Mailbag: incl. Evaluating turnaround investments. July 30, 2023

32:15They have a social security scheme that requires you to put some money aside. The government guarantees you'll pay out, yeah. Yeah, yeah, yeah. And that's$192 trillion in the US or about half a million dollars for every US citizen in the country. So it's sort of like the US is getting to, So it's a very interesting set of circumstances there. It's like, well, how do you get away with such a massive deficit, structural deficit for so many years? Well, you print the difference is the answer. Or you convince other people to buy your debt and say that you'll pay it back and probably have to print the difference there.

32:46And it's just sort of what I find fascinating about it is these things can go on for decades before anything sort of comes to a head. But maths, right? It's just maths. and I suspect and this is going to be a real tragedy for a lot of working class people over there that are just really going to get to a stage where it's just like, no, we can't pay it. But you promise, we don't have the money. We don't have it. We just don't have it. And it comes back to not conspiracy theory, just to maths. It's like there is, and this thing is growing at a rate that is, in fact, the US at the moment, given what's happened with interest rates, the interest bill for the US I think is the second or third or fourth largest line item in the budget wow there you go anyway that's a whole other kettle of fish it is I just leave that one sitting there it's also by the way I'm so keen on super there are people who say don't know about super the government will pay you a pension in 10, 20, 30, 40, 50 years when you retire and not even from an unfunded liabilities perspective per se Ram because arguably it's a bit of an accounting thing we're not going to go into now but the unfundled liability could be considered the same for the Australian pension because you have to raise taxes as in collect taxes not to raise and increase them but raise the money by collecting tax to pay for pay for pensions um I just think we have a moral to be kicking the can down the road I think is if we're decent citizens of any country or a society I think we have a moral responsibility to put money aside for our own retirements rather than assuming the kids will do it that that it's I just it's it is just clear as a nose on my face to me that saying let's worry let's let someone else worry about paying for my pension down the track at some point is exactly the GM problem.

34:24It's the American problem. Yeah. Rather than saying, actually, we have the wealth, the income, the opportunity, and the legislative framework to, you know, put money aside for our own retirements. Therefore, we should. I just don't know how that's not just a moral imperative. I just, people can differ. I get it. But for me, straight out, above anything else when it comes to super, is just simply, I have the income that allows me to prepare for my own retirement rather than saying to my kids and grandkids, sorry, kids, you're going to have to do it when I get a hold. Bad luck. Deal with it. Morally, I just don't.

34:56We talk about intergenerational inequity, and there's lots of areas of that with housing and other things. The simplest one is I'm going to put money aside, my own nuts aside for winter, rather than requiring someone else to go and collect their nuts for me when I can't do it myself. Where do I? Let me sign up to your newsletter. I 100 % agree. 120 % agree. It's just, it's not fair to steal from future generations or expect, you know, for me to party like it's 1999 and then just think, well, my kids and grandkids will pick up the tab. I wouldn't put that on future generations. I don't think it's fair to go the other way when all you're really saying is to square the circle.

35:31It's just, as you say, put some acorns aside now. Yeah. And it'll be fine. Yeah. The other thing that bothers me a lot when people say the government should pay, I think they kind of forget what the government is and where the government gets its money from. It gets it from government is us. It's just the people that we elect to represent. It's us. We're paying, you know, it's like, oh, the government's spending all this money on new, what is it? Cargo planes or whatever it is, the latest military expenditure or whatever. It's like, no, that's our money, right? And whatever they can't make up through taxing us, and I'm all for tax, by the way, is they borrow it.

36:12Correct. In other words, they borrow it from the future. And everyone's got to pay the piper eventually. It's just the way the world works. Anyway. Really quickly, I will finish this off by saying, some people will say, well, hang on, my parents' pensions were paid for by my taxes and that kind of stuff. That's absolutely true. And that's absolutely, on one level, unfair. We're paying, I'm paying, well, I'm not paying, I am actually, my mom's got to, so I'm paying my mom's pension as well as saving for my own future. That is double dipping to some degree. Yes, it absolutely is. But you know what?

36:38Choose where the buck stops. You know, we should be big enough and ugly enough to say, you know what? You know, was it great? No. Do I begrudge doing it? No, because, you know, fair is fair and they didn't have the chance to save for it. But that's why super was instituted 30 years ago was to mean we wouldn't have to do that in the future. We just simply have the mechanism now not to. The other thing I will say is, I talk about demographics with GM and forward, people are getting older and living longer. You just beat me to it. Yeah. Very real world fact. We're living a lot longer. And there's fewer working people per retired person now than at any time in history.

37:06And that will get worse before it gets better. And so there's just a, it just makes no sense. All right. Demographic trends are, you can't, no one can read the future, but when it comes to demography, actually, like, insanely well. China's learning this the hard way with, like, the one-child policy. Like, every expert on the planet is like, they're going to end well for you guys, you know? And it just, you can see that coming, living a lot, lot longer and a massive bulge from the post-war baby boom. It's just sort of like, yeah, this is high school maths that you can do to figure out that's not sustainable.

37:38Anyway Demography is destiny As they As the cool kids Yes Yes Motley Fool Money For more Subscribe to the free newsletter At fool.com.au Forward slash listener Mate here's one from Lockie G'day Mr. Phillips And Mr. Page That's very nice Oh this gets ugly Speaking of our dads Must be This gets ugly very quickly mate With too much spare time on my hands I've been back through your archives Uh oh I've begun to notice How unoriginal The podcast is you discuss the same themes and concepts week in and week out and all the changes the relevance to current affairs surely there is more to this big scary beast that is the investing world surely there has to be a sexier formula than just saving and investing in responsible stocks that match your risk tolerance then lucky says i joke of course your help has been invaluable to getting my portfolio on the run thanks for your help with understanding how to get involved in the game and for assisting me to not throw out the toys from the cot when the numbers are inevitably read by a few percent he says or in the case of my elder shares read by 48 that could be my fault that was a recommendation of ours i hope not but maybe i now have a very imperfect portfolio that i'm quite happy with and with 51 years left to retire retirement you bastard plenty of time to see the market cycles out question short-term investing now block your kids ears because i need to read this as written.

39:06Before Andrew starts his shit, says Lockie, I know, I know there are better investments than buying a house, but I'm looking to buy a home. With some rough and optimistic maths, I should have a deposit worth in about three to five years. What suggestion do you have to put the money to work in the meantime? Tone deposits aren't very exciting. Should I look to big, boring stocks, ETFs or more Berkshire? Or should I look to investment funds? Latrobe Financial offers 12 or 24-month accounts, which at this point in time are currently yielding in the low 6 % range. This places me at the investor's side of home loans, but I don't know how to evaluate the risk.

39:45Is it just trust in the company making responsible loans or other other ways to look at it? I'm happy to pay the price of admission, says Lockie, a reference to our comment that volatility is the price of admission. But what sort of return should I be expecting and how should I benchmark shorter-term investments? I think I was going to make a suggestion, which I'll go through in a minute. Can't thank you blokes enough. Full on, Lockie. Love it, Lockie. Great question, mate. Thanks for the stitch up at the beginning of the question. I did read it the first time around and go, oh, this is going to hurt.

40:18And then it's got better. We are not particularly original, mate. Like the proverbial preacher, there is not much new in the Bible, but hopefully a reminder every week or so is useful. Ram, before you start your proverbial, let's leave Lockie off the hook here. Let's assume he's going to buy a house for reasons other than investment, which I know you're a fan of. You're a fan of owner-occupier purchases. Oh, yeah. Of course. So that's what he's looking to do. So you're not going to start your stuff. Instead, you're going to help Lockie. He says as a warning and as a statement, but yes. That's right.

40:57But you're not Andrew, are you? I wasn't, but maybe subconsciously. Edric would not, are you? Don't produce a link. You may have to cut the next 15 minutes of this one. No. Mate, so yeah, three to five years, Lockie is looking, which is pretty impressive. Well done. As he gets closer, how should he be investing his savings? I think he needs to be... Actually, before I do that, I will do the usual scan. We can't tell Lockie what he should do personally. So when I say he, we of course mean generically, how would you think about it? We can't give anybody, any of our questioners, any of our listeners personal advice.

41:27But with that said, make it go. Yeah, no, it's really important to say. Yeah, I think as the timeframe narrows, you should bias cash more and more and more and more. I mean, it's the most ordinary of investments. In fact, it's a melting ice cube. The RBA on a good day wants you to lose between 2 % and 3 % of your purchase in salary each year, right? So it is a crap investment. But it has one saving grace in the sense that it's not volatile, right? Like, you know, you can be sure that if you've got$100 in your wallet slash purse today, you'll at least have, you know, hopefully, well, these days, $94 worth of purchasing power next year.

42:09But it's not going to drop in half. The$100 is still there, exactly. Yeah, the share market's not going to, like, share market could drop in half, right? Could go down even more. Could double. You don't know. But the closer I am to needing my money, the more I'm going to forego the potential of longer term attractive compounding returns and go with cash. Because I need the cash. As long as my time horizon, for me, look, this is just me. But for me, the magic number is about three years. If I feel as though I'm likely to need cash within three years, I try and keep it out of the market. So if me and my wife were like, we're definitely buying a house in the next couple of years, I would have a pretty sizable waiting in cash.

42:50Knowing full well that should the market continue to do what the market normally does, I'm probably going to be worse off. But I don't want to be in that situation where the day that I need my money happens to be the 1987 October crash or the 2000 tech crash or the 2008 GFC or the 2021 COVID crash. Like these things happen pretty regularly, actually, but unpredictably. and I just don't want to be in that situation where it just gets cut in half. Now, if I've got a long-term horizon, I can deal with that with more equanimity and just think, well, it sucks. But, you know, I know that the actual assets I own are good quality ones and they'll most likely come back.

43:33Very hard to say at the time, but I mean, how many times have we lived through it personally? And how many times can we reference it historically to know, like, the core of my soul, I know it's true, right? That this too shall pass. and I just don't have that luxury if I need the cash. So that's the short answer. And I just say very quickly, we do say the same thing again and again and again and again because the best investing wisdom doesn't change. It really doesn't. And if you ever find someone out there that's sort of saying, oh, actually, now you need to do this and now here's the latest way to make money and this and that is like, that's a big red flag.

44:08So run a mile. If ever you catch us doing that, switch off. Yeah, that's right. There is nothing you've been investing in the last 50 years. Hand on heart. But there are some new business models which are worthy of consideration. We're talking about SaaS on Friday. That's a new business model. And so incorporating those things into the way to think about valuing companies is new. But the basic fundamentals of the valuation itself aren't new. The basic ideas of successful businesses, moats, management. Honestly, nothing, nothing, nothing, nothing has changed in 50 years. So you're absolutely right.

44:38I'm going to agree with you, Andrew, with a slight – we talked about this a little bit before – with a slight caveat. There's two tracks here. One is if you know you need the money within five years, I would have it in cash today. If you're going to buy something, we're going to publish this one on the 20th. So five years is the magic number for you? For me, it went out. We published this on Sunday, the 30th of July. If I'm going to buy something on the 30th of July, 2028, and that's the date I need the money, five years.

45:04Because no one knows what happens from now and then. By the way, when I say in cash, the other addition I make to your point, mate, is you do get interest in the bank. So if you can get three or 4 % term deposit, you still go backwards because of inflation. But you can reasonably limit that. You can hold the purchasing power of your cash over that period of time. Yeah, good point. Now, that said, the second bit, which you mentioned, but I know you agree with, is if your purchase date is flexible, then that period shortens massively. Yes. I expect a 10 % return from the share market over the next 10 years on average.

45:35Might it be next year, it might not be in year four, it might not be in year seven. It may be three years of terrible returns before that. But history suggests that over longer time periods, you get closer to that number. So if you said to me, I want to buy a house somewhere between the 30th of July, 2028 and the 30th of July, 2035, then I'm saying one year is all I'd worry about. And the reason there is because I expect, no promises, no guarantees, I expect that the value of my investment, my value portfolio is higher, investing in shares and wearing the volatility, as long as I can choose on the 30th of July, 2028, the five-year period we talked about, I go, oh, bugger, the market fell 40 % last month like it did in March, 2020.

46:21I can say, okay, I'll just put off buying the house for another two years. And if you have that flexibility, I think your total value of your portfolio will be higher over that time period by investing it actively in, what's active? I don't mean actively as inactive versus passive. I mean in growth assets rather than in cash. I would rather be in growth assets if I have flexibility to what that date, that timing is. It won't be fun. You'll get there and you go, oh man, I got so close. The market was high only three months ago. Now it's crashed, but we have to put off buying a house. That's going to suck.

46:52And if it's going to suck too much, then go back to option one. But option two, if I had the flexibility to say, I will buy at a time of my choosing, at a market level of my choosing, then I'd rather be invested in growth assets in particular shares than sitting in cash with an arbitrary five-year period because of the opportunity cost of not having that cash working for me. Yeah. Yeah, I love that. I mean, and that is the reality of it, right? Like if you're – generally speaking, no one sets in stone the exact date they're going to buy a house. You know, if it turns out my aspirational goal in two years, market's down, okay, that's fine.

47:27I'll just continue to rent for a little bit longer. That's a perfectly sensible approach. with one exception and this is where I always go back to the reality of behavioural finance, if you're going to get to that point and say, oh bugger, I'll do it anyway, I'll just buy a cheaper house and you lock in the loss, I am allergic to locking in losses or locking in poor returns, right? So don't assume you're an option two person and then get to that point and either you or your partner or someone says, oh let's just do it, I'm sick of waiting, I'm sick of renting let's just do it now, get over and done with and you say, well my portfolio was $200 ,000, now it's$150 ,000 but I'll just sell it anyway and I'll just buy a cheaper house because of it.

48:04You've literally locked in that loss and you've crystallized it in the worst possible way because it might've gone back up to 215 afterwards and you either buy a better house, a more expensive house, you borrow less money, you do whatever else you want with that. So just be careful of that. If you think you want to go option two but you end up going option one, you have to go option one in the first place. So just be true to yourself as we always say. Know yourself, make the decision that's right for you, not just financially, not mathematically. make the right decision based on what you are likely to do and just be honest with yourself have a really good look in the mirror and have that conversation of in 2028 can i say i'll wait another two years or am i going to say i'm impatient i'm bored i'm over it too much pressure from the partner from the in-laws i'll just do it uh if that's going to you're going to be that person then go back to option one and just keep it in cash yep and just don't uh too many like i've known a few people recently who have bought a house to live in and have so when they're talking about it they're really rationalizing it from a financial standpoint and i'm not saying you ignore i mean obviously you don't ignore the financials but i think they're doing the mistake that i did which was to only think about the financials and like what is what does not fit into your spreadsheet is the incredible insane value that comes with security peace of mind you know um of of having somewhere to raise a family and be with your loved ones it is it's just it's worth more than anything really frankly in the world and so for me it's like the only financial consider again investment property entirely different and i won't rant i won't rant on that but for somewhere to live the only calculus is can i service this thing without going through huge amounts of stress and and turmoil and risk if i can do it with with the fed with a bit of a margin of safety and some rare um uh with a degree of flexibility accounting for the the curveballs that life is guaranteed to throw at me then the answer is yes yes and emphatic Yes, do it.

49:57I think I too often get misunderstood when it comes to property. That's what property is for. It's to live in, right? Now, if you want to talk about leveraging five to one in a negatively yielding asset, okay, we'll have a chat, right? That does not make any sense to me whatsoever. But to live somewhere where, again, I'm not stretched super thin and I can sleep at night, man, do it. Do it 100 times over and 100 times more on Sunday. Let's go to a question from Mick from Botanic Ridge. as he signs off his email. He says, Dear Ram and Scott, I've recently been researching Uranian companies to invest in and I've noticed there are some companies that are listed on different stock exchanges around the world.

50:37I understand that, he says. However, I'm confused by different market capitalizations. For example, a company called NextGen is listed on the Canadian exchange, which is the TSX, the Toronto Stock Exchange, and the Australian ASX. The listed market cap is over$3 billion in Canada, but the listed market cap is only$100 million on the ASX. Fair difference there, he says. I think I have some understanding that foreign shares can't be traded. Something along those lines. Long story short, if I invest in a company on the ASX with foreign ties, am I going to get the same returns that our Canadian friends will receive?

51:17Is it one in, all in, and the price moves accordingly on the local market, or is there some dilution? I'm very new to growing up investing, says Mick, and I've learned so much from listening to you guys on the pod machine. I like the pod machine, Ram. Keep up the amazing work. And that's from Mick from Botanic Ridge, as I said. Botanic Ridge sounds beautiful. I don't know where it is, but it sounds like somewhere I need to visit. Mate, what's the go? $3 billion in Canada,$100 million in the ASX. What's Mick missing? I suspect these are CDI instruments, are they? I assume that's what they are. Chest depository instruments.

51:49Correct. So it's basically the one that matters, I suppose, is the primary listing in Canada. And there's a certain amount that are held in a chest depository. I want to use the word derivative. It's not technically a derivative, but it derives its value from the actual shares. Correct. And there's only a lesser value of them that are traded here. You should still get one for one, excluding currency movements, the same kind of return. But there's a lot of nuance there, mate. Help me out. Yeah, no, look, Mick, I don't know NextGen particularly, but I want you to think about a pizza, because we like pizza analogies.

52:26Let's say you've got an eight-slice pizza. What happens with these CDIs is the Canadian exchange, where there's eight pieces of pizza listed, takes one of those slices away and puts it on the ASX. The whole pizza is still worth what it's worth, but more of the value is, air quotes, listed in the Canadian exchange. and the Australian CDIs have a proportional interest for what's left. So when you look at the market capitalization on the ASX, you're simply looking at the value of those CDIs that are traded here rather than the value of the entire company as a whole. And that's really, really important to make sure you get right.

53:02You can, by the way, also have issues on the ASX in different ways. If there are companies where there are large numbers of shares that are not traded at all, held by a seller, for example, an IPO, those market cap numbers actually can be wrongly stated. So always go back to the company's official documents. Don't trust market cap numbers produced by any of the brokers or any of the free websites like Google. But yes, effectively what you're seeing is a fraction of the business that is traded here. It's that eighth piece of pizza, if you like. It can be nine-tenths of the pizza. It can be 95%.

53:33It can be 5%, 1%. But generally, block and square the business board afterpay. Same thing here. So yeah, ignore the market cap by country. It is a bit messed up because not every one of the Canadian shares is available as a CDI in Australia. Some cases, Australian companies, by the way. So Americans have an American depository receipt, which works the same way in reverse. BHP is traded here and there. You can't get every BHP share on the American markets. The primary listing is in Australia. So you're always going to find that. Ignore the market cap. But to your question, yes, absolutely. Like for like.

54:07your dollar value investment will increase or decrease at the same rate as the one overseas, as Andrew already said, they were allowing for any currency movement. So be mindful of that. But yes, the Canadian dollar value of your investment on the TSX and the ASX are exactly the same and will move in exactly the same ways barring exchange movements with one quick difference, which is if there's super low liquidity here in Australia, you may find there's a lag to that value recognition just because it's up to the market to make those numbers the same. These are free floating instruments. It's entirely possible that a BHP share could trade in Australia for$100 and the American deposit receipts trade at$1.

54:46It won't happen because someone will buy the dollar and convert it to an Australian share and make the money. But in a small business that's less followed, less traded, it's possible for those to diverge by a small margin for a period of time. It's not something you should worry about. But just to be intellectually honest with you about the answer. It is possible. I don't exactly trade one for one, but over time, that's exactly what you should expect. Can I venture very close to financial advice? That is not financial advice. I would say, why are you investing in uranium stocks?

55:26I'm actually a big proponent of nuclear. I've come around to nuclear and that's a whole other kettle of fish. Let's not go. there. Right, I do fish at that. Three eyed fish. Go on. Blinky. But for whatever reason, there is increasing, I think, acceptance and a bit of, there's a bit of a ground swell at the moment for nukes. And it's coming, coming at the angle of reducing carbon emissions. And again, there's a whole very nuanced, complex discussion here, but it has reinvigorated interest in uranium stocks. And I would just to say again, not the first rodeo, right? This has happened again and again and again and again.

56:07Right. So the big ones on the ASX, I believe, are Paladin Energy. Yes, that sounds right. And the other one is ERA. Right. There's a whole bunch of them. So Paladin is a$2.2 billion company. Okay, that's impressive. They never make any money. They never, ever make any money. I can't as far as maybe there's a year or two, but they generally just bleed cash and they generally stay afloat by issuing more and more shares. In fact, in 2019, they've gone from 1.8 million shares outstanding to almost 3 million shares outstanding. That's, that's how they stay in business. By the way, back in January, 1999 ERA shares were 22 cents.

56:49Now they're four cents. Yeah. That's a long time. And on top of all the dilution. $3 at one point in 2007, when all of a sudden it was supposed to be wonderful. It's just, it's there. And you can be right on the nuclear thing. So we've talked about this before with lithium, right? Because people go, wow, electrification, electric vehicles, the world needs more lithium. It's like nothing wrong with that thinking. Where the thinking breakdowns is people go, well, therefore I'm going to buy lithium stocks. Not understanding that a lot of lithium stocks don't actually produce any lithium. They're kind of lithium hopefuls that one day we would like to, if only this, this, this, this, and this happens.

57:25And some might possibly maybe one day. Oh, guaranteed. Fortescue Metals is one of the best investments you could have made in recent history. But what you forget is that it's the one in 500 that made it. And there's 499 other Fortescue Metals that you've never heard of. And not only that, mate, I was on Sky News Business probably around the same time you were. And Fortescue was a weekend away from going broke when it's local called. So even that success was sliding doors. You know, maybe Twiggy's working middle management for BHP right now, right? Oh, man. And so what I am... I'm sorry, we'll be very careful here.

57:57I'm not saying don't invest in uranium stocks. I'm saying don't invest in uranium stocks simply. Howard Marks calls it first order thinking, right? Like if the thesis is we're going to see increasing number of nukes being built, therefore increasing demand for uranium, therefore I'm buying uranium stocks. That is, you are a jump. And I'm not trying to sort of put the listener into a box here because it could be a far more nuanced investment thesis. But make sure it is. Because if that is the investment thesis, I can almost guarantee statistically, it's going to be a very bad one. What you want to do is say, well, okay, I believe there's going to be more demand for uranium.

58:34So let me now have a look at companies that have actually got some uranium to sell in the first place. They've actually got productions there. They've got access to ports. They've got sale agreements. They've got all the mountains of legislation and regulation that is around all of that kind of stuff. And that they are viable and a strong balance sheet. You will find that your universe of investable stocks goes from thousands to probably, probably. So I just, I just want to be careful there because I know that I know that that's a bit of a groundswell at the moment. And I can, I can, as long as I can remember, there has always been someone who goes, you are, nuclear is coming.

59:06And it was actually back when Fukushima went pear shaped, right? Like there was a bit of a Renaissance there. And then that kind of just put the industry back 10 years, you know, and then, and then it was going gangbusters in, in Europe. and then they made this big, fairly dumb move to – well, be careful here. I really support the move to renewables, but they did it too quickly and they turned all the nukes off in the meantime. So now they've got all these massive issues with it. So it's sort of – there can be a lot of good reasons for something to happen. Whether or not it does happen is an entirely other thing.

59:36Yes, exactly. Whether it should happen and whether it will happen are two things. Yeah, be careful about how you put your worldview into investing. If others don't share it, you're in all sorts of trouble. By all means, you've got to be right. You can't just be, oh, I would have made money if they'd all listened to me. That doesn't matter. You still didn't make the money, right? The money doesn't care. It only cares whether the profit is made, the share price goes up or not. I'll give you another interesting stat too. And it depends on, I mean, it's different in China. But in the West, I think it takes about 30 years to get a nuke built.

1:00:04Largely because of the compliance and regulations and stuff that goes through. But even the engineering is quite intense. So even if the government of Australia said, we're going full nuclear, we're going to start now. I would not expect actual demand for uranium. I mean, the market will buy. You watch every uranium stock jump threefold on the day of the announcement. But in terms of them actually selling goods and making revenue, it's a decade away, if not a lot longer. And frankly, at that point, this is the challenge with nukes right now, is that the pace of renewable technology improvement, it means that an investment in, even if they approved it today, a commercial investment in nuclear technology that would take 10 or 15 years to come to fruition with an unknown ROI competitor, what else might be available at that point?

1:00:49Again, whether you care, whether you think it's right, whether you think it's wrong, it's kind of irrelevant, right? Because the question is, are people going to invest in it knowing it might be a massive white elephant or it might work? I don't know, and that's a big question. Yep. You know what I would do? I would invest in companies that do mining services kind of things. These are the picks and shovels, right? So there's a lot of companies out there that do engineering services. It doesn't really matter whether the mine's ever viable or not. These guys get paid to build it and service it. There's a smarter way to play these things is all I'm saying.

1:01:23Yep. Mate, let's go to our last question from Rob who says, Hi, Scott and Ram. My name is Rob, and I want to start by saying thank you for your effort in providing free and unbiased advice. Thank you, mate. I started my investing career using large and mid-tier investment firms who charged a percentage of the size of my portfolio. As it grew, the fees charged by my broker grew with zero input from my advisor. This was made worse as the majority of my investments were ETFs and managed funds. So I was losing money to the product owner and to the broking firm I used at the time. It still makes me angry that my fees increased as the size of my portfolio increased.

1:02:02He says, from funds I deposited and the growth in the ETFs, despite almost zero input from my advisor. In fact, the most advice I used to receive was to, quote, take profits and change the size of a position. Now I use the same investment strategy. I invest in ETFs using a low-cost brokerage account, he uses NAB Trade, he says, and I dollar cost average. Except this time it's without the fees charged by an investment firm. Smart. I still grab out the Money Smart Compound Interest Calculator and shake my fist at the sky. That one's for you, Ram, says Rob. I'm shaking mine as well. I'm with you.

1:02:39And I shudder at what those fees could have amounted to in value for me over the long term. It was your podcast four years ago that gave me the fortitude to leave my broker, open my own brokerage account, and invest for myself. For that, I thank you. Your advice has literally saved me thousands, and I feel will ultimately increase the value of my portfolio far greater than if I had remained with my investment broker. Now the pleasantries are over. Oh dear, Seth Rob. This is going really well. Time for the question. No, it's a question, not a criticism, which is not. As we move from the difficult financial times of the COVID pandemic and shift into a higher interest rate period with the possibility of a recession, my question relates to Peter Lynch's One Up on Wall Street, fantastic book.

1:03:25His six categories of companies, most specifically the turnaround. I have been researching retail food group, he says in brackets. Note, I didn't use a ticker. Well done, Rob. And I noticed that over the last two years, they have changed out management, slowed domestic store closures with possible domestic store count growth in FY24, he says. They've obtained store count growth in their international division and in December 2022 finalized the case that the ACCC brought against it. The management team prior to the current team treated franchisees poorly, but the company appears to have turned a corner and is now profitable with decent free cash flow.

1:04:05However, there has been significant share dilution of late. I know you both have history with the company, so please don't feel the need to use it as an example. But what makes a good turnaround story? As rates start to bite, as consumer spending begins to drop, companies will be impacted. What signs should we look for to identify a turnaround? Thank you again for all your help. We agile and long-term, in brackets, aka retail, Lale, close bracket investors, really appreciate all the effort. Regards, Rob. Rob, thank you for listening. Thank you for listening so intently. You can throw some of our stuff back at us.

1:04:40Much appreciated. Ram, really good question, mate. Turnarounds are one of Peter Lynch's six categories of company. And with circumstances possibly giving rise to the possibility of a turnaround or two, what should Rob and others be looking out for? Yeah. So I mean, the other famous saying in this domain is from Buffett, which is that the turnarounds rarely turn. So I mean, they do sometimes turn and you can do really well out of them because everyone's got so pessimistic on them that you tend to be able to pick up a bargain. But it is the exception to the rule. So what I would want to see with Retail Food Group is, and look, I agree, I agree, some green shoots that are there.

1:05:26but I would want to see more evidence of that. I look at their brands. Was it Donut King, Gloria Jeans, Brumbies, and Crust? I'm thinking here. It's been a while since I've looked at it. No, you've done well. I can't think of any others. Out of all of those - I think maybe on top of that one? Yeah, maybe. Yeah. I don't actually think there's much brand value in many of those franchises. Brumbies, I think, probably. these other ones are they're all in markets that are hyper competitive and i mean with crust you're dealing with dominoes so careful there right or just so you're either someone who likes the cheap and cheerful i'm going to go to dominoes because they're going to they're going to be able to offer me better value than than crust or i'm someone who likes a decent pizza in which case i'm going to the local italian joint which just does brilliant oven fire wood fire pizza right it's just sort of in between I've never seen a crust sort of do that well Gloria Jean's it's a coffee cafe business I mean that's just brutally difficult Donut King you know it's sort of it's just I feel as though these they what I think sucked me into retail food group years ago was they had the fundamentals were fantastic like sales growth margins and it was only with the benefit of hindsight this is a real i'm happy to sort of lean into this mistake because with the benefit of hindsight it was a real mistake but i think what i failed to see here is that a lot of this value was being created at the expense of the franchisees as as uh was said yep and and that's not sustainable so so you've got to sort of share the love and share the wealth creation in which case you don't tend to have as much profitability there where we talked we started off talking about moats you know i i do struggle to see some of the moats that that might emerge from a business like this there is i i went through the list of different ones there's probably something to be said in terms of brand name for some of these like bramby's and whatnot um there's probably something to be said in terms of low cost remember back in the day it was michelle's patisserie well they just they they had a centralized bakery that enabled them to sort of pump out a gazillion cheesecakes much quicker than you could do if you're doing it at each store level and there was so you could you could sort of get better margins or at least offer lower prices but they again pushed that so far that the quality was crap and no one bought them at all so it sort of it was just it was badly managed well depends on your context it was brilliantly managed for the person who was running it because they they extracted all the value much in the same way that russia's been brilliantly managed if your name is vladimir and and is terribly managed if you're anyone else right and and and so i'm i am absolutely you know once burnt twice shy on that um and i i definitely acknowledge the the green shoots i just would i want to see definitely this is just me right and i haven't i haven't i haven't done the due diligence that would be required to sort of speak authoritatively on it but i would i would certainly want to see more green shoots and i would want to have a clearer idea of the competitive advantage that they are offering offering franchises went and done well are incredible businesses but they're also they're they're tough to get right because you you do have a balance of interests that that is hard to balance and that's kind of what um lynch kind of says says similar things um i i think i think you're bang on actually i there's a couple there's a couple of ways i'd probably think about it i i guess your question is what you're looking for the turnaround for and there's two ways to think about that one is a business that is rubbish has been rubbish but is going to have a bright long-term future in other words going to go back to growing and growing and growing and growing that's one that's one option the other is simply a turnaround where it goes back to some sort of steady state it's it goes it's gone from 100 to 5 it goes back to 100 then stops there and in in the in the latter example you can't rely on long-term growth you're kind of playing a valuation game a little bit more in that case and so kind of knowing what you're looking for and therefore what the play is, how much upside is left is worth doing.

1:09:42To your point, though, mate, it's got to be about performance. You simply want to see runs on the board. Buying a business that's bombed out because it might possibly one day start to recover is bad business. Turn around, seldom turn, as Buffett says. You're absolutely right, and I wouldn't play that game at all. I would possibly look at a business that has started to return to growth. Your point about, I guess my point about long-term growth was the competitive advantage one, mate. I don't think the franchises have particularly large competitive advantage. I'm not sure they need to for a steady state business.

1:10:16Because if there's a Michelle's petition in every shopping center in Australia, no one's going to probably try and beat it for cakes in the same shopping center. So to some degree, its own presence in a relatively niche market is a bit of protection. Not perfect protection, not the sort of amount you'd necessarily look for from a long-term success story. but you know if you can say okay the store count's roughly the same and on that sort of store count there should be a reasonable level of profitability just to get back to that point and i'm going to sell it when the turnaround's complete that's a different story to whether it's a sustainable long-term business so i don't tend to do the turnaround complete get out i don't tend to do valuation only based investments that is you know crap business but worth a dollar and something for 50 cents i don't tend to do those i'll do worth a dollar trading 50 cents and maybe over time might be worth$2, that's when I'll get interested, right?

1:11:04But if you were going to play the turnaround value only game, you don't necessarily need the new businesses to be wonderful. You just need the management to stop scoring up. And if a reasonable level of long-term profitability is 100 and they're at 40 now and the share price is reflecting that, getting back to 80 or 85 or 90 would probably be enough for me to say, okay, I saw the turnaround opportunity. I saw it start to work. It's played out. It's been done. Now, here's the thing. I don't feel very good at selling, by the way. Here's the thing. You've it's done, I'm out. Because if you say, it's done, but I'm getting kind of excited about this business, wonder what else it could do.

1:11:37And it does become that mediocre business where I am talks about, about franchises that don't really have all that much to offer. And they're kind of pretty mediocre and profitability is never going to be through the roof. And there's already Michelle's in every cafe, in everybody's shopping center. So is there going to be more upside, more stores? Probably not. Okay, then there's a natural ceiling to the profitability of this business. So don't let yourself believe that a turnaround, once it's turned, has then become a high quality business. It may be. there are some that absolutely would be that case, but plenty that would turn around and stop.

1:12:05So look for opportunity, look for some traction at the top and periphery, the bottom line, look for enough of an upside. So even when it happens, you've got plenty of value left, but also when it does happen, unless you genuinely had already believed, not convince yourself now, but previously had already believed this was a long-term winner, recognize when the turnaround's been done, when it actually has turned around. If it becomes another category of company, fine. More often than not, good work, well done. You've made your money. Take your money off the table. Not that I'm going to take profits, guy, but if literally your thesis is, this will turn around and when it's done, I'm done, then make sure you follow through on the original thesis.

1:12:47Yeah, that's such a good point. It's called thesis creep and I'm a sucker for it. You buy it for one reason and you hold for another and it's really bad thinking. And it's such an easy trap to fall into. Particularly when the share price has gone your way. And it's like, oh, maybe go a bit further. No, no, no, no, no, no. There are some that deserve to be in the bottom drawer forever. And there are others that kind of like, well, there was an opportunity. It's played out. It's time to go. Just on your – the comment you made before about location, I think, is an important one. But I would also bear in mind that the – more often than not, who's going to be really extracting the value there?

1:13:23Probably Westfield. Yeah, exactly. When there's like someone doing gangbusters in the food court or whatever, they're just going to put the rent up. That's where the excess, that's where the value gets captured, I would say. So even when you happen to do well, there'll be a rent seeker, and not used in the nefarious term, but in the very literal term, who will say, I'm going to just put the rent up. You don't like it? Go and move your location to the street. and we'll sell it to someone else who wants to operate in this very high footfall area. And there are plenty of mediocre businesses out there that are in that space.

1:14:01Yeah. And that's okay. If you're turning around a mediocre business back to mediocre, then it's done. You just know that that's the net result, right? Because otherwise, is anyone going to beat Michelle's business? Probably not. But if Wentfield put the rents up, Michelle says, okay, I'm out. Someone else comes in and does it instead. There are many, many ways it can go well. Many ways it can go badly. unless you have pricing power that exceeds that of the business partner you're working with in this case the landlord uh then they're going to extract the maximum value by the way right now premier investments a business i really like um just jeans jj's peter alexander smegall others they are they are pulling out of uh real estate all over the place they've said landlords charge too much we're gone now they can they're choosing to do that rather than being squeezed out but But equally, they wouldn't choose to leave if the rent was okay.

1:14:49So this is a real-world example of where pricing for rentals is going to sit and who's going to win. They're saying, well, our online business is good enough. Thanks very much. Very, very hard to buy a Michelle's patisserie cake online and have it consumed online, right? You've got to get it from somewhere. You've got to have a coffee at a Gloria Jean's. Downloading a coffee on your home printer, harder than you'd imagine. So just be mindful of what options they have as well from that perspective. Yeah. I'll just have a quick squiz at the most recent sort of strategy presentation. This is from March.

1:15:19So they did a$47 million debt and equity recapitalization. Yeah. Raised$27 million, you know. And this isn't because – this is just to, like, fix the balance sheet, right? Yeah. Okay. So maybe – Which if they can do it is great. If they can generally fix it and then move on, then fantastic. But this is not growth capital. So the first slide almost, you know, what are we going to use the money for? Well, we're going to reset and strengthen the balance sheet. Why? Because it's in really bad shape. That's what we're going to do it. Secondly, to pursue core business and inorganic growth opportunities, i.e.

1:15:56they've got money in their pocket and they're telling you. They're telling you. Not necessarily a bad thing. They're going to go buy something. They're going to go buy growth. And, you know, you might get the growth, but you might overpay. or you might just buy something and doesn't deliver the kind of growth that you expect. Again, we're talking about sort of, you know, coffees and cakes and bread. These are tough commodity style businesses. It's just like, what? Again, now that I've said all of this, you watch the thing 10X from me, right? Right. You've got to all take this as a grain of salt.

1:16:28But I just, and then on top of it, so they've said FY23 underlying EBITDA of 26 to 29 million. So let's thumb suck it. Net profit's often about half. This is very rough. Rough and ready live analysis here for the listeners. So let's be conservative, say$13 million in net profit. Current market cap's$130. So you're paying 10 times earnings for a business that by its nature is probably pretty low growth. And let's say they pay a 50 % payout ratio. So you're getting dividends, right? So I'm not even beholden on anything else. It's just sort of like, so I'm going to get a 5 % yield. maybe they can grow earnings three four you know sort of like kind of like even under a reasonably decent scenario i'm still sort of nudging up towards double digit return it's not i mean if you can get it it's it's not terrible but it's sort of like i always love to as you know look at things through the lens of it i love the asymmetry a positive asymmetry and here i've got something that it's pretty shaky history might turn around if it does i mean i think you'd be lucky to get more than 10 12 15 percent per in like at best that's that's great if you can get it but that's sort of the best you're likely to get but if it doesn't and some of these purchases don't work out some of these turnarounds don't turn around well i actually not only could be low single digit could be negative and it's just sort of like you know i want i know i'm going to be wrong in a fairly high degree of a high rate so i i want the kind of scenarios that when i'm right there's a lot of upside and when i'm wrong there's not too much downside the heads i win tails i don't lose too much kind of scenario and i know i'm shooting from the hip here but it's it just it doesn't grab me it doesn't grab me yeah i by the way um here's the so so here's a story of a business that has had its market cap go from$24 million in 2019 to$83 million today, 2022, right?

1:18:26So old data, but that's what it was. At the same time, earnings per share have gone from$0.08 to$0.01 per share. And the answer is because the share count went from 182 million shares to 2.1 billion shares. So you got that simple dilution, as you've already talked about, Ram, and that's the business itself is one question. The question is how much of it is left to shareholders and of that, how much have you got given the massive dilution in the share count? So just be mindful of that. The right thing to do to save the business, by the way, it would have died without it. So they had to do what they had to do and that's fine.

1:18:59It doesn't mean you have to necessarily buy it. I don't have a strong view on RFG. I owned shares for a while. I will say that I got lucky. I sold them before they fell further. So that was, I think I bought them at seven and a half cents and now they're at 5.2. It's hardly a victory either way. I thought the turnaround was possible the other thing by the way is time can really be an enemy so even if a turnaround eventually happens how much longer would I have had to wait for it now it's now I don't know a year and a half two years further along so if there is a turnaround you're closer now than you were when I bought the shares and then subsequently sold them because I thought I was being silly um but yeah I went oh look it looks too cheap exactly as you've asked Rob looks too cheap maybe I should buy some shares maybe it's going to turn around maybe it will maybe it does um I jumped in too early there's no need to if you miss the turnaround you don't lose any money if you're there too early.

1:19:45Like I would have been, I'd be down, what, 30 % by now, still waiting a year and a half later. Maybe it comes good. Tempting to think a 5 cent stock only has to go up a little bit to make money. And that's kind of true, except the chance of going up and going up that proportion, given there's 2.1 billion shares outstanding. You realize how hard that is. So I don't know, mate, it could go really well. I haven't yet seen sufficient evidence that it's starting to turn around. The market will absolutely lead the reality. So if you wait and the turnaround does happen, you would have been better buying shares earlier rather than later.

1:20:19But if you wait and the turnaround doesn't happen, then you'll save yourself a lot of money. So again, back to the original rules, I'd want to see the turnaround actually happening and also have a very clear sense of, is this now a business you're going to hold forever? Or at what price do I believe the turnaround is completed and or the market's fully priced it in? And to ramp up, it's already 10 times earnings. Now, maybe earnings improve, right? So if earnings double, it's up a year five. to work out what price you'd want to get out at. But just think that through in advance. A plug for Andrew's business, Strawman.

1:20:48You know, you talk about writing down your thesis a lot, Andrew. I think this is one where if you're going to do something, absolutely write down why, what you expect to happen, what you think the outcomes might look like, you know, what success looks like, and then what you would do at what point when it comes to valuation and selling because those things are going to become really important and you don't want to let yourself get carried away at that time. Can I do an exercise in ego preservation here? Go on. So back when I was with you at The Fool, I ran a service called Dividend Investor. We recommended this dog's breakfast of a stock.

1:21:25I just had to look it up. It was late 2015. It was at$4.44. I did at ShareAdvisor too, by the way. I'm not sure of that time, but we were both guilty. I mean, and again, we were both attracted. When you looked at the earnings per share, the dividends, was that lovely, steady, bottom, rationalizing things to myself. But it looked good, right? It looked good. Anyway, what was the lesson? Well, the lesson was is that they were doing that by skewing over all the franchisees. And again, that came to a head. Here's the thing. I eventually bit the bullet and recommended the sell at$1.62. In other words, that was a 63 % loss.

1:22:01Why am I telling you this? One, because this is not unusual, right? As I said before, any investor, you have plenty of examples of this and it's the average that matters, right? But what I would say is I'm very proud. That's not the right word. I'm very, what's the word? I'm very pleased I sold when I did because the share price is$0.05 now, right? And so there's this saying that's like a stock that is down 90 % is one that was down 80 % and then halved, right? So it's just that the maths can mess with your mind a little bit here in the sense that when you look at such, this is very easy and this is a very easy trap for investors to fall into.

1:22:47I'm down so much, it doesn't matter. What's the difference? I've already lost 63%. It's in the price. And the reality is I could have held on to that and I would have taken that 63 % loss and I could have turned it into a 99 % loss. And even though, I mean, that money was gone, right? It was not coming back. It was probably, frankly, anything I should have, I should have come to that conclusion a lot sooner than I did. But my point is, is that the 30 odd, the third of it that was left, I could have put this to something else that did much better. So when you find yourself in a hole, stop digging, right?

1:23:24Like that's the lesson here. And I get it. It sucks. And it's going to happen a lot. But the mistake, and it was very clearly a mistake in hindsight, but at least there was some saving grace in the fact that it is better to acknowledge an error late than to not acknowledge it at all. And so much money has been lost just through pure hopium and denial of reality. And I tell you what, a 65 % loss sucks, a 99 % loss sucks a hell of a lot more. Exactly, exactly. Yes, I think we're probably done. Yeah. We've done this to death. I think hopefully we've made the right point. By the way, a big plug for One Up On Wall Street.

1:24:07If you haven't read it and you're listening to it, go and download a copy, buy a copy of One Up On Wall Street by Peter Lynch. Excellent, excellent book. Timeless. Yeah, exactly. A really great foundational book too. I need to reread it actually. Yeah, it's really, really good. It's a nice, what I love about it, a couple things, he obviously was successful himself, but those six categories are useful because they, I don't think you should do all six, by the way. I don't do turnarounds. It is an opportunity for an investor to do. So I'm not saying follow it necessarily, but he gives a really nice way of thinking about different investment opportunities, different frameworks to how to think about how you might consider them, analyze them, both buying and selling.

1:24:45Again, it's just, I think, you know, mental models are a really important part of investing. And there's some really, really good ones in the book overall. So give that a red hot go if you haven't already, or as you said, mate, if you haven't read it before, not for a while, I do recommend you go back and reread it because it's excellent. One of my favorite quotes from that book is, if I ever get a tattoo, it'll be something like this. It'll be, know what you own and why you own it. And I love it. I love it so much, you know? And that kind of encapsulates those different buckets that he puts things in.

1:25:14It's like, what do I actually own here? Like, it's not a ticker. It's something that's here. But there's a variety of reasons you can own something, right? And I just think it just encapsulates so much wisdom, that simple phrase. I'm a big Peter Lynch fan. it's good isn't it I think we're done yeah we are so done will you come back next Friday you know it can't stop me I have enjoyed being back with you I hope you've enjoyed our podcast this is two back to back that are probably longer than well definitely longer than average and certainly longer than a few recently so there you go hopefully you've enjoyed it if you're not still listening you don't care what I say next so until next time fool on see ya the Motley Fool and people appearing in this program may have positions in the companies mentioned general advice only Please speak to your financial professional to understand how it may pertain to your situation.

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