Is the Australian Foundation Investment Co.Ltd. (ASX: AFI) (AFIC) share price a buy?
There are a number of things to consider.
Quick overview of AFIC
AFIC is a listed investment company (LIC) which has been operating since 1928, it's one of the oldest listed investment businesses in Australia.
The job of a LIC is to invest in ASX shares on your behalf. It typically owns around 80 to 100 companies in its portfolio across a range of industries. AFIC chooses those businesses for their ability to perform through economic cycles and generate returns over the long term.
Costs
One of the main reasons to consider investing in AFIC rather than other investment managers is AFIC's extremely low management expense ratio (MER). The MER in FY20 was 0.13%. That's almost as cheap as the cheapest ASX-focused exchange-traded funds (ETFs) like Vanguard Australian Shares Index ETF (ASX: VAS) and BetaShares Australia 200 ETF (ASX: A200).
The lower the costs to manage the portfolio the higher the net returns are to shareholders. That's one of the main reasons why the AFIC share price is attractive.
On the costs side of things, AFIC is one of the best value options.
Net return performance
Costs are only part of the equation. It's the net returns that are the most important attribute.
In the recently-announced FY20 result AFIC announced that its net asset per share growth including dividends (and franking credits) outperformed the S&P/ASX 200 Accumulation Index (including franking credits) by 3.5% over the 12 months to June 2020. However, AFIC has underperformed the index by 0.8% per annum over five years and 0.1% per annum over the past decade.
The FY20 performance is a good start to the recovery of long-term underperformance though. Better long-term portfolio returns would be good news for the AFIC share price.
Dividends
But some investors may be less focused on total returns. Perhaps dividends are more important as long as AFIC delivers long-term capital growth.
AFIC's dividend has been very reliable this century with no dividend cuts. However, there hasn't been much dividend growth over the past few years. It's sticking to an annual dividend of $0.24 each year.
The danger of sticking to the same dividend payment each year is that you can eat into the portfolio value if the total returns aren't strong enough. We can see that in FY20; AFIC generated almost $0.20 of earnings per share (EPS) but paid $0.24 of dividends per share. That means it paid more than 100% of the FY20 profit out as a dividend.
If AFIC's underlying ASX share holdings can grow then it isn't a problem, but if AFIC keeps paying out more than 100% of its profit then the capital value would slowly shrink and make it harder to maintain the dividend. That would be bad news for the AFIC share price.
Many of AFIC's big holdings are being impacted by COVID-19 at the moment.
AFIC's biggest holdings
At 30 June 2020 its biggest positions were: CSL Limited (ASX: CSL), Commonwealth Bank of Australia (ASX: CBA), BHP Group Ltd (ASX: BHP), Wesfarmers Ltd (ASX: WES), Transurban Group (ASX: TCL), Westpac Banking Corp (ASX: WBC), Macquarie Group Ltd (ASX: MQG) and National Australia Bank Ltd (ASX: NAB).
With such a large focus on financial shares, it's clear that the AFIC share price is fairly reliant on the Australian economy to perform well. That could be tough with the recent Victorian lockdowns and the expected economic hit.
Is the AFIC share price a buy?
An interesting element of LICs is that sometimes they can trade at a premium to their net tangible asset (NTA) value and sometimes they can trade at a discount.
In the run up to the 2019 federal election AFIC (and many other LICs) were trading at a discount to their NTAs. But now AFIC is trading at a premium again, so it's not cheap today. It currently offers a grossed-up dividend yield of 5.3% – not bad for retirees. But otherwise I think there are better options for growth and dividends out there for most investors.
