ASX shares have their best week in three years, soaring 7.6 per cent. Fact is stranger than fiction, writes The Motley Fool
Reading last weekend’s Australian Financial Review you could have been forgiven for hitting the sell button on Monday morning, liquidating all your share holdings, and heading for the safety of cash.
It would have been a very costly mistake.
The S&P/ASX 200 finished the week up a whopping 7.6 per cent, it’s best week since November 2008.
And this, when on Friday, Australia’s big four banks had their credit ratings cut by Standard & Poor’s.
Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank (ASX: NAB) and Westpac Banking Corporation (ASX: WBC) were each cut one notch to AA-minus, the fourth-highest credit rating on S&P’s scale.
Crisis? What crisis?
It just goes to prove, once again, that predicting the short-term movements of the share market is a mug’s game.
Regular readers will know we’re optimists here at The Motley Fool.
We’re also realists.
For example, we don’t pretend to know the solution to Europe’s problems. We do think the euro will ultimately be broken up, but we don’t know how, or when.
We also think Europe could well fall into another recession. It may be in one right now. Will it have implications for Australia? Probably. In what ways? Hard to know.
Most investors are worrying about these macro issues, wondering if they have the potential to wipe out share portfolios.
But none know the answer. And worrying about it isn’t going to get you anywhere.
Bazooka gun, part 1
Our stance has long been that if push comes to shove, if Europe’s problems look like they could bring the global financial system down, politicians and central bankers will bring out the bazooka gun.
This week’s co-ordinated action by six major central banks to lower the cost of borrowing for banks may not have been the bazooka, but it did have the desired effect, with world share markets surging higher.
Back at the coal face
Meanwhile, whilst all this goes on around us, Dean and I focus most of our attention on searching for over-looked, unloved, under-valued investing opportunities.
And in this fearful market, we’re finding plenty of such opportunities, especially outside the top 200 ASX companies.
Like the company Motley Fool contributor and small-cap specialist Peter Phan has discovered. I present to you this stock on our radar. Over to Peter…
If you can’t beat them, join them – make money off lawyers and bankers
Investing involves a separation of price and value. Price is what you pay, value is what you get. Investors look for situations where they can pick up dollar bills for 50 cents. Here at The Motley Fool, we try to do slightly better.
Pay $1, get $3
IMF (Australia) Limited (ASX: IMF) makes money by funding large scale litigation and taking a nice big slice (bite) of the proceeds. This “loan shark” company is run by lawyers and bankers (what a moneymaking combo!) and management has significant shareholdings. The essence of IMF’s business model is to obtain $3 for every $1 invested in its portfolio of court cases.
Proven Track Record
IMF listed in October 2001. For the 10 years since listing, the company spent $86m on court cases, and received $273m, a ratio of $3 for every $1 spent. The deal for shareholders is even better. In a period of 10 years, IMF took $40m of shareholders capital, and turned this capital into $46m of fully franked dividends to shareholders, and $86m in book value as at June 2011.
On a per share basis, 41 cents of book value 5 years ago has turned into 71 cents of book value today. Along the way, 43 cents of fully franked dividends were paid to shareholder.
Investors must note that it is only in the last 5 years that returns have accelerated, driven largely by court reforms of litigation processes to avoid the endemic delays experienced in the past. An increase in the number of major funded cases and class actions also helped.
Nice tailwinds and a skilled captain
Past performance is no indication of future performance of course. Nevertheless, despite several competitors, IMF should continue to do very well. The litigation funding market continues to grow every year, both in number of court cases and dollar value of cases, including class actions.
A further reason IMF will continue to do well is that it is not just a question of deep pockets that makes this business successful. IMF must pick its cases well.
IMF loses money not only if it loses the case, but also if the case drags on for several years without a verdict. The quality of the portfolio is essential. I believe that based on their track record for the last 10 years, IMF’s management will not disappoint us.
Finally, there is a virtuous cycle at work. Because IMF is choosy and picky over its cases (plus it has an investigative arm to fund investigations into a case), potential litigants and their lawyers will approach IMF for funding purposes first, because if it is approved by IMF, chances are you have a near sure winner. Think of this concept as being the case of “the fish that John West rejects.”
Alignment of Interests
IMF pays fully franked dividends. However, the level of dividends is tied to the success rates from the case portfolio, and shareholders should not expect them to be regular.
Management compensation is reasonable, and is tied to the operating performance of the business. This is demonstrated by tracking employee expenses year on year with net profit figures. Other operating expenses are also controlled and managed well, with no blow-outs despite surging revenues.
The Foolish bottom line
IMF shares trade at $1.35, about $165m in market cap, being two times book value.
I estimate that IMF has net cash of about $35m to $45m. This means that Mr Market believes IMF’s $1.77 billion case portfolio is worth only $130m to $140m. I believe this is on the low side.
In the next five years, based on past performance, I expect a total of 70 cents of dividends and book value to grow to $1.20.
This equates to 14 cents per year of dividends, and assuming two times book value, a share price of $2.40 in five years time. Assuming a dividend payout ratio of 70%, IMF must achieve average net profit per year of at least $24m, which is undemanding.
If our expectations are achieved, based on current share prices of $1.35, this is about 15% grossed up dividends every year, and 15% per annum capital growth, totalling 30% per year of returns.
Applying a 50% margin of safety, investors will still have 15% per year of returns.
Fool contributor Peter Phan owns shares in IMF (Australia) Limited. The Motley Fool’s purpose is to educate, amuse and enrich investors. The above contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
As ever, we wish you happy investing.
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