Young Guns on the Sharemarket: Meet Australia's New Generation of Money Makers

By Eli Greenblat

Eli Greenblat is a financial journalist who has followed the careers of Australia's young, talented moneymakers. This book is a fascinating insight into the investing strategies of a selection of money managers -- all extremely successful, all under 40 - and shares with readers the lifestyle this affords them.

The group of Australian 'market wizards' includes: Roger Montgomery, managing director and founder of Clime Asset Management; Tom Elliott, managing director of MM&E Capital; Peter Constable, chief investment officer of MMC Asset Management; Michael Norster; Lawrence Gozlan; Gabriel Radzyminski; Karl Siegling; Campbell McComb; Peter Wilmshurst; Angus Gluskie and Atul Lele.

• Language: English
• Publisher: Wiley
• Release date: Dec 30, 2011
• ISBN: 9781742168920

Book preview

Preface

There is no better way to learn about investing in the sharemarket than from the professional investors who spend their working lives analysing, researching and valuing companies.

As a journalist for The Australian Financial Review, I speak to funds managers, stockbrokers and analysts every day. These are highly trained, intelligent and passionate people who invest hundreds of millions dollars on behalf of their clients. They work for some of the largest funds management and superannuation companies in the country, as well as a growing number of boutique firms that look after the money of wealthy individuals and families.

The boutique funds management businesses featured in this book are some of the most successful in the industry. Because of the small size of these boutique firms, these managers can be more nimble than those who work for the larger firms when it comes to taking and selling positions. Many of these investors once worked for the larger asset management companies but have since developed their own strategies best suited to the flexibility of boutique firms.

Other professional investors featured in this book have worked for stockbroking firms, banks or superannuation companies. What they have in common is a passion for the market and a strong belief that their investment strategies and processes will deliver the best long-term gains for their clients.

Most investors never get to meet — let alone chat with — the funds managers who ultimately watch over their investments or superannuation. The only exposure they have is seeing funds managers interviewed on television or in the newspaper. In both circumstances investors never really get a full and well-rounded insight into the managers’ investment styles.

Young Guns on the Sharemarket is the answer to that predicament. This is not a get-rich-quick book, nor is it a simple biography of professional investors. It’s an in-depth look at proven investment strategies as implemented by our ‘young guns’ every day.

Another feature the funds managers in Young Guns on the Sharemarket have in common is their age. This book focuses on investors aged in their 30s, the young guns of their generation. But this doesn’t mean they lack experience. Despite being under 40 years of age, our young guns have witnessed an impressive number of booms and busts, including the 1987 stock market crash, the subsequent property crash, the dotcom boom (and its collapse), the mining and resources boom and the current bull market.

They are young but they are not risk-takers; they are experienced but they haven’t closed themselves off to new ideas. They have developed some of the most innovative investment strategies in the market.

I chose these thirteen managers because they each have distinctive styles. In this book you will read about funds managers from the world of biotechnology, others who focus on small-cap companies and those who prefer investing in the leading stocks on the exchange. Some take contrarian positions to the market’s judgement, others ride with the momentum. There is also a private investor who will give you a glimpse into an entrepreneur’s approach to investing.

Over eleven chapters you will gain an insight into how the young guns construct their equities portfolios. Armed with their wisdom and the help of your financial adviser, you can implement their ideas for yourself.

After many hours of interviews and hundreds of questions, I developed a full understanding of each young gun’s unique investment strategy. These are the rules and regulations by which they operate, the internal guidebook they carry within them as they scour the sharemarket for undervalued companies.

One common theme that often surfaced throughout the interview process was the importance of cash flow. Whatever their investment style, the ability of a business to consistently generate free cash flow was always at the top of each investor’s list. Other financial ratios such as gearing, debt, profitability and earnings per share also cropped up, but cash flow was always mentioned as a key driver of confidence when investing in a stock.

What also became apparent was that most of our young guns placed great importance on management. These are not passive investors — when they buy shares in a company they view management as their partners, not just as a distant third party that runs the business. The young guns often meet with management a number of times before investing. If they don’t like what they see or hear, that can be enough to shake their confidence and push them to look elsewhere.

Over the past few years we have witnessed a polarisation of investment styles. At the one extreme is the strategy of buying quality blue-chip stocks and placing them in the bottom drawer for a few decades, perhaps only to sell them upon retirement or death. At the other extreme is the speculator who treats the market like a casino, jumping from stock to stock like a bee collecting pollen.

Young Guns on the Sharemarket introduces Australian investors to a middle way, a suite of investment strategies that straddle both conservative and speculative investment styles. These strategies will steadily build wealth over decades but also make room along the way for impressive capital gains.

This is an Australian book — written by a local about locals for the domestic market. Almost all the lessons and ideas that are showcased can all be put into practice on the Australian Stock Exchange. Plenty of books detailing the strategies of famous overseas investors such as Warren Buffett have already been written, but unless you are fabulously wealthy and have direct access to the US market, they are close to useless for the average Australian reader and investor.

I decided to write Young Guns on the Sharemarket because I believed there was a lack of quality Australian investment books that provided readers with a comprehensive study of a range of different and varied investment strategies.

You might not be attracted to all the strategies described in this book — some might seem too risky, some not risky enough. But there should be at least a handful which will grab your attention and start you thinking about new ways to invest in the market.

Eli Greenblat

Melbourne, Vic

July 2007

Tom Elliott

MM&E Capital

Chapter 1

Profit from takeovers: the secrets of corporate activity revealed

Risk means different things to different people. Gamblers yearn for that mythical big payout, the win against the odds that will settle all their outstanding debts and set them up for life in the sumptuous manner they have always dreamed of. Reckless investors often approach the sharemarket as if it were a poker table or roulette wheel.

Conservative investors try to minimise risk by diligently studying share tables, balance sheets and annual reports. Only then do they make their play, typically investing in blue-chip companies with dividends, good management and a history of solid returns. They move at a slower pace and because of that can sometimes miss out on the big wins.

But there is a third way, a middle ground between these two extremes that offers good, sometimes even stellar, returns.

Tom Elliott, a founder and director of Melbourne firm MM&E Capital, believes he has developed an investment strategy that straddles the risk/reward spectrum. It’s not a sure bet (nothing is in the stock market) but it is a proven way of maximising returns while also limiting the risk.

The investment style of Tom and his small team at MM&E revolves around corporate activity; namely mergers, acquisitions and takeovers. Part of this style is based on that of leading New York financial strategists in the 1950s, whose theories became the basis for today’s hedge funds. A more modern ingredient is some simple advice from the late Australian stockbroker Rene Rivkin. He said that when a takeover for a company is launched, always buy the target on the probability that a second and higher bid will eventually be placed on the table.

Tom, the son of 1980s entrepreneur and businessman John Elliott, has bolted on his own ideas to broaden and strengthen MM&E’s investment strategy, including a focus on small- to medium-capitalised companies. These companies typically have a market cap of under $500 million, slipping under the radar of large broking houses that rely on analyst reports to guide and shape their investment decisions.

Because of this there exists a gap or ‘niche’ in the market, a small window of opportunity where investors with a disciplined approach and some nerve can generate robust returns in both rising and falling markets.

Tom’s investment strategy works best when an overseas company bids for an Australian company, especially when the takeover target is involved in technology, medical research or other highly specialised fields of business.

As discussed later, Australian investors generally undervalue technology, whereas investors in the US, for example, place a higher earnings multiple on such assets. This means US companies will not hesitate to enter an expensive bidding war in order to gain control of a target’s intellectual property. This situation occurred in 2006, when three American companies fought an $800 million takeover battle for Melbourne-based Vision Systems. The first takeover offer was priced at $2.13 per share, but by the time the dust had settled the final price for control was $3.75 per share. It was a takeover in which Tom and MM&E Capital were deeply involved, using their investment style to generate an $8 million profit in only two months.

Background

Tom is always on the go. He is an active runner and can often be seen jogging from his inner-city home to his office in Collins Street. When he is not picking stocks he is picking albums and is a regular commentator on Melbourne radio station 3RRR. He loves reading and is a history buff, with a large appetite for books on European, especially Russian, history.

Tom was born in Melbourne and moved with his family to Chicago at the age of two. John Elliott, the man who would ‘Fosterise’ the world in the 1980s, was just starting his career and had landed a job with global consultancy group McKinsey & Co.

By the time he returned to Australia two years later, Tom had a slight American accent. He was educated at Carey Baptist Grammar School and was a prize-winning student at the University of Melbourne where he discovered his natural gift for commerce and accounting, also doing well at commercial law. Through his father Tom picked up a part-time job with leading Melbourne stockbroking firm McIntosh, Griffin, Hamson, Wallace-Smith & Co.

John McIntosh was one of Tom’s first mentors and proved to be a big influence on his future career and business choices. McIntosh’s broking firm had a strong reputation for upholding standards, value investing and growing the wealth of clients through traditional and proven investment styles. McIntosh is now chairman of Tom’s MM&E Capital.

Tom spent his school holidays and spare time hurrying around the financial district of Collins Street exchanging contract notes for share certificates, which was the way equities transactions were handled before the mass proliferation of computers and the internet made this highly physical job redundant.

He also enjoyed hanging out at the stock exchange’s Melbourne trading floor where clerks (or ‘chalkies’ as they were also known) furiously wrote, erased, then jotted out again the prices for stocks as the traders huddled in the pit below screamed orders back and forth. Tom’s own first play in the stock market consisted of childhood birthdays when his father would offer him the choice of cash or shares in a company. He always chose the stock option and by the age of 18 had enough money to buy a car.

Tom’s tertiary education included a period at prestigious Oxford University in England. It was there he was exposed to critical thinking, which helped develop his interest in finance, politics and the behaviour of various economic agents in the broader economy.

After returning to Melbourne, Tom took up a management role at upmarket retailer and housewares company Country Road. The experience would prove invaluable. Tom learned the workings of a business from the inside, the difficulties involved in management and how the behaviour of key staff can turn around or ruin a company’s fortunes.

Interestingly, Tom admits to little direct influence from his famous father, although he says John was very helpful as a sounding-board for his ideas.

MM&E Capital’s track record

Using this relatively simple strategy of investing in companies targeted for takeover, Tom and his team at MM&E Capital have managed to ring up robust returns. While he has scored returns of more than 40 per cent on major takeover plays (such as the $800 million takeover battle for Vision Systems in the final quarter of 2006), Tom aims for an average annual return of around 15 per cent.

This figure might seem fairly low in light of the current sharemarket boom and the stellar returns it is generating, but Tom is more concerned with the preservation of his clients’ capital. Typically high net-worth individuals and retirees, they seek consistent returns and an income they can count on year after year. Tom believes his particular investment strategy will generate returns of around 15 per cent annually, no matter what the wider sharemarket is doing. When the current bull market ends — which it eventually must — Tom’s returns of 15 per cent per annum will be highly valued by investors.

The beauty of Tom’s investment style is that it has low volatility and minimal risk. It’s a strategy that retail investors can also cash in on with as little as $5000 to $10 000. MM&E Capital was established in 2001 with only $12 million in funds under management. Today it looks after more than $250 million for its clients.

Takeovers: a game of probabilities

Consider these facts: over the last 10 years nearly 40 per cent of all takeovers of Australian companies led to a higher final price being paid for control. The average increase of the takeover bid was 18 to 19 per cent. Only 4 per cent of these takeovers failed, the acquirer walking away or forced to capitulate by competition regulators or government agencies such as the Australian Competition and Consumer Commission and the Foreign Investment Review Board.

A nimble investor who keeps a close track of financial news can take advantage of these generous odds. Tom suggests investors choose their targets carefully, but when the right situation emerges — pounce.

The beauty of this investment strategy is that it works in both rising and falling markets, in good times and in bad. That’s because it is driven by corporate activity, not profitability or the state of the general economy. Tom’s research has uncovered that in 1998 (the worst year for takeovers in the last decade) there were still around 25 deals. That’s plenty of activity for Tom’s investment strategy to succeed.

Why takeovers happen — it’s not just about the numbers

The word ‘synergy’ has become overused and clichéd in the finance community. When a takeover or merger is announced, it is invariably the first word to spill from the lips of the CEOs and board members pushing for the deal. Shareholders are told that a combination of the two companies will create savings, or ‘synergies’, that otherwise could not have been harvested. These synergies can run into the tens of millions of dollars and often get pride of place on press releases and stock market announcements issued to support the deal.

The reality is that takeovers and mergers take place for different reasons. Managers prefer to run bigger companies rather than smaller ones. Merchant bankers are always eager to sell a business to a company. They receive generous commissions if a deal is done, so corporate activity is always good for their business. Brokers also benefit from these deals; they create more trading and therefore more commissions.

But many takeovers and mergers don’t work out. Reasons for failure include cost overruns, key management and staff leaving, and black holes that are sometimes discovered in the balance sheet.

The funny thing about takeovers is that research, both local and overseas, has shown that as often as not the deals are wealth destructive rather than creative for the companies and shareholders involved.

What is interesting about takeovers is that around 50 per cent don’t create value for the company that is doing the buying. So what drives a company to do takeovers in the first place? Most chief executives would rather run a bigger company than a smaller one and quite often they are driven by growth, not size or profitability. There have been a lot of mergers and takeovers recently where the return on funds for investors has actually fallen. It seems to me this is a fundamental human trait expressed in the corporate world: the desire to get bigger and buy things.

After buying into a company once a takeover is announced, Tom sells as soon as it reaches his target price and moves on to the next deal. As a professional investor he is not a long-term holder of these stocks, though Tom’s personal investments do consist of blue-chip stocks that he has held for a considerable period of time.