This way you can determine the true value of a share. It is then a simple matter of comparing the true value to the price and then only buying shares when they are cheap. If your eyes are starting to glaze over at this point, dont lose heart. In reality, the maths is fairly simple but like all good theories when it comes to investing, it is not the answer but the idea that is the key. The theory points us to what is important.

The Dividend Yield

The yield for the past twelve months is in the newspaper everyday and while analyst projections are available from any broker or research house, the risk involved in using historic information is quite low. Companies will strive to at least maintain their dividend payments to shareholders the management like to keep their jobs. At Prescott Securities we use an average of the yield for the past twelve months and the consensus estimates for the next two years. We also use the pre-tax value of the dividend by grossing up to allow for the level of Franking (ie the level of tax already paid by the company).

Determining Earnings Growth

We know that if the level of earnings per share grows the value of the share should also grow over time. Earnings growth provides management with the ability to pay higher dividends. It seems obvious that if you have two companies that pay 7c per year per share in dividends, Company A has 2% per year of Earnings Growth and Company B has 12%, then you would pay more for the shares in Company B. Some investors believe that earnings growth is the most important focus because it is likely that you will make more from a rapidly increasing share price than from dividends. The problem is in getting a handle on what earnings growth is - the information is not readily available and is difficult to interpret and define. Earnings Per Share history is available from some research houses and commercial information sites. One approach is to average the earnings growth over the past two or three years. Most research houses and broking firms will provide earnings projections and the average of each future years earnings growth could easily be calculated. As it happens this would be a far more sophisticated use of broker research than taking notice of their Buy or Sell recommendations. The problem with looking only at forward estimates is that on average they are more positive than historical growth. There is an argument for considering the long-term earnings growth of a company as well as projections. If a company has been averaging 5% earnings growth over ten years and the projected earnings growth is greatly different (either higher or lower), you would want to understand what was going to make the future different. Long-term earnings growth is not the entire answer either. Companies can change. A good example is Wesfarmers. Its long-term earnings growth will give you information about a company focussed mainly on coal mining. The acquisition of Coles in November 2007 was

a company changing acquisition and the core earnings of the business now has a focus on supermarkets, competing with the likes of Woolworths. A substantial management shake up can also change the direction of earnings. Finally, it is easier to take a position on earnings growth where the earnings of a company have been consistently growing than where the earnings have been erratic. Below are earnings per share charts prepared in October 2010 for two companies; Westpac and Qantas. These are very different companies in many ways but there is also a difference in the consistency of the earnings growth. For many investors, consistency of earnings performance is an important indicator of the quality of the investment. The majority of the information on these charts is historical (we are using the earnings figures before abnormals so that we can focus on the actual business performance). The last two data points are consensus forward estimates. The level of earnings growth will vary based on the method used for calculation. Table 1 indicates the differences in average earnings growth rate for these two companies over various time frames. Clearly, some level of judgement is required. Table 1 Average Earnings Growth Past Two Years Forward Estimates Long Term Trend Medium Term Trend Westpac 10.8% 5.1% 11.2% 10.2% Qantas -10.4% 53.5% -1.4% 11.3%

For Westpac, given the long-term consistency an earnings growth estimate of 10-12% would seem reasonable. With Qantas, you may choose to discount both the long and medium term trend figures as the past inconsistency reduces the predictive power of these figures. The recent earnings recovery cannot be ignored, but we should take into account the conservative forward estimates but acknowledge that they are only analyst projections and will change from time to time. Perhaps a figure of 6-8% could be used.
Qantas Airways Limited

Westpac Banking Corporation

Price Momentum Earnings Trend Dividends Price

Momentum

Earnings

Trend

Dividends

250 $30.00 200 $25.00 $20.00 Price $15.00 100 $10.00 50 $5.00 $0.00 0 150 Earnings/Dividends - cents $6.00 $5.00 40 $4.00 Price 30 $3.00 20 $2.00 $1.00 $0.00 10 50 Earnings/Dividends - cents

Source: Prescott Securities Ltd., Iress & Morningstar

Source: Prescott Securities Ltd., Iress & Morningstar

At Prescott Securities, we find that an average of the Long Term and Medium Term Trends, adjusted for consistency and the average of the last years growth along with future projections, generally provides a reasonable basis for calculation but occasionally judgement has to be used. This does not diminish the validity of the overall process but merely indicates the difficulties in reducing everything to mathematics when it comes to investing.

At the time, the dividend yield was around 5.9%, the earnings growth estimated at around 6% pa and the PE around 11.3 times. On each of these criteria, the share compared favourably to the rest of the market. The market noticed the quality of the stock and there was a strong price growth from around $18.00 in May 2003 up to around $30.50 in April 2007 where it became rather expensive. It would be wrong to rely entirely on this analysis as many stocks have had well-deserved positive sentiment for a number of years and are worthy of consideration.

Current Price The Price/Earnings Ratio (PE)

Just as the yield based on last years dividend is readily available so is the PE where the current price is divided by last years reported earnings. Relying on the PE based on the past years earnings is reasonably risky as next year the earnings could be considerably different and knowledgeable investors will often know when this may be the case. At Prescott Securities we use the average of the past years earnings and the consensus projections for the next two years earnings in arriving at our PE figure for each company. We also find it useful to consider how an individual share is trading, compared to its long-term PE. The chart below for ANZ Bank was prepared in October 2010. The long-term earnings versus monthly share price lines are organised such that if the PE of ANZ Bank had been the same over time, then the Price line would be on top of the Earnings line. There are a number of things that are interesting to note from this chart. Since the early 1990s, earnings growth has been extremely consistent and on average the analysts in August 2010 expected the consistent growth to continue. By this measure, we can see that ANZ Bank is a pretty good company.

Increasing the attractiveness of the price when a

company is trading below the long term PE and vice versa adds an element of contrarian thinking into the valuation model and this is attractive for many investors. Hard Research is Good to Find and Good Research is Hard to Find Research is rarely, if ever, about getting information that the rest of the world doesnt have. It is about calculating what impact new information will have on a companys profit and when. If the new information will not affect profit for many years, to act upon it would be speculative as a lot can happen in the meantime. Some investors may be happy to speculate (gamble) but this is not serious investing. Share analysts are clever and well-educated. They do nothing all day but evaluate information and become experts about the relatively small number of companies they specialise in. And while some of them are not as good at it as others, it would be foolish to spend much time trying to do basic analysis yourself. While earnings and dividend estimates are available most private investors opt for soft research options.

ANZ Banking Group

Price

ANZ Banking Group

Momentum Earnings Trend Dividends

250 $30.00 $25.00 $20.00 Price $15.00 100 $10.00 $5.00 $0.00 50 200 Earnings/Dividends - cents

150

Source: Prescott Securities Ltd., Iress & Morningstar

They expect to gain an advantage by reading the paper, watching investment programmes on television or by subscribing to share magazines.

Why Does this Approach Rarely Work?

By the time the information is in the paper or magazine, it is in the market and prices have already changed to reflect the impact the information is likely to have. Even if researchers have important new information or analysis, the last people they will tell will be the general public or private client advisers. The research is actually paid for by large institutions and they understandably insist on there being an embargo period before this information is made public. People who are serious about investing for profit in the share market should have a creed they recite whenever they are thinking about investing: I will never know anything that everyone who can impact the share price doesnt already know. I am not smarter than everyone else in the world. I am unlikely to buy something at the lowest price it will ever be. I am unlikely to sell anything at the highest price it will ever be. I am more likely to make money by being wise than by being brilliant - and being wise is easier. Once you know these things are true you are liberated to become a successful investor in the share market. You will know that research is important because only dealing in historic information is dangerous. You will know that the availability of research defines the universe of shares you will be interested in if there is no research you simply wont have this share in your core portfolio. You will know the purpose of good research is to add to your understanding about the earnings outlook for a firm. And be aware that good research is hard to find. Individual share broking firms will have their own agendas, particularly if they have fund-raising or broking relationships with listed firms. And even when this is not the case, sometimes their analysts are not up to scratch. Also, if they are doing work for a firm they are precluded from providing any information. Multiple sources of research are required. At Prescott Securities we subscribe to consensus data to get the average projections from all analysts. We also draw qualitative information from various research houses.

Many people will be happy for all their portfolio to be core. Others will seek to add spice through small investments in less well-researched stocks or by allocating some money to specialist fund managers. Own more than one or a few shares - but not too many The risk reduction benefit that comes from diversification is less with each share that you add to your portfolio. Remember, you are not trying to replicate the index: you are trying to do better so some level of risk is good. Usually somewhere between 10-15 stocks is a good target where the benefits of diversification are not outweighed by the added complications. Once you have set a number, dont increase it every time you want to buy something - force yourself to decide what to sell. Hard decision making is good for the soul and for the portfolio. Establish exposure limits For example, you may want to say that no one share should be more than twice the average holding and that no share should be less than 25% of the average. Where a share does so well that it moves significantly above the maximum exposure level you are effectively saying that you have moved outside of your comfort zone. It will be sensible to sell some of the shares to come back to the top of your comfort zone. Where you have a small holding you should either buy more or sell altogether and make way for something that you want to own. Finally, establish a review process and time scale Formally reviewing your portfolio on a quarterly basis is sensible. You dont add much value by formally reviewing more often. In fact, it makes good sense to take a position and let the world turn for a while without making changes.

Identify Investment Grade Stocks

For your core portfolio it is sensible to identify the universe of investment grade stocks. Then keep an eye on them so that you can consider buying them when the price looks attractive. This does not mean only investing in Blue Chips, even if this meant something. The implication is that all big companies or only big companies are of investment quality and neither of these statements are true. All investment grade companies will be researched and will have one of the following two characteristics preferably both. They will have a significant retail franchise so that they have control over their own destiny and can be price makers rather than price takers; They have a history of consistently increasing earnings per share.

Plan to be Wrong - at Least Some of the Time

Have a Portfolio Management Strategy This may include ensuring that the majority of your portfolio is considered core. Your core portfolio will consist of investment quality stocks and will be managed in a disciplined fashion.

Westpac (as shown earlier) fits into both categories. Some of the other companies, such as Woolworths, Harvey Norman, Coca-Cola and Origin Energy that have both characteristics are in a group of charts on page 10. These charts show earnings per share and prices over time (prepared in October 2010). There are some companies that have strong retail franchises but have yet to exhibit consistent earnings growth. These companies are worthy of consideration due to the strong brand position they have. The charts for Flight Centre and Fosters Group as examples (as at October 2010) are also shown on page 11. Some companies may not have strong retail franchises but have exhibited long term consistent earnings growth. ANZ Bank (as shown on page 8) fits into this category. The charts for some other such companies, in this case Cochlear and Ramsay Health Care at October 2010, are also shown on page 11. There are some companies that do not fit this definition of Investment Grade Stocks, as shown on page 11. At Prescott Securities we have identified around 30 companies that we should be happy to have in a core portfolio at most times and especially when they are attractively priced. Investment Grade stocks have the capacity to forgive your errors. If you buy at the wrong time then the quality of the businesses will usually at least deliver your money back at some point even though it may take a little while.

Diversify
As well as owning a number of shares it is a useful discipline to have exposure to different parts of the economy. Popular wisdom would have you try to match your exposure to different sectors as closely as possible to their weighting in the index. Traditionally, the market is split into a large number of sectors most of them very small and it is difficult to gain exposure without managing a very large portfolio. The international categories make more sense, excluding property trusts and utilities, there are nine categories. They are listed on page 11 along with their size in the Australian Market (as at October 2010). Weighting the portfolio in line with the index really makes little sense. Judging risk based on the level of volatility of prices is a standard approach within the investment industry but for longer-term investors it is really nonsense. The reward for owning volatile assets is a higher return. Owning volatile assets is similar to a roller coaster ride - if you dont like the ups and downs you can cover your eyes (property investors have been doing this for years). Intuitively, however, it does make sense to own different sorts of things. Consumer Discretionary, Information Technology (a very small sector) and Telecommunications seem to have marched to a slightly different drum over the past decade. This makes these sectors good diversifyers.

Companies with Strong Retail Franchises and Consistent Growth in Earnings Per Share
Woolworths Limited
Price Momentum Earnings Trend Dividends Price

Harvey Norman Holdings Limited

Momentum Earnings Trend Dividends

$45.00 $40.00 $35.00 $30.00 Price $25.00 $20.00 $15.00 $10.00 $5.00 $0.00 0 50 100 150 $8.00 Earnings/Dividends - cents 200 $7.00 $6.00 Price $5.00 $4.00 $3.00 $2.00 $1.00 $0.00

45 40 35 30 25 20 15 10 5 0 Earnings/Dividends - cents Earnings/Dividends - cents

Source: Prescott Securities Ltd., Iress & Morningstar

Source: Prescott Securities Ltd., Iress & Morningstar

Coca Cola Amatil Limited

Price Momentum Earnings Trend Dividends Price

Origin Energy Limited

Momentum Earnings Trend Dividends

$18.00 80 $16.00 70 $14.00 60 $12.00 Price $10.00 $8.00 $6.00 $4.00 $2.00 $0.00 50 40 30 20 10 0 Earnings/Dividends - cents $18.00 $16.00 $14.00 $12.00 Price $10.00 $8.00 $6.00 $4.00 $2.00 $0.00

100 90 80 70 60 50 40 30 20 10 0

Source: Prescott Securities Ltd., Iress & Morningstar

Source: Prescott Securities Ltd., Iress & Morningstar

Companies with Strong Retail Franchises and Inconsistent Growth in Earnings Per Share
Fosters Group Limited
Price Momentum Earnings Trend Dividends Price

Flight Centre Limited

Momentum Earnings Trend Dividends

50 $8.00 $7.00 $6.00 $5.00 Price $4.00 $3.00 15 $2.00 $1.00 $0.00 10 5 0 $5.00 $0.00 45 Earnings/Dividends - cents 40 35 30 25 20 $35.00 $30.00 140 $25.00 Price $20.00 $15.00 $10.00 40 20 0 120 100 80 60 180 Earnings/Dividends - cents 35 30 25 $3.00 Price $2.50 $2.00 $1.50 $1.00 $0.50 0 $0.00 5 0 20 15 10 Earnings/Dividends - cents Earnings/Dividends - cents Earnings/Dividends - cents 160

Source: Prescott Securities Ltd., Iress & Morningstar

Source: Prescott Securities Ltd., Iress & Morningstar

Companies without Strong Retail Franchises and Consistent Growth in Earnings Per Share
Cochlear Limited
Price Momentum Earnings Trend Dividends Price

Ramsay Health Care Limited

Momentum Earnings Trend Dividends

$120.00 $100.00 $80.00 Price $60.00

500 Earnings/Dividends - cents $20.00 120 100 $15.00 80 Price 60 40 $5.00 20 $0.00 0

400

300

$10.00

200 $40.00 $20.00 $0.00 100

Source: Prescott Securities Ltd., Iress & Morningstar

Source: Prescott Securities Ltd., Iress & Morningstar

Companies without Strong Retail Franchises or Consistent Growth in Earnings Per Share
Australian Pharmaceutical Industries
Price Momentum Earnings Trend Dividends Price

TAP Oil Limited

Momentum Earnings Trend Dividends

$4.50 $4.00 20 $3.50 $3.00 15 Price $2.50 $2.00 $1.50 $1.00 $0.50 $0.00 5 10 Earnings/Dividends - cents

$4.50 $4.00 $3.50

Source: Prescott Securities Ltd., Iress & Morningstar

Source: Prescott Securities Ltd., Iress & Morningstar

Clarius Group Limited

Price Momentum Earnings Trend Dividends Price

Beach Energy Limited

Momentum Earnings Trend Dividends

$4.50 $4.00 $3.50 $3.00 Price $2.50 $2.00 $1.50 $1.00

30 Earnings/Dividends - cents

$2.00 12 $1.80 $1.60 $1.40 $1.20 Price $1.00 $0.80 $0.60 $0.40 $0.20 4 2 0 8 6 10

25

20

15

10

5 $0.50 $0.00 0

$0.00

Source: Prescott Securities Ltd., Iress & Morningstar

Source: Prescott Securities Ltd., Iress & Morningstar

Prescott Securities Limited I ABN 12 096 919 603 I ASX Market Participant I Australian Financial Services Licence No. 228894 Head Office I 245 Fullarton Road, Eastwood, South Australia 5063 I T +61 8 8372 1300 I F +61 8 8373 1710 info@prescottsecurities.com.au I www.prescottsecurities.com.au Melbourne I Level 40, 140 William Street, Melbourne, Victoria 3000 I T +61 3 9607 8571 I F +61 3 9607 8282 Gold Coast I Suite 105, Level 1 Eastside 232 Robina Town Centre Drive, Robina, Queensland 4230 I T +61 7 5503 5600 I F +61 7 5503 5699

Sector Consumer Discretionary Consumer Staples Energy Financial Institutions Healthcare Industrial Companies Information Technology Materials (eg Resources) Telecommunications

Share of Index 4.3% 8.0% 7.2% 32.0% 3.6% 6.6% 0.8% 25.0% 3.4%

Volatility 25.3% 16.1% 23.5% 21.1% 23.3% 25.5% 38.6% 24.5% 16.0%

Correlation 34.5% 91.7% 80.9% 91.1% 80.8% 88.6% 11.9% 91.3% -35.6%

Consumer Staples and Financials seem to have lower volatility, indicating that they may provide a solid conservative investment base. Also, you may choose to take a view that the prospects for some types of businesses are better than others at the moment and favour investment in those sectors. Prescott Securities periodically produces reports on the investment sectors that seem to offer the most medium term potential.

end costs money. By getting good advice you share this cost with other people. The bad news is that good advice usually costs more than bad advice (though not always), the good news is that there usually isnt that much difference when all the costs are taken into consideration. There are a few golden rules. Dont pay for advice by the transaction Sometimes the best advice is not to invest and you need to be prepared to pay for this advice too. If your adviser only gets paid when you do something dont be surprised if you are often advised to do something. Pay your adviser a retainer. Dont pay for reports - pay for advice Many firms will provide regular reports showing the value of your shares - often with beaut graphs showing how your portfolio compares to the sectors of the market, as if it really matters, and sometimes you will get some tax information. This is low value add. You dont need a description of your portfolio; you need well-considered advice on what to do next. Ensure that there is an advice process Stockbroking firms usually leave the advice to the adviser and often there is no controlling process. Good advice eventually flows from having well considered and proven processes delivered by knowledgeable and experienced advisers. Financial Planning firms often have good process when it comes to structures, asset allocation and the use of managed funds but generally get their share advice from stockbrokers where there is no advice process.

Doing it Yourself it Certainly is Cheaper (like brain surgery at home)

Lots of things are cheaper if you do them yourself. Sometimes the result is not as good but often this doesnt matter. There is a certain sense of satisfaction that comes from doing things for yourself. Otherwise, no-one would knit jumpers, turn a piece of wood in the shed, fix up old cars or roast their own chicken. When the consequences of failure are low, why not have a go - you might even save some money. This can be true of investing if the outcome doesnt really matter, where the money involved is relatively small or where it really is just for fun. Serious investors know that good advice can add value. Good advisers bring information, experience and, probably most importantly, detachment to your decision making. The purpose of this report is to show that investing professionally is not rocket science. But investing with purpose is hard work, it takes a lot of time and in the

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Disclaimer: The information contained within this document was compiled by Prescott Securities Limited (PSL) based on materials from other sources and PSL provide no warranty regarding the accuracy or completeness of the information. All opinions, conclusions, forecasts or recommendations are reasonably held at the time of compilation but are subject to change without notice by PSL. PSL assume no obligation to update this document after it has been issued. Except for any liability which by law cannot be excluded, PSL, its Directors, employees and agents disclaim all liability (whether in negligence or otherwise) for any error, inaccuracy in, or omission from the information contained in this document or any loss or damage suffered by the recipient or any other person directly or indirectly through relying upon the information. This publication is intended to provide background information only and does not purport to make any recommendation upon which you may reasonably rely without taking further advice. This publication does not take into account any persons investment objectives, financial situation and particular needs. Should you consider the acquisition of a particular financial product as a result of the material contained, you should obtain a copy of and consider the Product Disclosure Statement (where applicable) for that product before making any decision. PSL may receive a fee for advice and/or the implementation of an investment decision. PSL and their representatives may have financial interests in some/any of the product(s) included within this report. Prescott Securities Limited (PSL) is the holder of an Australian Financial Services License No: 228894. PSL is a WHK Group firm. Prescott Securities Limited December 2010. All rights reserved.