As investors continue to look for opportunities to increase their exposure to shares against a backdrop of record-making low interest rates we believe it is important to reignite a conversation about how AFIC is valued and to help investors understand what factors they should consider when analysing a Listed Invested Company or Trust (LIC/LIT).
There has been significant growth in the amount of LICs/LITs in the market over recent years, which brings much commentary about what it means to trade at a premium or discount to net tangible assets (NTA). With more than 90 years’ experience in the market, we understand that the NTA is, on one hand, quite simple, but on the other hand, when considering an LIC for investment other factors should also be considered such as fund performance over time and management expenses charged by the portfolio manager. We have outlined below what investors can consider when understanding and comparing NTA.
Simply put, NTA is the total value of the portfolio divided by the number of shares on issue. If an LIC has a $100 portfolio and 100 shares outstanding, the NTA per share is $1.
What is important to understand is that the NTA per share does not always reflect the market price of those shares; this is due to many reasons, some easier to analyse than others.
This is what is meant by trading at a discount or premium to NTA; if the share price is higher than NTA per share (say at $1.05 from the example above), the stock is trading at a premium, and if it is lower than NTA per share, (say at $0.95 from the example above), the stock is trading at a discount. It is a conventional investment belief that shares in LICs trading at a discount to NTA represent a good buying opportunity, but it is not always as straightforward as this.
The driving forces of NTA
Investment Performance and Costs
Good management and track record are important factors for AFIC when we consider our investments, and we expect that many investors apply the same rigor when evaluating a LIC. A track record of good performance does mean that a LIC is an attractive investment, which helps drive awareness and demand for the shares. As a result, the share price will usually, over the long-term, trade in line with the NTA. When fees are considered some investors may be willing to pay a small premium if the managers can deliver excellent performance in relation to the fees over the long-term.
Many LIC investors are looking for stable/growing fully franked dividends as part of their investment strategy. This is particularly so for self-managed superannuation fund investors who can take advantage of these dividends and are looking for income in or approaching retirement. As a result, those LICs that have stable or growing fully franked dividends sometimes trade at a premium. On the other side of this equation, there are those LICs that have more variable dividends, or no dividends at all, which can often lead to greater fluctuations between the price of shares and the NTA. In fact, this can lead to a persistent discount.
In addition, many long-standing LICs have profit and franking credit reserves that they can draw on in more difficult times. In AFIC’s case, we have been able to draw on these reserves to distribute attractive dividends to our shareholders even when companies are delivering subdued dividends, as has been the case more recently. As a result, when the market is under more pressure or uncertainty prevails, AFIC has traditionally traded at a premium.
While not wanting to generalise too much, there does appear to be a correlation between the size of a LIC and the long-term position of its share price relative to the NTA. Many small LICs have traded at a discount for long periods of time. This may be because of the lack of liquidity in the shares, the small shareholder base which means a reduced pool of buyers and sellers or even general investor awareness may be limited.
For AFIC, we have observed that with a shareholder base of over 150,000 word of mouth is an important driver of demand for shares as is the ongoing promotion of the company which helps lift awareness and support demand. As a result, periods when the share price trades at a discount to NTA appear to be mostly short-lived.
When buying a LIC at a discount it is prudent to consider the many factors outlined above. Of course, buying a LIC with a good quality manager that trades at a persistent discount can still produce satisfactory returns if the value of the NTA continues to increase in line with the investment objectives of the fund. However, it may take time before the extra benefit of closing the discount accrues to an investor, if at all.
At AFIC, our share price relative to NTA per share often correlates to the current state of the market, including the outlook for income across companies.
Before the Global Financial Crisis, many investors pursuing short-term gains through a period of very strong markets were not as attracted to our more conservative, long-term strategy. However, when the GFC hit and dividends were being cut across the market, we quickly began trading at a premium. Investors were attracted to the more stable portfolio of quality companies and our ability to maintain dividends from our capital reserves throughout that difficult time.
We are again seeing this now with the impact on markets from COVID-19, as we once again paid a consistent dividend to our shareholders in August this year despite subdued earnings. Unfortunately, as it is early in what will remain a difficult year for many companies, we cannot make any reliable forecasts yet about dividends for this financial year. Suffice to say we are well aware of the importance of dividends to our shareholders in these difficult times.
At AFIC, we see more value in considering factors that contribute to the long-term performance of a LIC rather than the short-term focus on discounts and premiums. We view share price relative to NTA as something to consider when looking for the right time to buy, but certainly not the only consideration.