Equitable Investors - Investment Management Australia

Unique Opportunities | Intensive Research | Constructive Engagement

Investing independently of consensus.


Equitable Investors is an independent investment manager focused on identifying listed investment opportunities and engaging constructively with the people behind them to maximise shareholder value. Its directors have approximately 50 years of combined professional experience in investment markets focused on micro, small and emerging companies and special opportunities.

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investment management Australia, unique opportunities, micro cap, small cap

Sleepy Heads

(from our blog - blog.equitableinvestors.com.au)

Australian investors have done well out of sleep with ResMed’s market cap multiplying nearly 19x since 2002. Equitable Investors Dragonfly Fund’s best performed investment (at the time this was written), Rhinomed (RNO), has a different angle on sleep. So does a newer investment for the Fund, Oventus Medical (OVN). Both were contributors to the Fund’s positive performance in July.

RNO has a consumable nasal insert sold as a solution for mild sleep apnea but is also now emerging as a drug delivery platform. During July, RNO (a) released data showing its “Mute” nasal insert is the fastest growing product in its category in US drugstores; (b) received a CE Mark registering its “Pronto” nasal insert that releases vapour (essential oils) for Europe (having already received US FDA and Australian TGA approval); and (c) released its June quarter cashflow showing cash receipts up 150% year-on-year to $1.5m. As Figure 1 below shows, RNO has emerged as a rapidly growing product in US drug stores.

While RNO’s consumable device dilates the nose, OVN’s mouth insert acts like a “second nose”. In July, the Fund also participated in a capital raising for OVN. In its pitch, OVN set out the scope of its target market: 12% of US adults suffer from obstructive sleep apnoea (OSA, the most common type of sleep apnoea); that includes 6m adult patients in the US who are prescribed CPAP alone (CPAP devices such as those produced by ResMed pump air into a mask worn while sleeping) - of which 50-60% quit CPAP. So OVN sees 3m adults in the US requiring an alternative treatment that is more easily adhered to.

OVN has historically struggled finding a path to market due to the dominance and profitability of CPAP. But OVN has now established a US strategy that positions its device as more profitable and it is now signing up North American sleep centres.

Figure 1: US Drug Store “Nasal Strip” market - 12 months to April 21, 2019

Source: drugstoremanagement.com, Rhinomed

"The probability of a stock going up or down"

(from our blog - blog.equitableinvestors.com.au or Quora)

"What is the probability of a stock's price going up vs going down at any given time?"

The answer depends on how you are looking at this:

(i) if you are looking purely at the very next second with no additional information, there are three ways the stock could go: up, down or flat (no change).

(ii) if you are looking at buying a stock at any given point in time but then holding it for a period of time, historical data starts to indicate that the odds favour up over down.

A while back we ran some stats on the domestic equities market (Australia). We found that 64% of industrial stocks (a broad category that excludes resources plays but includes most other sectors including tech and financials, achieved a positive return in the five years to May 20, 2018. The first chart accompanying this text sets out the distribution of returns.

But that is just one time period in time. Using US data, alpha architect ran a more detailed study that you can read here.

If you look at market returns rather than individual stock returns, famed academics Fama and French have written a paper, “Long-Horizon Returns” and they found the distribution of continuously compounded (CC) returns for US equities “are close to, but not quite normal for return horizons of ten years or more”. The accompanying table, from that paper, shows CC returns have a positive mean over all periods from one month to 30 years.

And the next chart is also taken from that Fama and French paper, plotting out monthly US equity market returns.

ASX industrial stock returns - micro, small, mid and large
US equity market compound returns
Equity market returns by month

"Forget EPS accretion and focus on value!"

(from blog.equitableinvestors.com.au, June 2019)

We happened upon a copy of Credit Suisse's "To Buy or Not To Buy" - 26 pages on M&A - a couple of years after it was published (Feb 2017) but found it compelling - particularly in relation to EPS accretion.

  • Three quarters of investor relations professionals surveyed by AT Kearney said stakeholders place a “strong emphasis” EPS accretion or dilution - and that EPS accretion or dilution was deemed to be, by far, the most important metric.
  • Most announced M&A deals today are accretive to the EPS of the buying company.
  • But EPS accretion or dilution actually provides little or no insight because value creation is based on cash flows rather than accounting measures - and the cost of capital rather than the funding source.

Credit Suisse took a sample of 95 of the M&A deals, categorised them based on whether the company said it would be immediately accretive or dilutive to EPS, then reviewed the one-day abnormal return for the buyer on the day of the announcement .

The accompanying table shows that:

  • Roughly three-fourths of the deals had a neutral or negative impact on shareholder value.
  • The bottom row reveals that 27 percent of the deals in this sample created shareholder value.
  • The box in the upper right corner shows that almost half of the deals add to EPS but subtract from value!

"Great Expectations"

(an adaptation from our Dragonfly Fund update for the month of January 2019)

At the time of writing this, mid-February, Australia's half-year profit reporting season is upon us. The months of February and August are always a little volatile for investors of ASX-listed companies and there is the capacity for significant swings in individual stock prices - should their financial results include any surprises. We have had a number of companies in the portfolio to date report without surprise. We would like to think there is scope for some positive surprises before the month is out but we’ll have to bide our time and see.

Leading into reporting season, our data shows that sell-side (broker) forecasts for EPS (earnings per share) in FY19 declined 1.5% on average (or 1.2% using the weighted average) across the ASX in January. We’ll discuss this in detail - and its relevance to long term value.

We made comment in each of the past two reports that earnings expectations were looking like they were sliding ahead of the half-year profit reporting season that occurs in February. Our data now shows that over the course of December and January, analysts cut their FY19 EPS forecasts by 2.8% on average, including a 3.2% average trim for IT stocks, 4.2% for Financials and almost 18% for the Energy sector. The one classification to experience a slight increase in average EPS forecasts was - you guessed it - “Other”.

This matters for two reasons: (1) our read on market behaviour over the past year or so has been that any negative surprises have been treated as triggers to sell-out at almost any price, causing short-term ructions; and (2) the more rational response is for investors to update their view on the medium to long-term value of an investment when they receive new information and that information may, for example, indicate the gross margins are trending lower than expected, which means that if this trend is assumed to continue, the “present value of future cash flows” expected from the business will be reduced.

A great book focused on this subject in relation to investment management, “ Expectations Investing: Reading Stock Prices for Better Returns ”, by Rappaport and Mauboussin, explores this topic in detail. Some relevant quotes include:

➔ “Investors make short-term bets on long-term outcomes… most companies need over ten years of value-creating cash flows to justify their stock price.”

➔ “Investors must separate companies that genuinely achieve better-than-expected operating performance from those that skilfully manage expectations and earnings.”

➔ “Two or three key leading indicators typically account for a substantial percentage of the variability in the turbo trigger [the value trigger likely to have the greatest impact on shareholder value].”


"Cannabis stocks weren't smoking in 2018"

(an adaptation from our blog posting in February 2019)

From time to time we've published an index on cannabis stocks and on other speculative thematics - lithium, China consumer plays and cryptocurrency stocks.

We had another look at these indices, based on the average share price moves of baskets of stocks exposed to the relevant themes, to provide a client with some perspective on how they have performed compared to the continually bubbly narrative of newsletter writers.

On our calculations, cannabis stocks fell 36% in 2018 - but that was better than cryptocurrency stocks (down 62%), lithium stocks (down 53%) and China consumer stocks (down 40%).

These stocks tell the story of market sentiment – they will run very hard when sentiment is strong and they will have the biggest declines when people start to worry.

Click here to see the charts accompanying the original blog post.