Mailbag: incl. The skinny on SMSFs and Industry Super. May 28, 2023

32:38And the thing's at$2. Or not, by the way. Yeah. Look, they're raising this money for a reason. I haven't read far enough through it. But I assume they're going to be investing that money with the hope of a very attractive rate of return. And guess what? If they get a really attractive rate of return and you don't take up the right tissue, you're still going to be okay, right? Because the dilution will be offset by the realized returns on that investment. There's one more too many in between that, which is they could use the money, use it really, really, really well, but the shares are actually only worth$5 now anyway.

33:13Yes, right. It's another wrinkle. So if you own the shares, you probably like it. You probably think it's good value and all that kind of stuff. This is a$5.8 billion company on a PE of 1 ,600 times. so you know if you like it great and you probably did love it because you own it and it's probably done well for you which is awesome um but you know 1080 is a discount to 12.09 uh there's plenty of companies that would have raised money in the last 18 months tech companies at whatever discounted the then prevailing share price that ended up being double what the current share price is and so it's it's always you gotta ask yourself what do you think these shares are worth worth not selling for not available for worth if it's a 15 company you buy for 1080 go for it it's a $5 company you buy for$10 ,80, even though the share price is currently$12, and you're probably playing, you know, you're playing chicken a little bit.

33:57Now, there is no way to know for sure, but that's why the question is about it. It's a really, really good question, Ben. Thank you for asking. This is the only sort of like a mailbag Q &A pod where you're going to leave with more questions than you came with. You're welcome, Lister. I just want to ask this question, and now all you've done is throw a bunch of other questions back at me. Yeah. It depends. Can I just look, I haven't looked at Next DC for a while, but you just got me thinking there when you're talking about the PE here. So it's always worth understanding, again, what do you own here?

34:29And data centers cost a lot of money to build. You know, a big plot of land, lots of air conditioning, lots of racks, lots of things. And then you build all this and then you've got to get customers for it. And the first person who buys a bit of rack space is really not even covering your basic costs, not even in Europe. Correct. There is, I would, again. Great for them. I'm shooting from the hip here, but I'm sure the argument would be the PE multiple is so high because a lot of this investment has gone out. As capacity rises, and don't forget, these are very fixed costs, largely. So as occupancy rises, like a childcare centre or a nursing home or anything like that, you pass this magic threshold where now you've got enough subscribers, users, whatever, that cover all of that.

35:16And then the rest is 100 % margin that just drops to the bottom line, more or less. And as these, look, they're saying there's a huge demand for data centers. This is the way the world is going. We've got an opportunity here for all these sites. We can throw all this money at it. All the money is out the door on day one. But once that starts, that's the gamble here, I suppose, for want of a better term, but that the occupancy will be filled at a rate that you are confident that you can achieve. And if that's the case, is probably going to be a wonderful use of funds and shareholders would be glad that they tipped more money in to help the business sort of achieve that.

35:49But that's more the thinking here. That's more the thinking rather than whether it looks cheap relative to the terp price or to the current market price or any of these other kinds of factors here. Because if this comes off, then again, even if it's a full 10%, 12 % dilution that you end up copying, but they managed to now boost their return on equity and their equity, you know, you'll be glad of it, right? So that's the fundamental question at play here. Motley Fool Money. For more, subscribe to the free newsletter at fool.com.au forward slash listener.

36:27Let's ask a question from Drew who says, Hi, Scott and Andrew. Thank you for your outstanding podcast. Drew said it right, not me. I can only pass it on. I have listened to every episode from the start. Man, that is commitment. Thank you, Drew. and it gave me the confidence I needed to get started investing. There you go. I'm pretty stoked. I really believe my investing journey, yes, including all my mistakes, will literally pay dividends for my family's future. I am hoping, he says, that my long-term loyalty will allow me to ask a personal question to you both. Though hopefully not too personal as you've both talked about this on the podcast before.

37:01Scott, you have mentioned you have an SMSF. Andrew has talked about being in an industry or retail fund. I would have expected it to be the other way around. given your investing styles. So I'd love to know the reasons why you are both set up this way. I have a wrap fund, says Drew, that allows me to directly invest in individual companies, but frustratingly only the ASX 200. No small caps, no international shares. And I've not found any similar fund that would allow me to invest in anything else. Andrew, as someone who focuses on small caps, how do you invest inside your super and why would you not have an SMSF?

37:35Scott, what has your experience been with an SMSF and who would you recommend it to? You've mentioned that it can be a lot of paperwork. What exactly is involved? Your great chat with Meg Heffron made me think a lot about the idea that as our super grows, so do our percentage-based fees. At some point soon, our own super fees will overtake the administration costs of an SMSF, so I'm starting to consider switching purely on a fee basis, but with a bonus of flexibility to invest in whatever we choose. And as a bonus question for Scott, you have also mentioned having cash in a savings account but you also have a home loan.

38:10Why would you not use an offset account? Wouldn't you hashtag get a better rate? Thanks, guys. And hashtag fool on from Drew. And then Drew finishes with PS. What is the Motley Fool? Ah, good man, Drew. It's a private online investment club, obviously. No, it's not. We give stock advice to individual investors, Drew, or as I prefer to call them, retail investors. Just get up Andrew's nose. Thank you, Drew. Great question and love the PS. Mate, okay, let's start with you. yeah why do you not have an smsf given the flexibility given the opportunity to invest in your favorite little small caps uh why not why not take the plunge the sad truth is i don't have the funds in super to justify it that's the truth you know um yeah i don't have enough money i i i in starting a business i mean i had five years almost without a salary there was no money going into super at that time.

39:06I've liked, I've right or wrong, I've kept a lot of money outside of super. I could have contributed a lot more, but because, you know, you have this crazy startup with just sucking money. You need a bit of a buffer that's sort of there. So there was sort of that personal situation around it. If I had a million bucks in super, yeah, hell yeah, I'd do SMSF. Don't forget about it. I'm always flattered that people assume that I do have millions. Like I don't, I'm renting here, right people? Well, there's not a Maserati out the front. So, yeah, that's the cold, hard truth of the matter. So at the point in time at which the fees make sense, do you intend to switch?

39:47Yeah, I think so. Yeah. I mean, I'm with Australian Super, the member direct option. So, again, I can choose amongst, I think, the ASX 300 with mine or whatever. Plus some ETS from memory. So I can still scratch that more stock picking it through super and do and do but you know what actually within that it's it's a very etf heavy super because it's sort of i i get to i get to have all the challenge fun reward of stock picking outside of that this stuff is look i don't think i'll have too many regrets if in you know i'm 48 so i'll probably be around working for another 20 years or something like that and all i get in my super is just the average market return over that period it's not the world's greatest problem right no i could have would have should have if i kept it all out or if i'd just been more active there where i had been i maybe i could have gotten a little bit more and all the rest of it it's just it's just a very easy low admin low cost kind of option and uh i'll chase the dreams outside of it nice nice i um so you so drew you ask two questions what's my experience who would i recommend it to and be also asked about why i'm set up this way i'm gonna i'm gonna be really really really honest i am not sure if i have my time again whether i go in smsf and probably for the reasons you mentioned drew um the vast bulk of my companies are in the asx 300 anyway the ones I own.

41:19I have US stocks, but that's actually outside super. I don't own any US stocks inside my superannuation fund. There are many more options now. Sorry, I should have to start it again. The other thing is there's more opportunity now to Vanguard's personal super account and that kind of stuff. I fully expect in five years' time, there'll be platforms that allow you to have almost full flexibility with relatively low fees. The biggest challenge for those big institutional guys and why they're limited to the ASX 300. Part of it's liquidity and risk. They are the trustees of the fund. So even though you want to make your own decisions, this gets technical pretty quickly.

41:56As the SMSF, so I am both a member of my fund and the trustee of my fund. And that's not the same thing. And it's not even the same person. I can't even say, well, I'm both, so that's okay. I have two distinct legal roles in that super fund. As a member, I can say to the trustee, make me a lot of money. As the trustee, I have to say, I'm responsible for a reasonable, appropriate investment of that cash on behalf of the member for that member's retirement. And the fact it happens to be the same person is a bit of a mess with your head, but there's a different obligation. Now, if I choose to invest my SMSF responsibly, I'm actually legally responsible as the trustee for things I actually should be doing or not doing as an individual, right?

42:36As a trustee, that's my job, is to make sure the fund is invested appropriately. Even if, as a member, I want something different. Now, by the way, there's a whole lot of SMSFs who probably arguably aren't doing that right now. And it's a very, very hard thing to prove what's responsible, what's irresponsible, what's appropriate, what's inappropriate. But that's the reality. If you're a super fund, even Australian super with a direct investing option, you're still the trustee. And your obligation is still to make sure that the funds are invested appropriately. So they have rules around what you can do because they take that trustee responsibility seriously as they should if it's taken off them, they don't exist.

43:08So they have to make sure the money is invested what they believe is responsibly and appropriately. At the same time, there are also costs with that. The fact they can be so low cost is because they're not executing little$5,$10,$15 trades over and over and over and over again. They're making big lump sum trades with big lump sums of cash. They're a balanced option. Every time they get$100 ,000 worth of contributions for their members, they buy a certain number of shares and a certain number of companies. That's how they do it. When I want to make a$100 purchase of some little specky biotech. I don't do that, of course, as you know.

43:45If they incur 20 dollars worth of trading costs, then that costs them more money and they can't keep the cost down. So those two factors are at play when it comes to why they don't offer more. I think that'll break down as things get cheaper to do, by the way. But that's kind of why and what's going on there. I have honestly considered reasonably recently going into Australian Supers Direct Investment Option or going to Vanguard Personal Super. um the and part of the reason is you ask what the paperwork is it's not super complex quite honestly uh there's a tax return you have to do every year you have to allocate the trades in the paperwork to you know cash in cash out you got to pay tax bills um you've got to get documentation and keep documentation on the trades the dividends um now it's all in my system it's all done automatically but you have to basically allocate them it's a boring process but you have to do it um you have to have an investment strategy you have to have a meeting of the trustees of the fund lots of my wife and i are both trustees of the fund um you have to do all that stuff and it's just a pain honestly it's just my life is busy enough as it is i just don't need it um would i invest differently yeah because i have individual stocks currently but if i went to a direct investment option and i get 85 of the same result would i do it probably yeah really like that's the thing so i'm not miles away from kind of just throwing the whole thing in and doing it now it's interesting because plenty of people say well you know uh the Motley Fool's pick stocks.

45:07And so we want to attract and have people with SMSF so they can do it in their funds. Most of our services, not all, most of our services would allow you to reflect most of that in your direct super investment rather than just an SMSF. So I could do it. You could do it. I don't really care whether members have SMSFs or not. Combination of SMSF, direct super, and their own money outside super. I think our services are perfect for that. And I think you can do it anyway. So yeah, that's the honest answer, mate um i the fees are probably important as you as it gets bigger but again as i said before the fees are coming down across the board with investment options and vanguard personal super and australian super as direct investment they they get pretty cheap pretty fast um i wouldn't you couldn't make me invest my super in a retail fund um but a cheap big low-cost industry fund is is perfectly good i'm not sure as i didn't i didn't maybe go too far in one direction in setting up an smsf i'm not sure if i have a time again i wouldn't seriously consider staying with with some industry super fund hmm more on that mate no i hope that i hope that helps um in terms of drew's comment about cash in a savings account i think i might have just i think i might i'm not sure if i said saving cut specifically if i did i might have just been um i might have just been using the term you know indirectly cash in a savings account unless so why would you use a cash a savings account rather than rather than offset a couple of answers if you had the cash set aside for a particular purpose you might do it that way if you were budgeting for something you might do it that way otherwise offset accounts perfect generally would you get a better rate yes you absolutely would so you know as long as you can as long as you can budget appropriately using an offset account.

46:53A lot of people will use the offset and why do the banks like it? Because we all think we've got to put money in there and then we use it because we can. Look at all that money in the offset account. It's a credit card. An offset account is a line of credit. Let's call it for what it is. Correct, correct. Well, I mean, it's your own money so it's kind of not necessarily directly but if you use it that way then yeah, you end up spending more than you would otherwise. It's not your money. They gave you a bunch of money to buy a house with. You paid some of that house. You owe them a bunch of money.

47:17You pay some of that back, not all of it back but they just say, out again you can so it's like that's redraw that's redraw not offset i'm not offsets specifically but can't with offset account the money i've got in an offset i can take out right i can do what i like with it yeah but it's not but it's my money if i if i get paid and i put my pay directly in offset accounts my money the effective the effective action of it though is to reduce the principal amount that interest is being calculated on so yes yep so it's kind of paying off the debt right it's it's it's there it's offsetting the interest yes correct yeah and and it just but but what you to your point i mean you just nailed it why is it there because it's there and you can use it, right?

47:53If the only option was just to repay it, then you would have to like apply for another loan to do it. Correct, or a redraw or something else. That's exactly why it's there. Yep. I'm not saying I wouldn't use it by the way either. I mean, it's sort of like great, right? It gives that flexibility. I'm not saying that people are wrong for using it. I would absolutely use it, but I would also try and have as much, any cash that I have would absolutely be parked in there. Correct. unless you're at a particular use for a particular yeah I can't imagine a scenario where you would have money in different places for the sake of it but you might for budgeting reasons or for something and I guess I would have it there really mentally I'd just be considering it a repayment of the principal because that's the return that I'm getting it depends though right most people have their salary paid directly to the offset account so it's and that maximizes it if you just said I'm just going to put in the extra amount I would otherwise have repaid that's different.

48:48If you're manually adding money into it as a way of paying down the mortgage then you're absolutely right in your example. But most people say or everything goes into the offset or my salary goes into it every dollar is being used. That way is it a... But it's only being used until you spend it again. So it has a marginal difference and that's a good one and you should definitely... Again, I'm not saying people are doing anything wrong but it is... Yeah, it's... It's only really... when you work out the mass, it's a marginal, I would imagine, difference by just having a bit of money in there for the week until I spend it.

49:24Monthly cash flow, correct. Exactly, yes. Right? Once you have more money to pay off, I agree with you, Matt. So I would split it three ways. One is, the monthly back and forth is worth nothing. I mean, it's something, but it's not, don't bother. I wouldn't put rainy day money on a mortgage. So actually, to answer your question, Drew, I would have rainy day account money well if you want to leave it in the offset go for it but yeah pay down anything else otherwise all you're doing is tempting yourself to use it yeah if you've got a half million dollar mortgage and four hundred thousand dollars in the offset pay the money off the mortgage and have a hundred hundred thousand dollar mortgage don't don't pretend you're going to leave it there and then maybe at some point they equalize right let's say at some point you have a four hundred twenty five thousand dollar mortgage and four hundred twenty five thousand in the offset just to go with my example i mean what would you use that money for other than pay the mortgage off and And if you're not going to, then it's a bit of false economy at some level.

50:16As I say, it becomes a credit card at that point. I'm just lending against the house. And I'm not even judging on that. But that's – I think – With those lump sums, correct. Yeah. History will suggest that when there is a pot of money within easy reach, you will probably use it. I'm not saying don't use it. Money is there to be enjoyed and to be spent. But it's just where you – There is something that is incredibly empowering to be debt free and to not have that ongoing monthly cost. That's the return, right? That is the return is that you are mortgage interest free, right? You just you live in your house and you've got some basic maintenance and rates and that's it.

50:54That's a pretty good return. Yeah, correct. Correct. Yes, we're done. A question from Bryce. Hi, gents. Before my question, I thought, oh dear, I'd like to report an interesting side effect of listening to your episodes while I do the yard work. I'm not sure where this is going. I should have pre-read this. It seems like I have trained myself to feel better about my long-term financial security when I am pushing a lawnmower regardless of whether or not I am actually hearing your advice. Maybe something like a Pavlov's fool. That's fascinating, Bryce. I'm glad that mowing makes you feel better about your finances, mate.

51:28That's a win for everybody. That may be about you. It may be about us. I'm not entirely sure, but I like it. My question, he says, is one I've been circling on for a few weeks now. I haven't been investing for long, but I have an interest in micro cap, even nano cap businesses. While I learn about being a better judge of their value myself, I really enjoy listening to my favorite micro cap fund managers chat about their favorite stocks and why they like them. Recently, after hearing you discuss PE valuations, I was doing some exercises and bumped into Shine Justice Limited. I'm vaguely aware it has a checkered past but has a PE of close to 4 sits on a lowly straw man company rank of 603 apparently by comparison XRF Scientific currently sitting in the number one spot on straw man with a similar market cap has a PE of around 25 I know it's never going to be as simple as just researching which company is most popular on whatever website or which company has the most attractive PE my issue is if I was some sort of hypothetical gazillionaire shopping for businesses, how could I justify purchasing XRF over Shine?

52:36Ignoring the share price, I can't figure out how one business who could pay for itself with its current earnings in four years is so much less popular than one that would take 25. Is it really just the market sentiment on growth potential which has both businesses separated so far from each other? I feel like I'm missing something big and simple, but in the spirit of Mr. Page's advice, have decided to ask the dumb question. Please help me square this circle in quotes, which I think is a reference to one of your favorite sayings, Ram. Love it. It's a really good one, mate. It's a great one. I've been in a version of this before.

53:08I don't know either of these companies well enough to actually have a view, mate. I'm not sure if you do. I know XRF pretty well. It's a very good question. Four times and 25 times earnings. A lot can go wrong with the business on four times. A lot has to go right with the business on 25 times. Yeah. it's a fascinating fascinating question to ask i wish any companies i'm not gonna be able to do the value to your question bros i don't know there's businesses well enough uh ramo's xrf scientific which is great but it's not necessarily about the one business it kind of it makes it hard to answer because you know knowing more about one than the other probably is maybe it's a better quality business but a lot can go wrong with a company in a pe4 and still you still make money right yeah no i mean absolutely and i don't know shine that well um but the i think there's um we need to correct the premise of the question here to say one would take 25 years to pay off, one would take four years to pay off.

53:58That's true if both of these companies continue to earn exactly what they earned last year. That's right. Right. So there's the clue because XRF is a business that they're, I'm just trying to look it up now, their net profit after abnormals, they weren't even making a million dollars in 2017. Now they're over$6 million as of last financial year. You just, again, for whatever it's worth, the consensus guidance on Comsec is for XRF's per share earnings to grow by 40 % over the next few years. Shine Lawyer, again, take it with a grain of salt. The analysts there are saying basically flat earnings for the next few years.

54:40Now, those might be completely wrong, but that's the bet. And that's what the market is saying to you. The market is sort of saying, actually, and you've probably got to look out a bit further than that, but they were saying, actually, over a 10-year period, I'm actually probably going to get much more money back out of XO. It will pay itself back much quicker than Shine because each year the earnings will be growing more and more and more and more. That's why you pay a high multiple. You and me have both got a lemonade stand. Every week, you pull in$10. I do two for the first week. The next week, you're still on$10.

55:14then I'm making$20 and then$30 and then$40. Now, with anyone who had any confidence in our different lemonade entrepreneurism, and at the start you say, which one do you want to buy shares in? Scott's offering shares in his business for five times earnings. I'm offering it to you for 10. Yeah, I mean, mine sounds a lot more expensive, but look at the difference in cash flows relative to those cash flows. I'm actually much cheaper. So that's, again, I don't want to, I'm not trying to say that therefore buy XRF. I'm not saying that, but that that is that is how you square the circle yeah it's fascinating i've not looked at shine in a million years um i'm trying to find why the market hates it i actually can't so uh i don't know how to best answer bryce's question um and the reason i say that is because and you're absolutely right mate in terms of um it's the future that matters that that's the that's the answer your question bryce but there is also an element of and and this is you know we talked just literally before about trying to find stuff the market's missing uh for what it's worth i'm looking at comsec here i don't think i'm giving away too much in the way of uh proprietary information from comsec so apologies to the good people at cba if i am uh but if i look at the at the business itself uh there's a there's two different i won't name what they are i'll tell you one the the consensus uh view on shine is a strong buy there's only one research analyst covering it, the Comsec reports, but a strong buy.

56:41They also have some other research there from a particular entity that considers it undervalued and the fair value twice the current share price. Now, that's a pretty big opportunity. It's currently paying a dividend yield of 8.3 % and for the last three years, four years, three years, earnings have grown year on year on year. Now, those earnings are still less than they were in 2015, so that might tell you something. and by definition that means i've spent the last six years below that level so you know what's a reasonable level of earnings if earnings was to half from here the p goes to eight now again not particularly expensive but that's kind of what you look like uh and so it's worth asking yourself you know what a company needs to do right or wrong and how likely you think that is as to whether or not it's worth your investment i don't see anything to hate about shine i'll give you something oh good okay yeah please so i i wasn't familiar with it either and and uh They're right.

57:36It doesn't rank well on Strawman. But people have added some comments. Okay. So shout out to a couple of members here. Hack of All Trades, great name by the way, says there's a short report out against them. So that would explain it. There was a big blow up a few years ago in terms of what they call WIP accounting, work in progress accounting. So as RH8178 on Strawman points out, this is a no win, no fee business. So if they don't win, they don't get paid. So they have all this work in progress. So if we are going to get paid and we're going to get paid this amount, we're going to average this out over the period that we're working it on.

58:16And it's all an accounting measure. It's not actual real cash flows. Money is not going to show up unless they win. And they're not going to win every kind of case. So that's not a bad – I mean, you've got to be very aware of the accounting that's being used here. So the summary would be a company that has not covered itself in glory in the past. So there's some mistrust from the market. And look, I don't want to speak ill of them because as far as I know, they've probably got a new management team in place. They've found religion and they've turned things around. It absolutely could be possible.

58:46And by the way, isn't that what you're looking for as an investor where the market is overly down on something, right? So I don't want anyone to walk away from saying, oh, Andrew hates it all. lives i don't i don't either because i don't in either way because i i don't know it well enough but but i'm putting the thesis out there as i've seen it which is yeah a a a bad history some very um some accounting that while appropriate is subject to all kinds of revisions and and changes and a someone's put a short report out which no doubt makes a whole bunch of very bearish cases against it. Now, if they're all wrong to sort of, if, if this work in progress accounting has actually been estimated well, and if they have a good win rate, um, and, uh, if some of these aspects, you know, and, and, and the, the, the trust is regained by the market.

59:41Yeah. It's probably normalizes to even a PE of 10, something, something like that. And you'll, you'll, you'll do extremely well, or it turns out that all of this, these accounted for profit never emerges. all of these issues were lurking in the shadows and and that's that's your job so we we can't give you that advice and i don't think either of us have nearly done the work to to even get close to that but that hopefully gives you a starting point on what to look into i have a really good summary mate i can't i can't do any better than that other than just to say that as you made the point uh you know you're looking for a different perspective to the market if if if there's things are already fairly valued then there's no upside so your question is to ask yourself which if it and maybe both these businesses you know maybe maybe shine is too you know hairy too many hairs on it and maybe xrf is too expensive and you ignore both that's completely cool too i don't think you need to necessarily you're not necessarily saying either or um but you're right to highlight the two and say what's going on there is absolutely i i don't want to say this about shine or xrf particular certainly not about straw man but there is just there is a very real reality because say real reality probably not about sentiment right sentiment sentiment drives up and down there's some great businesses that market hated for a while for lots of reasons again everyone knows i own corporate travel management he got smashed by a short report 2019 maybe around i think um for a while and it was just it was just sentiment the results weren't any different it was just the market was expecting bad things didn't happen but could have uh other times markets expecting good things other stocks dominoes 140 market expects good things goes to 50 I own those shares, as everyone knows.

1:01:17You know, it falls by two thirds. Is the business any worse? No, but the market was expecting a whole lot better than it did. So you've got to think about sentiment, absolutely. And this is where investing is hard. You've talked, Bryce, you asked about four times and 25 times. Even allowing RAM for flat earnings, you don't even necessarily get that money back. Yes. Because the market, at the moment, it shines dividend yield is 8%, which is good. But that takes you 12 years to get your money back if you're just waiting on the cash flows. Now, can it be that good for 12 years? Yes. If you get your money back up to 12 years, you're still going to earn more than that.

1:01:47So in year 13, you finally make a dollar. If the market never pays you more than four times earnings, then you spend a lot of time getting average-ish returns for a long time. That might be okay. Maybe it goes to 10, as Ram says. Maybe though, at the same time, XRF goes to 35 or it saves at 25, but sales go through the roof and shine just ticks along. So there's lots and lots and lots of questions to answer. One of the most frustrating things about valuation for me, mate, is there's no cast-iron rule that says a company has to trade at its fair value eventually. Shine could be a really great business.

1:02:22The short report could be wrong. The work-in-progress can be perfect. Over time, they could be really profitable. And the market could never pay more than four times. And that would be unusual and it would suck, but it could be true. Well, that's tobacco stocks. They perpetually trade at very low multiples. Great example. On the flip side, XRF could fall to 12 times earnings and the share price halves. It could go to 40 times earnings and the share price almost doubles and profit may not change. And again, all the same could happen with Shire. Shire can go to two times earnings too, by the way.

1:02:51There's no guarantee any of that happens. So it's why it's hard because you can't say, eventually I will get that money. If the dividend doesn't get paid, the PE doesn't matter unless someone else says, I think it's worth, to Ram's point, 10 times earnings at some point. And then you're sweet because you made two and a half times your money and you're a genius. But if it stays at four times earnings by 2028, then all you've got is a dividend, which is lovely, but you won't necessarily get the value that you perceive. If XRF continues to grow and the share price grows, then that could be the better investment.

1:03:18It is a very, very imprecise science dealing with human nature and hoping other people see the value you think you see. That's kind of bottom line, exactly the hardest part of investing. It is a huge assumption we make that value will out. Yes. But it's not a terrible assumption. I mean, again, history is just that guide of, well, it's kind of always happened. And when I say always, I mean literally always happened. I've often put out the challenge, find me a company, you know, whose earnings have grown materially over a long period of time and that wasn't reflected in some way in the share price.

1:03:52It just, you know. Except you've answered it yourself with Altria. Or tobacco stocks.

1:04:00Actually, they've done really well, tobacco stocks. But there's been no PE. Well, it might have been recently actually, but for a long time there was a low PE forever. Actually, it's part of the reason why the returns are so good because the yields are so high and the buybacks have been so good. Correct, correct. Yeah. But that's actually the point, right? So if tobacco was only hype, then there's nothing to sort of fall back on. So I think you don't assume that this is going to be a very popular trade and that a lot of people will bid it up and that there'll be a good premium. But at the same time, cash is cash, is cash, is cash.

1:04:35And for better or worse, these corporations are spinning out squillions of dollars. And at a point, you get to a point where it's just sort of like, you never say never, but it'd be very unlikely for the PE to compress sustainably and significantly from already extremely low levels. Because then you get to the point where it's not about sentiment. It's just purely on yield. Let's say that they dropped to one times earnings and they had an 80 % payout ratio. I mean, you're getting an 80 % yield. It's like, I don't need the market anymore. Yeah, that's right. Give me my shares and I'll take it. That's right.

1:05:11So there's no hard wall where these kinds of things kick in, but it's a rubber band. And the more you sort of stretch away from the anchor of earnings, the more likely it's to spring back, either if it goes too high or too low. Again, I'm not suggesting a strategy built around any of these kinds of things, but it's just that usual refrain when stocks like XRF, which are trading on a PE multiple of 25, that's fine. The rubber band sort of stretched up there, but it might be that the earnings rise to give it a bit more slack rather than the share price comes down and vice versa for the ones on the very low PE.

1:05:51They could trade at lower multiples, but as long as those earnings are more or less consistent, that'll sort of keep things pretty taut there and keep it where it is. So I never like to be reliant on PEs on what the market is doing, but I very much, I mean, this is the uncomfortable, unavoidable truth is you do have to have some assumption in there at some point, right? Either pure DCF and that the market will recognize that, or I think that this is a reasonable assumption for the PE in the future. But I always do it. I always just estimate towards the sort of the lower end of the bound so that if, look, I just want to be reliant on my company doing well.

1:06:26If it does well and the PE doesn't really move up and maybe it even gets a little low, I'm still going to be okay.

1:06:36If the company races to the moon in terms of its earnings and then the PE collapses, maybe then I'm still okay under that scenario. But if I'm wrong and the PE ends up being much higher than I was accounting for, I'm not going to complain, right? Like just it's a win if it happens and if not, where you've still got the bedrock of the fundamentals. 100%, 100%. It's worth saying, by the way, half the company is owned by two people. When it comes to shines, that's possibly there might be a liquidity problem there as well. I'm going to say, I'm actually fascinated by this. I'm going to look into what we finished this podcast.

1:07:10No promises, no guarantees. And as always, if I do buy them, it won't be for at least two full days after this podcast goes to air. I don't think I will because I don't tend to play in this space. But I don't know, a P of 4 and an 8 % dividend yield in a business that's kind of grown profit for the last three or four years, I'm going to have to look at the cash flows. Well, that's the thing to get comfortable with. I mean, again, just the flip side of it would be, don't forget, PEs can normalize not because of the share price, but because of the earnings. Like if Shine's earnings drop in half tomorrow, the PE is all of a sudden 16 as well.

1:07:41Yeah, correct, correct. Yeah, that is the question to ask though. And that is the conviction that you need to build. And if you have that conviction built around that, not even like rising in, they can just more or less chug it out as is. You've got an investment thesis right there. Just be sure of it. We're not going to go too much into this, but just for the fun of it, we talked about the learnings and everything else. Even though they reported higher profits last year, their cash inflows from operating activities was$49 million in 2021 and only$10 million in 2022. That's not necessarily bad.

1:08:16There might've been a big payout in 21 or a lot of work done in 22 and no payouts or whatever. but the earnings are the accounting combination. By the way, we have an episode coming up while I'm on holidays, where Andrew's here, but I'm on holidays, about the profit loss statement, some of the things to think about. So just keep an eye and ear out for that one. But yeah, the cash inflows fell by 80%. Not necessarily a bad thing, I want to be really careful here, I'm not saying therefore it's bad, but as a result, they had less cash at the end of the year than at the beginning. So this is a business that reported a profit and a good profit, but cash fell because they're hoping that all that cash spent is worth something when the payouts come, that the work in progress accounting for this sort of business is really, really, really tough.

1:08:57So I don't see anything at all wrong with the way they're doing it. Just know that it's lumpy. And accounting profits in this business are a best-guessed estimation. So you have to just allow for that. So again, we'll talk a little bit about the P &L in a couple of weeks' time. But when you think about this, think really carefully about when the reported numbers make sense and when the cash flows, if you look back over time, the cash flows will also be super lumpy. There'll be years when cash flows were much higher than profits for exactly the same reasons. I'm not saying it only goes in one way.

1:09:27Just be really mindful that a couple of big wins could go really nicely, a couple of big losses and non-results for them in terms of the money they've invested. And you could see cash flow and even potentially reported earnings fall as well. So again, there's some people involved in this business who have a lot of their wealth tied up in this business who are trying very hard to create lots of value. whether they can do it, open question. I'm sure they're trying their absolute hardest, but don't just look at the reported profits, particularly in a business like this. Yeah. Let me, I don't own shares, but I'll give the pitch for XRF though.

1:10:02There's something to be said for the risk adjusted returns as well. I'm very big on sort of saying there's no extra prizes for degree of difficulty. So there's nothing, anything wrong with Shine's model. It's just the model that it has to operate under. and you've got all these things to contend with. XRF make analytical machinery for mines, basically. So you send your core samples there. They tell you the purity and all the kind of stuff that you're actually super important to run, not just mines, but a bunch of industrial processes and the rest of it. And they've got this really cool razor and blade model.

1:10:37It's like Gillette or it's like selling printers and print cartridges. So you kind of get the machine, not that they're giving them away, but the margin on the consumables is really nice. So what's the thesis here? It's just sort of like, well, actually, it's a company that's been around for quite a little while. Things cooled off a little bit after the mining boom, but since 2016, I mean, the earnings have just been going gangbusters. There's a very strong tailwind behind it. Remember, it's like they always say in a mining boom, don't buy miners, buy the pick and shovel provider. It's like the Levi Gene story, right?

1:11:12Like it's just like that is where the money to be made. So they're more of a volume game, really. It doesn't matter how profitable miners are. It's really a question of how much activity is going on. Now, we're the second largest provider of all these rare earth minerals. There's a massive boom underway. We know that even a government elected in on rather green sort of promises of promoting new mines and the rest of it. that's the thesis right there's going to be more of this activity they provide an essential product for some very big name players very diversified um and and so long as those customers are in operation and continuing to expand and run operations they will be getting pretty reliable cash flows and and that's that's the thesis right there yeah don't run out and buy it based on that i'm just i'm just giving you i'm just giving you the argument it's a really honest about the The earnings growth has been phenomenal.

1:12:06According to the ComSec numbers here, two cents a share in 2020, which doesn't sound that much. Three in 2021, which remember is a 50 % increase, five cents in 2022 per share. Now, that's why the PE is still massive, but you can absolutely imagine a scenario where if they can continue to get that. Again, by the way, we're going to talk about operating leverage in a future episode. Their earnings went from two cents to five cents a share. So two and a half times. Thing and beauty. Their sales went up by$0.08 from 22 to 30. Basic math says that's about 40%. Yep. So 40 % increase in sales, two and a half times in profit.

1:12:41Now, that won't continue forever. But you can imagine why investors look at this company and go, well, hang on, another couple of years of earnings growth, and all of a sudden the peer goes from 25 to something lower. All of a sudden the stock that looked expensive at 25 times is either much cheaper at 16 times, or it's 25 times earnings, but the earnings are much higher. So the share price goes for$1.30 to$1.80,$2, something like that. And it looks like an absolute no-brainer. Yeah, hardly any debt, strong balance sheet, reliable cash flows. I mean, here's the other thing as well. It's not like this is some pre-revenue growth tech startup.

1:13:18It's a profitable business. It pays a dividend. It might be at 25 times, but if you gross up for franking credits, you're getting a 3 % yield in this thing. Get that in a bank. Right. And then there's – so the argument – the lovely rule of thumb, if you haven't heard it, is sort of a derivation of the Gordon growth model. But what you can do is you can say my total long-term return, making a few basic assumptions here, will probably be my starting yield plus the growth in dividends over time. Starting dividend yield? Starting dividend yield. So one analysis of this would be – I won't include franking credits to make it easier.

1:13:55So 2.1 % yield. I want a 10 % yield. do I feel as though over the medium to long term, XRF can boost its dividend by about 8 % per year? If that is true, you'll very likely get a double-digit return when all is said and done. It's a rough-and-ready kind of approach to do it, but companies that pay dividends, that's a nice little way to thumb-suck an idea of value. So, yeah, anyway, that's the case for XRF. And it's another great example,$178 million company. No one's heard of it, right? It's a big company,$178 million. I know on the ASX, it's not a big company. There's lots of liquidity there, actual real business, real earnings, real dividend, industry tailwinds.

1:14:40I'm starting to think why I don't own it now. Why? Talking myself into it. But I just want to put the positive case out there. And I guess my circle back on the original point I was trying to make is, it's just there's less, or any of the things I've said and the assumptions I've sort of implied there could absolutely be wrong. But they're just easier, for me at least, I think they're easier guesses than when it comes to Shine. How many people are going to be launching class actions? What's your success rate going to be, et cetera? So that's hard. And this means it's just a lower bar to step over.

1:15:14Yes. That is a wonderful place, I think, to finish our podcast, mate. Thank you for spending some time with me. I've always, always enjoyed it. I'm sure our listeners do as well. As always, if you want a question answered, hit us up on the socials or via email info info at fool.com.au is our email address drop it there in the member services fools at the motley fool get it to me i'll ask the question follow us on the socials if you're on twitter that's the only place you can get andrew page at sage underscore simian or at straw man invest you get me on twitter or insta at tmf scott p or at the motley full au and on facebook follow me facebook.com forward slash scott phillips money i've said before i think i said one of the pre-records and i said i try and remember it in advance of that pre-record which i have finally and thankfully mind you i was so far through the episode there's probably our mother's listening and no one else at this point um just a just a quick call out uh the podcast already long i'm not gonna take too long quick call out uh i am having my account spoofed by scammers uh they are using slightly different spellings or different characters in my Twitter handle, pretending they're me and then adding my followers to their account, trying to swindle them out of money.

1:16:26Scumbags, I wish I could do something about it. I can't because apparently Twitter and Facebook aren't big enough tech companies to actually find a way to solve for this. He says sarcastically. So yes, please be very, very careful. So let me be very clear. TMF Scott P, two Ts in Scott. One of my scammers on Twitter is only using one T. I'm also being scammed, I think it was on Facebook or somewhere else, Insta, putting an R on the end of it, Scott PR, for reasons only best known to them. But yeah, so TMFscottp is the only Twitter or Instagram handle you should follow for me if you're getting invitations from somebody else.

1:17:00By the way, if someone pretending to me add you and hit you up and says, hey, how are you? I love you all. I'm glad you're following me. I'm not going to add you on Twitter and then say, hey, how are you? That's not my deal. So as much as you might be excited by it, and I love that you're excited by it, just please keep an eye out because I really, really don't want any of my followers or our followers to be scammed by falling for that sort of stuff. It's easy to do when you're not thinking. You're between meetings. It's late at night or whatever. First thing in the morning, you click on it, you start chatting.

1:17:26All of a sudden, there's a link there and they're trying to scam you out of something. I'm not going to offer you Bitcoin. I'm not going to offer you a deal. I'm not going to offer you a special investment opportunity. Again, as much as I love you all, I'm not going to do that. So just please be mindful of that. Until next week. Fool on. Cheers. 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. Subscribe to the free newsletter at fool.com.au forward slash listener.

1:17:58The Motley Fool operates under Financial Services License 400691.