The Valor Blog.
Investment News and Views, Direct from Our Team.

Permanent Wealth Creation

Over the last few months, the markets in Australia have had an excellent run. Banks, miners and residential property are all having their day in the sun. The question is whether these rises in prices are permanent?

The secret to wealth creation is not losing money. As Buffett always says:

Rule Number 1: Don’t lose money.

Rule Number 2: Don’t forget rule number 1.

This is all fine and well, but how do you not lose money?

The two easiest ways of losing money are by either buying the wrong asset or over paying. The wrong asset is usually quite obvious after a period of ownership. “Time is the friend of a wonderful company and the enemy of a poor one”. Below average businesses show their true colours within a few years. The losses are catastrophic and mostly unrecoverable. It is usually far better to get out of these assets than hope that they will one day return to their previous highs.

Overpaying a slightly less obvious. Overpay for an excellent business or property and you may still have ok returns over the long-term. In the medium term, your results will likely be below acceptable limits and often below what you could have achieved in a term deposit. Significantly over pay on an excellent business or property and you may have virtually no returns over periods of 5 to even 15 years. Coke is one of the worlds best businesses, however its current share price is below where it was in 1998! Coke’s PE got to around 48 times earnings in the late 1990’s. By the way, the net return of many residential “investment” properties at present means you are paying between 30 to 50 times earnings. Is Aussie residential property over valued? Is Aussie residential property as over valued as Coke in 1998? Maybe. This is something that only time will tell.

Buying any Aussie bank, any residential property or any large diversified miner has proved to be a wise strategy over the last decade. These three investments have paid handsomely to those who have owned them. The question is whether they are overvalued today based on what is likely to happen in the future rather than looking in the rear mirror.

“If past history was all there was to the game, the richest people would be librarians”. (Buffett)

Australia has had an exceptional run since the early 90’s. We have not felt much pain with over two decades of uninterrupted economic growth. Has this lack of pain made Aussies complacent in their investments? Are most Aussies expecting that we will never have another recession? Humans are designed to forget pain, otherwise women would never go back for multiple child births. However this human condition of pain numbing over time means that we often repeat our mistakes.

The recent fever in the property market is a sign that most are oblivious to any potential pain in the Australian economy over the coming years. Those buying “investment” properties with low single digit yields are unlikely to see much wealth creation over the medium term. Those buying with excessive debt and being reliant on servicing that debt from other sources may destroy significant wealth if we have moderate rises in unemployment. I am very supportive of New Zealand style macro prudential controls to avoid asset bubbles in property whilst lower interest rates allow the rest of the economy to catch up. This is unlikely with the current government and I fear that this current bubble could get worse and potential destabilise the economy in future years.

At Valor Private Wealth, we focus on not losing money and growing our clients wealth permanently. This focus on avoiding losing money is leading us to avoid at all costs over priced assets. At present we are allergic to residential properties with low single digits net yields, banks reliant on credit growth at above national income growth rates and miners reliant on mineral prices at two to three times their long term averages.

The trends of these overpriced assets can last for years. The difficulty for those speculating on the greater fool theory (finding someone to pay a higher price than you have at some point in the future) is that eventually you run out of fools. No one knows when you will run out of patsies.

A far more permanent method of creating wealth is to own exceptional assets that are not over priced. There are fewer of these assets available in markets at present and so holding cash patiently until they appear is prudent. The ability to be patient is one of our greatest strengths.

Our avoidance of overpriced assets in no way changes our belief that Australia is one of the best countries on earth to reside. I get paid to travel the world and I can honestly say that Australia’s standard of living is above all that I have encountered. Our health system, whilst not perfect, is one of the best in the world. Our education system, which could also receive a few improvements, is well above average. Our retirement system is exceptional compared to most. Our choice of food, albeit expensive, is possibly the best in the world. Our governance of financial markets is relatively well structured. Our sporting achievements punch well above their weight for our population size. Even our governments over the last few decades have been on average mostly competent. I am very much and will alway be very bullish on Australia. What I will not do is over pay for assets regardless of the country where they reside.