The ABC of value investing with Cannon

Adrian Saville, Chief Investment Officer of Cannon Asset Management takes every opportunity he can to preach his version of the gospel of Benjamin Graham, high priest of value investing. Many investors, including value investors are confused about where to invest and what to invest in in the current environment. A few salient points from Saville as presented recently might add clarity.

1.       The current global investing environment is weak, with many of the developed countries experiencing a combination of high public sector debt, measured as a percentage of GDP and public sector deficit, (difference between tax revenue and public sector spending) measured as a percentage of GDP. Saville describes these countries (circled in the graph) as ‘in the ring of fire’ He quotes Bill Gross of Pimco as saying that ‘(UK) gilts are resting on a bed of nitro-glycerine. High debt with the potiential to devalue its currency present high risks for bond investors.

However, Saville said that there were value opportunities available in some of the highly indebted countries, as other investors were scared off by the negative sentiment. He said that the Cannon Global Equity Fund was presently overweight Japan, and had made recent high quality investments in a few Greek companies.

2.       Saville pointed out that high debt has clear implications for growth. The slide below plots the relationship between debt bands (greater than 90% on the far right) and historic growth, using data from the 20 most advanced economies between 1790 and 2009. Historically, countries with debt in the greater than 90% zone have grown less than 2%. According to Saville, growth levels of this order would be realistic for the United States, Ireland, Greece, Italy and Japan, as per the graph above. But the International Monetary Fund has announced that they expect global growth of 4% for the next few years or so.

'For this to occur, the developing countries would have to have growh in the order of 10%, which is not realistic,' he said.

3.       Slide three compares the government debt to GDP ratio of advanced countries with developing countries between 2006 to a projected 2014.

4.       Slide four shows the market capitalization of the Financial Times top 500 companies split according to whether the companies concerned are listed in developed or emerging countries. In 2000, only 4% of the Top 400 were in developing countries, in 2010, 22% of the companies are in developing countries.

5.       Slide five is one of the most interesting slides of the presentation. It plots the relationship between equity returns and economic growth, using data between 1900 and 2009 in 16 countries, including South Africa.

 The bars show the average real equity returns of the countries during the period under review, while the dots show real per capita income growth during the same period.

Australia is the most stark example of a country where average equity returns have been much higher than real per capital income growth. Suffice to say that the graph disproves the commonly held assumption that equity returns are higher when GDP is higher.  In fact, economic growth rates are irrelevant to stock returns

6.       Slides six and shows comparative earnings growth in the value and growth sectors over rolling five year periods. Saville says that this chart illustrates that the price that is paid for a certain company is far more important than either the geographic location of the company or the economic growth in that country.

7.       And the last slide is an analysis of the price earnings ratio, the dividend yield, the price to book ratio, the return on equity and the Headline Earnings per share growth (over inflation, measured as a percentage) of two Cannon Funds, the Cannon Global Equity Fund and the Cannon Equity Fund, compared with the same figures of the relevant benchmarks.