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What to do?

I am constantly thinking about what are the next buys that I am going to make in the market. This is always difficult as I tend to have much more ideas about what to buy than what to sell! My capital is limited after all, and I don't like the idea of constantly selling things to buy things, as this will only lead to a mountain of brokerage commissions! Fortunately I am able to (slowly) build up some capital through my disposable income that I can buy something new once every few months, and there are a couple of stocks I have that will likely be sold in the next six months, so I will recycle that capital. In this article I will go through my basic parameters for making an investment, and talk a bit about the investment spectrum.

To start off I will mention that I do make monthly contributions to two ETFs i.e. the Total World Fund and the US 500. I could lower these contributions to create more disposable income for myself, but I don't want too. I see ETFs as being at a point on the investment spectrum whereby you do not sell, at least not until you are 60 or something. ETFs and Indexes are best not being traded, and instead should be seen solely as an investment. I have about 20% of my portfolio allotted to these. Likewise, I have about 15% of my portfolio allotted to passively managed funds. This is not my style, as I have a passion for research. But holding these funds (10 in total), is an important component in my overall portfolio diversification.

Now thinking about my future individual stock buys; these will be on the ASX and/or NZX. The NZX stocks I have been looking at are LIC and KPG. LIC is Livestock Improvement Corporation, and has been around since 1907. It is a service company to the Dairy Industry and operates in NZ and in overseas markets. Considering that it has been around for so long, it obviously has a proven track record. It helps dairy farmers to maintain a top milk-producing herd by keeping track of the genetics in the herd. It also has divisions in farm software, farm automation and herd testing. It has a low PE Ratio of 6.7, a very high trailing yield of 10.25% and a market cap of $159 million. It also has full imputation credits and a long running dividend reinvestment plan. These are all massive positives. The one problem? It pays the dividend only once a year, in August. Not ideal for personal cashflow. The other niggling problem is that there is a lot of talk about political pushback against Dairy Farming in NZ, because of their effluent and emissions i.e. the so called fart-tax. Maybe these increased costs for Dairy Farmers mean that they can't afford to pay for LICs services; or they could mean that LICs services become more valuable as the farmer will need to extract more value out of each cow. Overall I do think that LIC would add good value to my portfolio, because of the stated positives and the diversification benefit. Food and Fibre is by far the biggest contributor to the countries GDP, and will likely always be so.

The other NZX company that I have been looking at is KPG/ Kiwi Property Group. I have done a lot of research on this Real Estate Investment Trust (REIT). It is the only one on the NZX that still trades under its Net Tangible Asset Value i.e. for how much they could sell their buildings for. They have a market cap of $1.8 billion and a net asset base of $2.13 billion. They have a net dividend yield of 4.38%, paid twice yearly, with full imputation credits. They are 84% Auckland property, with The Base in Hamilton (mixed-use retail) and two office assets in Wellington on the Terrace. They also manage the Majestic Building in Wellington for a third party. Their asset with the greatest risk attached to it is likely the Vero Centre in Auckland, because of the decreasing reliance on companies having to have staff work in the office. Covid Lockdowns meant that a lot of people became accustomed to working from home, and some of them won't go back to the office. This is a positive for the balance sheets of law firms and accountants, who will pay less on rent, but it is a negative for the landlords (who own the buildings) as they will likely have to deal with lower vacancy rates in the future. Experts recommend that you have about 15-25% of your portfolio in REITs, and I already have enough, as I own PFI, GMT and IPL, as well as the ASP (ETF). KPG would not really add to my overall portfolio diversification.

Now to discuss the ASX shares on my watchlist. A few have gone in and out of the watchlist over the last few weeks, but some have been a constant. Aurizon (AZJ) and Fortescue Metals (FMG) have been constants. Both for their high yields and stable businesses. Aurizon though, is very exposed to coal transportation, whereas Fortescue is totally exposed to fluctuations in the iron ore commodity price. Both have obvious risks attached to them. Stocks that have gone in and out of the watchlist include ASW, BHP, CHN, RFF, RF1 and KAT. ASW (Advanced Share Registry) is a smaller share registry trying to take on the big boys in Computershare and Link Market Services. It focuses on helping bring small market-cap companies to the market and states that it has superior technology for both companies and investors to navigate. I have started to doubt their technology though, and have not found their website easy to navigate. BHP is known as the 'Big Australian'. It is one of, if not the largest company on the ASX. It has a substantial mining business, focused on iron ore, coal, nickel, potash and copper. It trades at a PE Ratio of 12.76 and has a trailing yield of 10.62%, fully franked. It's share price fluctuates around quite a bit due to the volatility of commodity prices, but since it operates a dividend reinvestment plan, this could actually be a positive, as I could average out at a reasonable price over time. It has recently come down in price quite a bit due to the Evergrande crises in China depressing the iron ore price. BHP is right now near to where it was a year ago. Considering that the money I will put towards my next ASX buy is not money that I want to lose, BHP would be a solid buy. They have recently divested out of their petroleum business and are moving more into 'green' materials like potash.

In comparison to BHP, Chalice Mining (CHN) is more of a shot in the dark. They are a mining exploration company with a Nickel, Copper and Cobalt project 60 miles east of Perth (Julimar). They do not yet have any earnings, but have a market cap of $2.5 billion. They have risen 180% in the past year. The materials they are exploring for are so-called 'green' materials, as they are used in electric cars and solar panels. Cobalt is a particular opportunity, because most Cobalt is mined via child labour in Africa and that is a frequent criticism of electric vehicles who use Cobalt. Mining it in a first-world country like Australia, who don't have child labour, is an obvious positive. It is important to note though that Chalice have had a big share price rise from making a discovery early on in the Julimar project. I am unsure if any future discoveries will make as big of a difference. RFF is Rural Funds Group, and I liked them originally for their dividend, but didn't end up buying them because of their lack of franking credits. They are a farmland landlord. They are making a big move into Macadamias at the moment, and this will impact on their earnings and resultingly on their payout ratio, as Macadamias take a few years to yield anything. A stated aim of theirs is too increase distributions by 4% annually, and to continue doing this may mean that they will start to eat into their capital. Because of making a significant capital allocation to (currently) unyielding Macadamia orchards, this is already starting to happen

RF1 and KAT are LICs, or Listed Investment Companies. These are basically the opposite of ETFs. ETFs are designed to passively track an index, whereas LICs are comprised of active managers trying to beat an index. It is well known through research over the past 50 years, that 95% of active managers fail to beat the market index. So unless you are lucky enough to choose a Warren Buffett or Peter Lynch, your active investment manager will be lagging the market, while charging excessive fees as a thank you. But Peter Lynch, who achieved a 28% return on the Magellan Fund between 1977 and 1990, used to say that you are better off to invest in a good company in a terrible industry, than a good company in a brilliant industry. Because what happens is that companies in brilliant industries often become overvalued, whereas those in terrible industries become undervalued. The opportunity here becomes when you can find a diamond in the rough. RF1 and KAT are a couple of diamonds in the rough that is the LIC industry. RF1 is an alternative asset manager who run a number of hedge fund strategies throughout their portfolio, while having a cornerstone investment in Kilter Rural (Australia's largest water asset manager). Their share price has risen 50% in the past year though, so they have been rewarded for their outperformance. Unlike RF1 though, KAT (Katana Capital) trade at discount to NTA (Net Tangible Assets). They have risen by around 22% this year. But since their inception in 2005, they have only risen 5%, despite having beaten the market by an average of 6.9% over the past 15 years. By comparison the market in question (ASX all ordinaries) has risen 62%. This makes no sense, and I believe they are getting punished for being part of a bad industry. But like how Peter Lynch was rewarded for his successful management of the Magellan Fund, it shouldn't be long before Katana Capital is rewarded for its market beating performance.

For whatever reason, both Aurizon and Fortescue have sentimental value for me, and that is always a bad reason to buy a stock.. Aurizon are the largest rail freight haulage operator in Australia. They transport coal, agricultural goods and iron ore in Queensland, NSW and Western Australia. They trade at a PE of 9.4 and have a most franked trailing yield of 7.8%. They do not have a dividend reinvestment plan, which is deterrent. I like rail though, especially for the transportation of commodities. And I am actually positive on the future of Australian coal exports, because all these other countries (like NZ) are putting limits on coal mining due to its environmental impact. But the reality is that the vast amount of electricity generation is still done via coal-fired burners. So you have an environment of decreasing supply with relatively stable demand, And this will only lead to all-time high prices, which is currently the case, with coking coal (the dirtiest kind) in heavy demand. FMG are solely focused on mining iron ore in the Pilbara region of Western Australia, and are the third biggest producer after BHP and Rio Tinto. They have a very low PE Ratio of 3.62, a trailing yield of 22%, fully franked with a dividend reinvestment plan in place. They are obviously not diversified though, but that is okay since I do not yet have anything involved in iron ore mining. And they have a founder and now non-executive chairman who I am a huge admirer of, Andrew Forrest. Until the recent wobbles in the iron ore price, the FMG share price was driven to all-time high levels. They are starting to recover though, so if I am not quick I will miss my chance.

I definitely have a decision to make about my next share purchases. The next one of make though will be something on the ASX that has the potential to give me good future cashflow. I want to build up my shareholding over time through a dividend reinvestment plan (rules out AZJ) and be able to invest at an attractive valuation (rules out RF1). Chalice Mining still has too much uncertainty attached to it to know that it will provide me with a solid cash-flow in ten years, and I don't know if Katana Capital has a dividend reinvestment plan. Having an LIC also goes against all the research on the subject of active vs passive investment. So this leaves me with two choices, BHP or FMG. Of the two, FMG has a lower PE Ratio and a higher trailing yield. Obviously though, a trailing yield is called as such for a reason though, and there is no guarantee that they will be able to continue paying such high dividends in the future. While BHP has a higher PE ratio, that is often indicative of a well run company. The diversification they have across a range of materials is also a positive, it means that you can be fairly confident that they can continue paying a 10%+ net dividend into the future. Iron Ore is very prone to the Chinese economy, and if their high debt levels become a concern, their growth will continue to slow (below 7%). BHP is the more solid investment. But FMG would become attractive at a lower price. So maybe this year I can buy some shares in BHP, and next year perhaps FMG.

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