The New Margin of Safety

What do you reckon is more important when buying a stock? Price or value?

It’s a loaded question, reader, as you probably already guessed. You need both. The two are separate concepts.

But you can’t calculate value without considering price. And in this kind of market, you definitely shouldn’t buy the price without figuring out what kind of value it has.

Macquarie Bank, for example, obviously had more price than value. Its price is now lower than it used to be.

Figuring out the value is notoriously difficult. The big cheese of value investing, Benjamin Graham, said to buy companies at prices below their book value, or below their net tangible asset value. He called it the ‘margin of safety’.

Safety, because you were literally buying a stock for less than the market value of its assets. With a bit of discretion, that’s one of the safest ways to invest.

There are one or two companies we’ve seen recently that are selling below their book value. AGL Energy (ASX:AGK) used to be, but the market quickly corrected that.

(We like AGL, by the way. It’s the cheapest energy retailer going around. There are only two, really.)

Anyway…in a market slump, you might occasionally find value with Graham’s book-value method. But other tools will probably help you identify more regular opportunities. One is Return on Equity (RoE).

Return on Equity tells you how well a company has invested cash to make earnings. Simply put, it’s the company earnings divided by its equity. It’s a bit like looking at the yield on a bond. That way you can get a grip on whether it’s overpriced or under priced.

RoE isn’t perfect, by the way. Like most ratios it relies on past figures. But it tells us one thing for certain. How much value the market is placing on earnings over different sectors.

We’re running a scan of RoE over the entire ASX today. Tomorrow we’ll show you which sectors are pulling their weight…and which aren’t worth your cash.

US Mortgage Lenders Make Aussie Coal Stocks Cheaper

The Dow Jones fell back to earth yesterday. US stocks los 2.3%. Oil had nothing to do with it this time; it’s still US$136 per barrel. And, oddly, the Australian market is following US stocks down as we write. It’s opened down 1.6% so far today.

The Dow fell because two government-backed mortgage groups, Fannie Mae and Freddie Mac, tumbled by 13% and 24% apiece. A derivatives trader downgraded both stocks.

The market is terrified about how bad the mortgage situation is. The two major lenders are now at serious risk of collapse…though we’re not convinced the US government would let that happen.

A bail-out may be required. But people could still lose plenty of money on the lenders. And they could fall further on the market. The mortgage black-hole is still vacuuming up bad credit.

Now…do you see why the Aussie market’s slump is odd? In a sane world, if Australia has any exposure to Fannie Mae, it’d be the size of a ladybug’s thimble.

But our world is not totally sane, we guess. So we’re not ruling out any finance companies announcing new exposure to the US mortgage lending fraternity. There’s no underestimating the enthusiasm of idiots during a credit boom.

In fact, our colleague Dan Denning wrote to APRA yesterday to ask whether it had any info on the subject. Here’s the reply he got:

Hi Dan

Thank you for your enquiry about debt owned by Australian banks.

For all of APRA’s publicly available statistics on Authorised Deposit-taking Institutions (ADIs), please refer to

There’s not much use in looking at those spreadsheets. There’s no column titled “Owns US Mortgage Institutions”. The fact is, nobody really knows how much exposure Aussie firms have. We’ll probably only ever know if some company announces it.

We do know one thing though…Aussie shares are not as exposed as US stocks. And Aussie stocks get cheaper this morning, reader. There’s stupidity in the air.

Ahem. Excuse us…who’s driving this market? You have your eyes on the wrong lane.

Take Felix (ASX:FLX). It does not lend to home-owners in America. It digs up black stuff called coal in Australia. There is no direct link between the two. Do not try to find one. Someone should tell this to the investors who are willing to sell it for 3% less this morning.

In fact, in the words of a Citigroup analyst yesterday, “the coking coal market is expected to remain tight for many years”.

In the meantime we’re keeping our eyes on Energy, Earnings and the Economy. Those three factors will have more bearing on Australian shares in the long-term than Fannie Mae and Freddie Mac.

Consumers are Still Low on Confidence

The Economy: Westpac released its consumer confidence survey yesterday. It’s at a 16-year low. That makes sense. It’s been about that long since we had a recession. Petrol prices and interest rates are high. Credit is not.

The message here: nothing has really changed in the last month or so.

Banks Raise Mortgage Rates

But if that encourages the RBA to halt its rate cycle, it might not matter. Bankwest raised home loan rates by 0.2% yesterday. Now St George has some company up there. It did the same thing last week. Both banks are nearing double-figure interest rates.

This article is contributed by Money Morning. Click on the link below for more information and to subscribe to their free newsletter /20080710/mortgage-lenders-make-aussie-coal-stocks-cheaper .html”

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