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This article appeared in the February 2012 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.

During volatility, share prices may not reflect true value.

Photo of Frank Gooch By Frank Gooch, Milton Corporation

Over the past few years the value of many asset classes has been challenged. Many investors in bonds, property and equities have seen the value of their investments affected by the GFC and more recently have seen the effect that uncertainty has on all markets.

Consequently, some investors are questioning whether the traditional long-term "buy and hold" strategy for owning shares still works.

In uncertain and volatile times, share prices may not always reflect long-term share values. This can provide patient long-term investors with unique opportunities to acquire shares in profitable companies that are going to deliver a growing dividend income stream.

Milton, a traditional listed investment company (LIC), has been a long-term investor since it was incorporated in 1938. Its main objective is to pay increasing fully franked dividends to its shareholders out of investment income.

It invests in companies with a history of profits and dividend payment to shareholders. Its experience is that well-run profitable companies increase their dividends over time and company value usually increases also.

Australia's current "two speed" economy makes it difficult to generalise about the 2012 outlook for profits and dividends across all sectors. The economy will be affected by events in Europe and the likely reduction in world growth. However, the economy is in reasonable shape and will benefit from trading links with China and the substantial capital investment in major resource projects. Companies not involved in resource-related activities will be hoping lower interest rates will stimulate consumers and lead to improved trading conditions.

Milton's operating income has been unaffected by the movements in share prices. Indeed, a lift in dividend income from its investments last year enabled it to increase its ordinary fully franked dividend and pay a special fully franked dividend. Its ability to consider the long-term value of its investments enables Milton to invest in companies when it considers their shares have been oversold.

Increase in trading discounts

Despite this, Milton and other LICs have seen an increase in the discount at which their shares trade. When an LIC's share price is less than its net tangible asset backing before provision for tax on unrealised capital gains, it is generally considered to be trading at a discount. The discount is a function of supply and demand, which has been affected by a general trend to reallocate investments from equities into cash.

This trend can also be seen in the reduction of the flow of funds into unlisted managed investments and is probably because of the effects of high market volatility and uncertainty causing many long-term investors to become short-term focused.

The increase in the discount has provided long-term investors with opportunities to buy into a professionally managed, diversified portfolio of Australian-listed equities at historically high discounts. These discounts could be expected to narrow as the uncertainty overhanging the market dissipates and confidence returns. In the meantime, these investors can look forward to receiving fully franked dividends every six months.

We can use Milton as an example of building wealth over the long term. It has paid a dividend every year since listing in 1958. If £1000 was invested then to purchase 1000 of its shares, the annual fully franked dividend in 2011 would have been $4337. The value of the Milton holding would now be $85,590. This is a far better return than from a fixed-term deposit.

Milton is able to take this long-term approach because it has a fixed capital structure. This gives it control over its cash flows, so it does not have to be concerned with retaining liquidity or selling investments in a falling market to meet redemptions. This has been particularly important as the equity market has become increasingly volatile.

Steady profits and dividends expected

The companies in Milton's portfolio are generally well capitalised and we expect most to remain profitable over 2012 and to at least maintain their dividends, while the more profitable may increase them.

Although Milton has a diversified portfolio, two sectors likely to influence its overall dividend growth are banking and resources. It has been a long-term investor in the banking sector and currently has 32 per cent of its assets invested in it. Australia's banks are profitable, well capitalised, highly rated and strongly managed. Over many years Milton has derived strong dividend growth from its bank holdings as the economy has grown, and when the economy slows we have seen the rate of growth in bank dividends also slow. In 2012 the banks' earnings and dividends are likely to grow marginally.

Milton's strategy of investing in companies that pay dividends means it is relatively underweight in direct investment in resource companies. However, profitable resource companies paying dividends, such as BHP Billiton and Rio Tinto, are among Milton's top 20 investments and it also has exposure to New Hope Corporation, both directly and through an investment in Washington H Soul Pattinson.

Even if the slowing global economy adversely affects commodity prices and volumes, these resource companies are still likely to deliver profit growth and improved dividends. Usually, lower commodity prices and interest rates would cause the Australian dollar to weaken and this would increase the dividends received by Australian shareholders of these companies.

Milton also has exposure to the growth in resource sector activity through its investments in companies that provide services to miners. Companies such as Bradken, Campbell Brothers, Cardno, Sedgman, UGL and Worley Parsons have a sound history of growing profits and paying increasing dividends, and this should continue in 2012.

Short-term predictions of profits and dividends are fraught with danger as there are many influencing factors, both positive and negative, known and unknown, that may affect outcomes. However, over the longer term I am confident that company profits and dividends will grow.

About the author

Frank Gooch is managing director of Milton Corporation, one of Australia's largest and most successful listed investment companies.

From ASX

Listed Investment Companies provides a wealth of information on LICs. Use ASX Market Update information to review LIC premium and discounts to NTA since 2004. View the monthly sector update to see overall LIC performance. Examine quarterly performance returns to gauge an LIC's investment performance against others.


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