Mailbag: incl. How can you buy permanently expensive stocks? May 7, 2023

25:11Yes, it would if that was a quote-unquote normal figure. And there might be something there where there was an asset write-down or something where the equity really shrunk. So it wasn't like the profit went through the roof, but the equity fell down. Am I right? Would it surprise you if by 2019 that ROE had fallen to 37 %? No, not at all. Would it surprise you that by 2020 on it was less than 30 %? No. Would it surprise you that last year the return on equity was about 16 %? Well, isn't that interesting? Yeah. Because what return on equity does is it sets the pace of earnings growth. Right. Because maths is way too complicated.

25:51Not that complicated. It's hard to do verbally. But that's the return that they're making on the net assets of the business. Right. So you can't do better than that as a share. That kind of sets the pace. It's the pace car. You can use debt a little bit just for the sake of just cloud. Oh, sorry. You can use debt a little bit to juice that, but you can't do that consistently either because at some point your debt maxes out as well. So you're absolutely right, yes. So profitability is coming down. That's interesting. Do you know the reason behind that? The profitability has actually gone up every year with the exception of 2015, which was an unusually big year, so that was probably part of the ROE jump.

26:25It wasn't actually an equity reduction. It was a slight profit jump. But every year since 2016, profit has increased, which I find fascinating. So earnings per share in 2016,$3.10,$3.81,$5.25,$6.03,$6.73,$7.21,$7.36. That's in dollars a share. But that's slowing, isn't that interesting though? Because the growth between – I think I'm eyeballing the exact same page you're looking at here. So between 2016 and 2020, that was – actually maybe 2019. It was pretty aggressive growth in there. But 2019 to 2022, not so much. Correct. And it doesn't surprise me, at least just the simple metrics that we're looking at here with the profitability as measured by the return on the net assets of the business is falling.

27:11That is going to limit the rate of growth. So there'd be a reason for it. And that's part of the fun of doing the deep dive research. Do you have any theories? COVID is part of it, allegedly. they make blood plasma products and US donations fell meaningfully I think Australian donations fell a bit too so it's partly that okay but I guess I I use that for a couple of reasons one is to just just not ask you the question but posit the question of the difference between a blue chip and a genuinely good business and I'm not saying CSO is not a genuinely good business what I guess I am saying is the metrics don't suggest this is a business that is that has a particularly strong future necessarily ahead of it if the future is anything like the past.

27:56Now, big asterisk, it really is, or at least we shouldn't assume that it will be. But slowing growth in earnings, falling returns on equity, that's not the first thing you'd think of when you said, show me a quality business. And so I guess, and I'm not saying you're all mad at all, I don't necessarily sell. The true believers say that earnings will bounce back post-COVID and they may well. So we might be in a year's time where earnings have jumped by 40 % and return on equity is back above 30 and everything's okay again. I just wanted to flag it because I think it always, my suggestion to my listeners is always, always, if someone says, oh, it's obviously a quality business, everyone says it's a quality business, of course it's a quality business.

28:33Just check and make sure the company, if it's temporary, then this is great. If there's a temporary low on earnings, temporarily low return on equity and people start to believe it, that's what you want, right? You want to go and say, beauty, I'll snap that up. If there's something temporary here and I get a temporarily good price, then hey, I'm in boots and all. The alternative might be, this is a business who's, and we talk about the banks regularly, whose reputation is based far more on the past, and in some cases the distant past, than it is about today, right? And if a bank's built a reputation from 1980 to 19, well, from 1980 to 2015, you say, well, look how good that 35 years is.

29:08It's a great business. Everyone says it's a great business. So, of course, it's a great business. It becomes self-fulfilling. You look at it and go, but aren't returns negative over the last five years? Oh, yeah, yeah. And I didn't say, isn't profit growth falling or not growing? Yeah, but it's a great business. at some point your assessment has to give way to reality not just reputation and that that can often be the case and just to make it more complicated oh good thanks the the i don't i just i just haven't i haven't done the the due diligence on it yes this is why you should always i've always got a problem with people who rely purely on metrics because it tells you in most cases just what happened it doesn't tell you what's going to happen so we can say with absolutely a statement of fact that the return on equity between 2018 and 2022 for CSL has gone from, what, 40-odd percent down to 15%.

29:56It just has. Oh, it's bad. That's bad. Well, yeah, it is. I mean, it's not what you want to see. Here's the other narrative here, and I don't know if this is true or not, but the other narrative is, well, actually, that was a period of very heavy investment for us. The assets on our balance sheet expanded quite a bit as we invested into more IP. we did more R &D, we acquired some businesses, et cetera, whatever it happens to be. And those investments have just not come due yet. I mean, again, talk to anyone who's run a business. You spend, you know, a cafe, right? You spend the first few months just finding the site, putting in the coffee machines, buying the coffee table.

30:36It's all money out the door. Nothing's happened yet. Is that a stupid thing to do? Well, it's too early to tell. You don't know until you do it. So there could be a scenario here where return on equity goes shooting back to the moon as all of those investments are better down and start generating more profit. And this is something I'm always on the lookout for, for bigger businesses where, not even necessarily bigger businesses, but there's been a few in my career where you have actually within that one business that's listed on the ASX, there's actually like four or five different business units.

31:07Some of them are just humming. They always have just beautiful cash cow of a business. and the companies take, diverted those profits and put them into something else, which either isn't performing well or just isn't performing well yet, but that masks everything else. And so you can go, oh, look how crap this business is. It's doing this. And they say, well, actually, even if that's true for that part of the business, this part of the business over here is pure gold. This is what PE, private equity and the like are always on the sort of lookout for. It's like, we could do a lot. We can really, let's flog this off, write this down, do this, and all of a sudden it comes with the true beauty within shines through.

31:46And yeah, it's always worth asking why. So I think you start with a really great observation. Hmm, result in equities falling. Huh. Earnings growth is slowing. Huh. The market still seems to think that's a 40 to 50 times PE. Okay, there's a reason for that. And that might not be a good reason, but there's a reason for it. And that's your job. That's what makes this so fun. Fun is the right word. No, no. Yeah, that's the challenge, right? That's why we do it because it's partly fun and partly a challenge. No, I agree. Just that it was worth a worthwhile issue kind of pushing into a little bit. You're right.

32:20A second Buffett quote. He said, if history was all that mattered, the richest people in the world would be librarians. Right. You can't extrapolate. By the way, if you could extrapolate, everyone would extrapolate if the computers would have done it already. You are always and always looking for a variant perception. You look for something you think the market's wrong about. Yeah. Extrapolation of history is not going to get you there, right? But in fact, it's probably going to end up potentially when you're paying more than you should or ignoring stuff that's actually really good value because no one's paying attention.

32:46Those are the areas where you have the opportunity to look a bit deeper and take a slightly different view. I've found some really good examples in history. We just think the share price is bombed out because everyone's just looking six to 12 months ahead. Earnings growth has stopped or slowed. There's all this cash out the door and, oh, it's terrible. It's like, no, you've got to ask your question, where did the money go and why? And it may have just been that this was sowing the foundations for the next leg of growth. I mean, do you think Amazon got into the web server business? Was it a cheap move?

33:18You know, they could have made much more profit in the interim if they just never went into that. It was the best money that they ever spent. It's now one of the more attractive parts of the business unit, but it's money out the door on day one for more money in the future. So if you find that example where the market's going to go, oh, it's really crap, and this is uncertain, it's never going to work. And maybe that's all true, but you now get a situation, well, actually, if you look at it logically, the shares are much cheaper. And now they've actually finished that period of heavy investment.

33:49So that capex, that investment cashflow is going to go away, that outflow is going to go away next year. So that's nice. And not only that, the operating cash inflow is going to start to radically increase as these new units and whatever endeavors they're doing starts to come online. That's a really lovely setup if you can find it. Now, no guarantee those things are going to happen, of course, right? So you've got to be careful of that. But that's... Yeah, yeah. You're exactly right. You've got to have conviction. That's where the opportunity is. Exactly, exactly. Motley Fool Money. For more, subscribe to the free newsletter at fool.com.au forward slash listener.

34:25Really quickly, man, I want to read something. You mentioned Amazon and I own shares. But I wrote something in... When did I write it? Late 2021. So the data is horribly out of date. So just bear with me. but I just want to, speaking of extrapolation, so I'm going to just read it. Here we go. I'm a shareholder on amazon.com. It's a wonderful business with a very bright future, and it's had an impressive growth story over the past 25 years. More recently, though, not so good. Since August 2020, now remember I wrote this in November 2021. Since August 2020, Amazon share price is up a measly 3.4%, not flash, and between August 2018 and April 2020, shares were actually down.

35:05So much for the best e-commerce kid on the block, right? Well, kind of. See, over the past four years, shares are up threefold. Huh? How is it possible that shares were up a little over one time period, down a little over another, but have tripled in the last four years? Well, as you may have guessed, I kind of cherry-picked those time periods above. Now, I won't read the rest of it, but my point was there were very long periods. So again, August 2018, April 2020, nothing. What's that, 18 months, 20 months, something like that? Between August 2020, November 2021, nothing. The reality was in between those two things, the shares were up threefold.

35:43Just to remind you, whether it's business, we shouldn't worry about the share price movements, by the way, but don't tell yourself the business isn't doing well or can't do well if the share price is flat. Similarly, don't extrapolate business earnings for their own sake either. Even if the shares had been up over that time, doesn't mean they would have kept going up. Just want to use that example, mate, for a different way of addressing the same kind of issue. Yep, yep, 100%. Hey, let's ask a question from Harry. In fact, I'll let Harry ask the question, but I'll read it. Hi, Scott and Ramble, he says.

36:09Thanks for the continued good banter on the podcast. Harsh. A little harsh. A few questions to kill time. Three. I remember a few podcasts ago, Scott mentioned a solution to some of Australia's problems. I do that a bit. By putting$6 ,000 into an indexed ETF for a baby. And by the time that baby reaches 67, they would have a great amount for retirement. I can't remember the exact figure, says Harry. And then businesses can grow, perhaps pay more in wages as they would not have to pay towards super for each worker. Well, we've just had our fourth baby and maybe our last. And we're interested in trying your theory as a set and forget investment for our newborn.

36:46What was the index ETF you were talking about regarding this idea? And would you put it through an app like Perla to keep it separate? I thought you also had a sign up promotion with Perla. So really quickly on that one. Yeah, I talked about the idea that rather than have employers put hundreds of thousands of dollars worth of superannuation contributions away during a worker's working life from 18 to 67 to end up with$1.6 million. I use that number because it was the maximum you could put in a pension phase super account, just picking a number. You could instead have the government put aside, or in this case, you could do it for your kids, put aside six grand at birth.

37:20And if you got the market average return, you'd get about that by retirement. Now, there's a few wrinkles, mate. So let me just run through them quickly for the sake of the podcast. First was the future might not look like the past. We just talked about that. So I don't know what we can deliver for you or you could deliver for yourself. There are fees to consider, although I expect they'd be pretty low in a very low cost index ETF. But those are just things you need to be mindful of. And of course, circumstances can be different. But yes, that was my general proposal. I think that proposal actually assumed zero fees altogether because I said it could be run by the Australian government's future fund effectively at zero cost.

37:54But conceptually, reasonably conservatively, I reckon six grand, well more than a million dollars in, by the time the baby reaches 67, probably closer to 1.6, 1.7 million bucks, depending on how the markets go. So I'll put that out there just for fun. But yes, that's what I would do. In terms of which ETF, I didn't suggest one in particular. I think you could, well, I use the Australian share market as an example. So if the future was something like the past, something simple like the Vanguard Australian shares ETF would be the one you would do if you were trying to follow that strategy. I think I may own units that maybe for my young bloke so I should disclose that I think I should know whether I do or not I think I do so yeah just keep that keep that in mind but that was the one we were talking about I would do it separately put it in their own name because that just means there's no tax when you transfer it from your name to theirs when they get to 18 best way appeller does have a an ability to kind of set up an account for the kids specifically denominate it that way I've done that for my young bloke I've said that before you can just do you know Harry Smith it's not you know Smith but Harry Smith as trustee for Little Babysmith.

38:59And as long as you have their own tax file number and their own account that any dividends are paid into, again, speak to your accountant, but that should keep it pretty sweet from the ATO's perspective. You just transfer that to their name when they get to 18. Any thoughts on that, mate? Sorry, it was just a quick laundry list of tidying up. No, no. I mean, no. I've got nothing wrong with that at all. Saving for the future and investing in something very low risk and low fuss, nice and easy. Yep. Harry's second question, mate, is what we talked about before. I'm only asking it because I like the second part of his question.

39:29He said, my final question is regarding Kelly Partners. They are the only listed company on the ASX that pay a monthly dividend. We talked about that before. Of course, it's nice to get paid monthly, he says, but is this a marketing ploy to get more people to buy the shares? I've got to say I'm a little more sceptical than you were on this one, Andrew. I think there's at least a part of that in it. I don't know if you had a view or you have a view on the answer to that question, whether you want to just take the fifth. No, look, I've spoken to Brett Kelly a number of times. And he's an unconventional thinker and he does unconventional things.

40:09But I think to great effect. I don't see it. I could be reading him wrong, but I don't see it as a cynical ploy. I think it's very much based on the – Don't forget a lot of the – you've got to look at where the business came from. So a lot of the shareholders were people who had been taken out by the business who just wanted that regular income and the rest of it. So they just basically said, what do you want? This is what we're going to do. The difference is I would be much more cynical if they chopped and changed to do whatever the market sort of felt like it demanded at that time. For whatever reason and for pretty good reasons, I think they decided that this was a pretty cool thing to do and they're stuck with it.

40:47And it's sort of like when you're buying shares in this, you know what you're going to get. And they're not going to change that anytime soon. So look, and here's the other thing. Does it really help the shares? Like it might give an initial pop as you say, oh, and maybe there's a little bit of something. But there's no sustainable advantage to the share price, I would argue, for that policy. So it's kind of like if that's the raison d 'etre from them, It's kind of like, well, it's not really going to move the dial, guys. So, yeah. Mind you, mate, you could tell every single company with an IR rep exactly that and they still do it anyway.

41:24So I'm not hoping for logic or rationality just to return to the ASX anytime soon. For the record, too, I don't think it's cynical. I'm not sure it's not – he's not proud of it as a point of difference either. There's a long continuum between those two points. Yeah, sure. But Harry's last question, mate, is the one, I guess, that is worth asking, which is he just says, why don't more ASX companies pay monthly dividends? I guess that's also - Admin and costs are probably in there as well. You got to send out a letter. You got to get, you know, it's probably just a hassle. It's probably it. And don't forget so much of human nature is very easily explained by we've always done it this way.

42:03That's the bit I was going to - Exactly. And everyone else does it. It's the most - I bang my head on the wall every time. I think when I used to work in more corporate organizations, Patients like, oh, why do we do it that way? Oh, we always have. It seems like there's a lot of costs and inefficiency. Yeah, but we've always done it that way. It's like, that is not an answer. And I suspect that this is an example of why do we pay our dividends half yearly? Oh, that's what we do. That's what everyone does. Okay, but why? Because everyone does. It's very circular. And the other thing is, by the way, once you try and ask someone to answer that question, they will invent answers that justify the current position.

42:36So it'll start with why we've always done it. Well, this, but why? Well, because that's when the cash balance is the highest and it's just easier that way and the CFO has to sign two checks a year and you start backfilling answers to justify the decision you've already made, which is, as you said, I don't know. We've always done it that way and now I feel silly if I have to say, you're right, I shouldn't have done that, so now I have to justify why I did it. And I do that by inventing reasons that then if I can stack them high enough, become justification, which is human nature again. I mean some companies are very seasonal.

43:10That's also true. We spoke to – many people wouldn't have heard. We spoke to Kip McGrath recently. They were on tutoring centers, whatever. So obviously in school holidays and their business dries up quite a bit. So the commitment to have sort of cash commitments to shareholders at every single point along the way isn't as plausible for some companies as well. So there's a whole bunch of different reasons, each to their own. Yeah, I think that's right. Actually, I think to your point, we've always done it. I think when you had to send physical checks, your paid companies to do it, it was a big hassle.

43:44These days, I dare say, I'm not even close enough to it, I dare say you could press two buttons, three buttons and have everyone paid monthly and I think you could probably absolutely do it. So I think it's convention now. Ten years ago, I would have said, and probably rightly, the paperwork, the hassle, the mail, you got a 45-cent stamp, which is not a big deal, but do that 12 times a year versus twice a year. do it for thousands of shareholders starts to be a big difference um so i think i think that's i think that's fair um but i think these days you absolutely could to your point too mate just very quickly most people don't understand this or recognize this but there are a whole lot of companies out there that don't pay even dividends even over those two six monthly periods you talk about seasonal businesses there's a whole lot that pay a smaller interim dividend and then a larger final dividend with kind of the surplus cash for the year uh because they're seasonal because they've just they've been more conservative during the year to make sure they get to the end of year with enough cash and they pay out the extra because they've got it.

44:35So there are a whole lot of things. Yeah, not a lot of businesses have that really significant regularity of cash flow, even retail. I mean, think about retail. You mostly make a squillion dollars in the fourth quarter because that's Christmas. Don't make any one year as much the rest of the year. So again, even quarterly, monthly, it'd be a very, very different story. And just more optionality for the management team as well, right? So it's sort of like you've only got to think about that dividend once every six months. It opens up more possibilities of what you might be able to or want to do or just things that land or come across your desk or land on your plate, whatever metaphor you want to use.

45:09You know, it's just sort of whereas when it's out the door each time, there's less flexibility there. I'm going to speak out both sides of my mouth because sometimes that's a good thing. I think one of the good things about dividends is it sort of limits the largesse of companies and what might otherwise prove to be silly investments. Because like, well, we've always made a commitment to pay the dividend. We'll pay that first. There's much less money for reinvestment left over, so we're going to be much more careful with it. There's nothing more dangerous than a company that's flush with cash and where the shareholders are cheering for growth.

45:43Yes, exactly. Beware, beware. And they will want it now and they will make that acquisition, do this. And it's usually, well, yeah, I think I can say that. Usually, more often than not at least, it doesn't work out well. Yeah. Mate, here's one from Rachel. Rachel, I love your email address. I won't share it, of course, but I love your email address. You know what I'm talking about. I know what you're talking about. There you go. A bit of inside. I don't know what you're talking about. You don't, but I'll tell you later. Hey, Rachel says, hey, Scott and Andrew, love the podcast and your very informative banter.

46:14Thank you very much. Each morning I hear news services telling us about the Dow, the other US indices. Oh, by the way, Rachel, the plural of index is indices, not indexes. So well done. I'm a pedant from long back, Andrew, and indexes just grinds my gears. Don't I know it? Indices. Oh, thank you very much. Indices. Thank you, Rachel. Tell us about the Dow and other US indices and the SPY or the ASX futures. The expectation is that somehow the Aussie market is going to follow the US lead. But in the best Professor Julius Sumner Miller voice, if you're too young, you won't understand this. Rachel, you're probably too young as well.

46:49But Rachel asks, why is it so? Did you like that impression? Was that close? Yeah, that's a Cabriad reference for those. Yes. And what was he talking about? What was happening when he asked why is it so? Do you remember? Wasn't there an egg being sucked through a bottle? Well done. A boiled egg into the neck of a bottle. All right. Anyway, why is it so when the ASX contains such a completely different mix of companies, mining and banks, shares to the US market, largely tech and industrials? And what value is the often quoted SPI, which is the share price index, as to where our market will be going for the day?

47:23It often seems that we behave like lemmings, just following these leads at the start of the trading day when they may have very little predictive value at all. Appreciate your comments. Fool on, says Rachel. Andrew, why do we follow the US lead so slavishly? I don't know. It's stupid. I agree. No rhyme or reason to it. Don't look at it. Who cares? I mean, the Dow is, what, 30 companies in the US, right? And wasted by share price, landed by market cap. You know, it's an anachronism. Anachronism or something like that. Yeah. It's not word of the day calendar just paying itself back tenfold over what I spent on it.

48:05Yeah. It doesn't mean anything whatsoever. And then I would sort of say, even if it did, again, I always come back, you've got to think it through. Even if it did, it would be exploited. And if it was exploited, the act of the exploitation would render it ineffective. So it's not used there. The more maybe satisfying answer is that we all live on one planet. The US is the largest economy. It's a big trading partner. The US catch – what is it saying? The US needs as the world catches a cold. If you start singing Imagine, mate, I'm going to catch you off. No, I'm not going to do that. So that is true.

48:47That is true. But then I would, again, go the other direction, which is like, yeah, but on a day-to-day kind of basis. I can't tell you the number of times because I used to, well, 100 million years ago and I used to do sort of morning updates for Sky Business and that. And you'd say, oh, the market's going down today because the future's at, it's probably 200 is down this and the US was terrible. And it just ended completely differently because different things would happen throughout the day. New news would come to light. And it just, and then very different structured markets. I mean, half our market's basically a few miners and some banks, right?

49:19Like it just sort of like, what's that got to do with what Google or an Amazon or, you know, JP Morgan or you name it, are out there that do it. It is what we were talking about before. Oh, it's always been that way. That's what we do. People who are trading and speculating or gambling need something to look at. I guess it's as good as anything if you're going to try, you know, cut open a goat and read the entrails. Sure, why not? Well, you don't really have much else to go on. But for a true investor, absolutely pointless. Yeah, so that – I love that your last five or six words completely through my next set of words, which is why, by the way, listening is better than just waiting for your chance to talk because when you do that, you go, oh, bugger, okay.

50:05So the why it does and whether it should are two very different things. And I think that was exactly your last point. You just kind of, you know, you threw that at the end almost as an afterthought or as a finishing comment, but it was a really, really important one. I, so I think, you know, capital is largely international. Money can go wherever it wants to go. And so there's that. Second thing for me is we know that share prices are set in the short term by sentiment, effectively only, right? The occasional company announcement, but realistically, when all these reports earnings in February and then again in August, but they do quarterly sales earnings, but, you know, sales results, but just stay with me.

50:45in between times why would the shares move? Well, because people just have different thoughts about will this future or the economy or how popular they are or what other options they've got and so they just move because they kind of just do and I think, so it takes back to the daily thing, if investors wake up in the morning and think, oh actually no, I think I will actually buy some shares and more people want to then buy those shares, the supply demanding balance creates higher prices when the reverse is true, when they go, oh I'm not as excited as I used to be or someone else says, well, I'm not going to give you that much for them.

51:15They go, oh, I'll sell them anyway, so I guess I'll take a lower price. It is just sentiment on a daily basis. And I think it's not unreasonable actually, mate, for that sentiment to be largely international. Now, does it matter? No. But to Rachel's question, I personally think it does kind of follow because, Rachel, your point about the companies, the composition of the businesses makes up the index that's already known, right? That was already done. We're at a place now where we know what the differences are. The shares have set their own level. we've separatized the set. Now something happens, whether it's a real thing or just sentiment.

51:48And if that sentiment is to some degree global and people, because there are US investors that buy ASX futures, right? During their trading day and during ours, there are Australian investors who buy US companies, banks or Amazon or whoever, already mentioned Amazon, so I can mention that again without disclosing they own it, but I will. You know, that rollover, it does make some degree of sense, actually in my mind anyway, that the transmission effect of a globalized world means that, you know, equity markets are moving in similar directions more often than not. Now, there should be other movements where new news comes out during the trading day, to your point, Andrew, or where the news means that oil is higher.

52:21So we've got more oil companies than the Yanks have, so our market might go up a little bit higher on average. There's always those changes. I think it's entirely unreasonable that they have some sort of relationship and a relatively tight relationship once you allow for those changes, as Rachel mentioned. Your last point is, so what? Well, so nothing, because who cares if you're a long-term investor. It doesn't matter what happens, even if it was justified or not justified, they're both useless to any investor who's saying, I think in five years' time, Woolies is burning 40 % more profit than they are today.

52:50Because that is literally all that matters. And how much you pay for that matters. Now, you might sell it at some point over that period of time if the market offers you a stupid price. You might buy more if they give you a too cheap a price. But that, to my mind anyway, is kind of precisely why, even if you can answer the question, you still can't, it doesn't make it right. So knowing why something happens and knowing whether it should happen are two very, very different parts of the same puzzle. Mate, I can even further tighten the frame of reference here. So often you'll be out and about or whatever and you'll hear on the news or just tap on your phone, all the market's up 2 % today.

53:27You go, oh, that's fantastic. Maybe I'll check my portfolio. I'm down, you know, or vice versa. And it happens like the mathematicians call it beta, sort of the degree of correlation between, yeah, that's a whole other topic. But the beta for my portfolio, it's almost negative. I would say it's almost anti, not by design, by the way, but it's just when whatever, quote unquote, the market here in Australia does is a very poor signal as to what my portfolio is doing, just because of the constituents and what it's made up of. So it's sort of like, you know, And this is always worth bearing in mind when people say, oh, it's really tough on the market right now.

54:08It might be generally true, but I bet you anything that there's exceptions to the rule. Anything. There's too many out there for it to be just true across. Well, very rare is that kind of the case. So it's sort of like not only is it kind of irrelevant as to what the US is doing as far as the businesses I'm a part owner in are concerned, but I'd even say it's kind of irrelevant to what our market is doing. yeah i think i think that is the kind of the key point is just just because just a thing happens it doesn't mean you have to respond to the thing or care about the thing um even though that's what happens i know like i've i've as with most things in my life and certainly investing i've mellowed a little bit um where people want to know what happened and why i don't think it's an unreasonable thing i think often we do actually have an answer for it i think i think so i think you can say a thing happened there's a reason that thing happened and then you can ask so what does that mean for me and more often than not the answer is nothing i think those two things are okay you know there was a i used to say oh they took a point about the morning thing oh that guy gets on the tv out of the morning he says oh this happened overnight the market's up four percent because this happened how could he possibly know and and i used to get a little bit self-righteous about it maybe a lot self-righteous about it um i get self-righteous about a lot of things still but not that stuff because it probably is true i mean you know the the reality is investors sorry traders tend to respond to the same stimulus or stimuli and in doing so do a certain thing i mean that's not it's not that hard you made the you made the joke on friday about economic forecasters it's actually not that hard after the fact to explain what happened right because generally speaking we all know the stimuli every night again it's like that happened i don't know why it happened and that's okay to say too we don't have to make up an answer and often if the answer is i don't know you should say i don't know but often there is okay well jaron powell said a thing and markets went down that's what actually happened now what i should do about that is a different thing so i'm a little a little more saying what about news outlets reporting the news literally the the new thing that happened and if there is an explanation that's reasonable just don't fall into the trap of believing you have to have a response to it yeah let's finish off with a couple of questions from jared he says hi scott and andrew i've got a couple of questions for the mailbag please greedy i know says jared that's right firstly on franking credits would it be right to assume that as dividend paying companies expand and seek growth outside of australia that franking credits may potentially reduce over time as the proportion of revenue and profit derived from overseas increases?

56:31Yes. This is more of a broad question, but specific companies like Harvey Norman and Sonic Healthcare come to mind. Yep, 100%. I mean, you only get franking credits for tax paid in Australia. So any earnings overseas that are taxed overseas, they're not going to have the franking credits. Now, why can companies continue to pay fully frank dividends when they are generating a decent amount of money overseas? it's because they have a whole bunch of franking credits in the bank well not in the bank account in the franking account that they have earned over the years that they just haven't paid out sometimes companies with excess capital have sold down a division will pay out a special dividend as opposed to doing a buyback or something because they want to get rid of the excess credits and in doing so they're able to do it at more attractive prices because they they recognize the very real value to australians and to australians only of those of those franking credits but yeah ultimately i mean just extend that forward and logically you're going to run out you're not it if you transition it what am i saying if harvey norman in five years time is earning 90 of its money overseas and continues to to pay out a pretty high payout ratio it's just mathematically they're not going to be able to to make them fully frank they just can't yeah yeah and that's not a bad thing no i mean what do you want let me ask you this let me ask you this and I know where you're going.

57:46I'm stealing your thunder here. It drives me up the wall. Someone will go, oh, this dividend is fully frank, so it's better. It's like, well, I would rather a 5 % unfranked dividend than a 2 % fully franked dividend. And that's an extreme example. It's not that extreme, actually, because a lot of people do. A lot of people do. The way to normalize it is you hear people calling about the grossed up dividend where they factor it in. And I think the math is you just divide by 0.7, which is 1.41, I think. Yeah, same thing. Same thing, right? Same thing, yep. And that's it. So then just look at the gross pre-tax yield and then you've got apples with apples.

58:28Yep, exactly. I think that's the right approach. I don't think you should avoid companies with lower franking credits because, I think if it's growing. Like if you're, I mean, Harvey Norman's dividend by now, by the way, it's great. But if you get a good yield now and that yield grows in dollars because profits are growing and you get lower franking credits, like, well, half of it can make less money if you'd prefer to have 100 % franking or you could have 85 % franking on double profits. Which would you prefer? You know, there is not even between companies, even for the same company. I don't want to verbal jarred.

58:57I'm not suggesting that's necessarily what he's saying, but it just gave us the opportunity to have that conversation because falling franking credits is really, I promise you, not a problem, particularly if profits are growing. It's a reality. I will say too, by the way, plenty of companies still manage to make most of their money in Australia and even some with decent overseas operations still manage to have 100 % franked dividends. It's, you know, if overseas grows massively, it's not going to happen. But it's not necessarily, well, it's not a problem at all. The only thing I would say is if Australia shrinks and overseas grows and you're getting the same dividend with less franking credits, well, the business itself has probably got a problem rather than the franking again.

59:31It's probably still a question of investment analysis, not maximising franking. So don't fear reduction in franking credits if it comes from company growth. Yeah, and I'm going to say something we've said before, but it's just a good point to do it. That's unusual for us. I know. There's not very few new things in this game. People focus too much on the yield, way too much on the yield. I mean, here's a case in point. I'm going to buy ANZ 10 years ago, 2014, because it's a very high yield and it's fully franked. Tick and tick. The only trouble is it was paying$1.77 per share back then. Now it's paying$1.46.

1:00:06I would much prefer an unfranked dividend at a 2 % yield, but where that dividend is increased significantly each year. I mean, what matters here is the aggregate amount of cash that the company spits out and what you get to keep after tax. That's what matters. You know, and I can give you a 10 % yield on something and then just cut the dividend each year. It's going to sound good right now, but it's about that stream of after-tax income. That's what you've got to compare it to. And too many people, usually with some pretty poor advice from well-meaning planners or where else go, oh, you know, I'm your retiree.

1:00:43You must have fully frank. You must have high yield. It's like, by the way, all else being equal, a hundred percent, you know, give me a higher yield. If two dividends are going to grow to the same degree, I will take the higher yield. Thank you very much. And I will take the franking credits, but, but, but, you know, you've got to, again, standardize all of that kind of stuff. And too many people suffer through too many really, really ordinary investments because they just don't go beyond the high yield, fully frank, tick, tick, I'm an income investor, that's all I need to know. And it's just very poor thinking.

1:01:14Yep, absolutely, 100%. Mate, Jared's second question to round us out is his, when companies report sales growth numbers during periods of high inflation. He says, for example, when a company reports sales growth that is relative in line with inflation, I'm always wondering whether they are selling more actual stuff or sales growth is inflation driven. My question is, what's the best way to cut through this to be super clear which one it is? Are there specific terms companies use when reporting their results that retail investors, as Andrew likes to call them, LOL, can refer to to help clarify this?

1:01:47Recently, Coles released their Q3 results with 7 % sales growth, but considering inflation has been around that range, it got me thinking. I'd appreciate any advice on this. Cheers, Jared. Jared, first thing is, mate, well done for actually thinking this through, right? Because that's really, really important. The critical thinking that gets you to, hang on, is that legitimate? Should I take that? as read is a really, really, really important starting point. So well done. Andrew, we'll answer it for you. While you were talking, I'm desperately trying to Google you. Sorry, mate. We didn't walk up a bit of hand signals.

1:02:21I just happened to be walking through the lounge room last night and the TV on and Alan Kohler was on. Right. And he was talking about exactly that. Oh, here you go. Yeah. So in retail, I can't find the chart. I'm sorry. But the sales figures were holding up pretty good. But in terms of the volume sold, it had fallen, i.e. they're selling less stuff but a higher price. And the aggregate result just gives a different picture. And again, you can pick whatever it is that helps suit your narrative here. But he was just making the point here that in a way it's not really that great there because less stuff is being sold and they're making up the difference by putting through the price increases for those that do remain.

1:03:12Yeah. So it is absolutely price rises that are included in that. Some data sets will normalize that kind of stuff. but then there's a lot of subject very subjective what do you use the CPI or do you use just the component of CPI that relates most to that category and even then does the company represent the category and all that kind of stuff two thoughts from me first Coles actually does provide food inflation data with their earnings as a help because I know investors want it which is really great most don't so what's that most what Coles and Wildeys both do so kudos to those guys for doing it it makes most sense for them because it is such a big impact because they have relatively little pricing power and relatively low margins um so those things are absolutely absolutely true uh i think that's that's a a worthwhile point to make um the answer to your question i reckon jared and andrew b kenny all thought this i would and i've i've had exactly the same observation some companies will report volume growth or decline so that's that's obviously they'll do it for you the others look at gross margin is the way i kind of try and look at it Now, it's not perfect because companies can increase and decrease margins, receptive volumes and whatever.

1:04:25But basically, if companies are simply passing on cost increases, then the gross margin or the gross profit won't change. So if I buy something for$100 and sell it for$110, I'm making a 10 % margin, not because it's a 10 % markup. Let me go on again. If I buy something for$90 and sell it for$100, just to make my maths easy, I'm making a 10 % gross margin, right? It's a 10 % profit, 10 over 100, 10%. If I, next year, my cost of goods was 180 and my profit was 200, sorry, my sales were 200, then again, I'm still making 10%. So the gross margin in that case would tell you what's going on in terms of whether or not I'm increasing prices and increasing margins, whether I'm paying or covering my costs or whether those costs are accelerating faster than my sales.

1:05:15So generally speaking, looking at the sales line and the cost of goods line, the net result of that is gross profit, will give you an indication about whether profit margins and profit dollars are increasing, decreasing, or shrinking. Oh, sorry, or stabilizing. Although in that example, gross profit doubled. Yes, correct, exactly. But the margin didn't. So it's the margin and the dollars that matter. Yeah, it does. But this, which makes it more complicated, But there can be situations where the gross margin can be falling, but the business is growing very well. Correct. Yes, absolutely. And what do you want?

1:05:53Yep. Yeah, that's right. Do you want to – are your shares going to be priced on what the gross margin is or is it going to be based on the actual cash flows of the business? And if those are growing, then that's – as long as it's sustainable. Yeah. But yeah, that's – That's a great question actually, mate, because it's kind of a question of what do you want. You made the example of the coffee shop with the 80 % margins. Right. And I think that's a really, really, really good point. I think that's a really useful comparison. Generally, again, I'll speak on both sides of that. Jared, I don't really care whether it's inflation or not, right?

1:06:30All I care is they're making more money than they were. You know, so, you know, I wouldn't only, but I guess in that concept, I wouldn't only look at the sales line. So your question is absolutely right. Don't just look at sales and say sales are going there, therefore things are good. By the way, if sales are growing at 7%, but costs are growing at 10%, not just product cost, but all the cost of the business, it doesn't matter what inflation is doing. That's the bigger issue, right? So if you think about the impact of inflation, if we talk about just input cost inflation, which is just the cost of goods you buy, we talk about gross margin, that's one thing.

1:06:58But if you're going to pay your salespeople all 10 % more, if you're paying 10 % more for your advertising, if you're paying 10 % more for your IT equipment, those things don't hit the gross margin line. They go all the way to the bottom. So honestly, there is no single simple answer. It is a case of looking across the balance sheet and the profit loss statement and working out what's changing and some hopeful management commentary informing you of why, but also making some of those evaluations yourself. If a business is growing nicely despite inflation or because of inflation, maybe it's flat for either reason.

1:07:31It's not, there is no simple, single answer as I said. Nice. Any more from you on that, mate? No, I think we covered it. I think we did. Hopefully that's useful. Well, if it's not, let us know. Ask us another question. If you do want to ask us a question, make sure you hit us up. All the socials, info, I-N-F-O at fool.com.au as our email address. You can get Andrew exclusively still on Twitter on the show. Are you on Blue Sky yet, mate? No, I haven't heard of that one. Are you on Blue Sky yet? Isn't that what's his thing you like, the Jack Dorsey open source? Jack Dorsey. Oh, is it a Noster client?

1:08:05Ah, right. Yes, I'm with you now. Yep, okay. No, well. Yeah, hell yeah. There you go. You can get Andrew probably on Nostra if you can be bothered. It's too hard at this point. In the meantime, get him on Twitter at Sage underscore Simeon or at Strawman Invest. You can get me on Twitter or Insta at TMF Scott P or on Facebook at facebook.com forward slash Scott Phillips Money. Hit us up with some questions, some comments, some feedback. We'd love to read it. We'd love to answer some of your questions next week. But until then, at least until next Friday, fool on. See you. The Motley Fool and people appearing in this program may have positions in the companies mentioned.

1:08:43General advice only. Please speak to your financial professional to understand how it may pertain to your situation. Subscribe to the free newsletter at fool.com.au forward slash listener. The Motley Fool operates under Financial Services License 400691.