Investment Matters

Banks and long term investing

It is usually the comings and goings of securities in portfolios that creates the news and excitement for investors; the more slow moving holdings tend to be overlooked, as they appear unexciting.

The reality, however, can be far different.

If you analyse share market returns over the long term, the key to successful investment is investing in businesses at good (or even fair) prices and then seeing those businesses grow (their earnings per share).

In Australia the long-term picture (since 1896) is ~12% pa equity returns delivered from 4% dividends and 7.9% pa earnings growth (including inflation) i.e. long-term earnings growth is the key contributor.

Therefore the most exciting investments tend to be the ones that grind out returns (and then dividends) year in and year out, for as long as possible.

In Australia, we have been blessed with some terrific examples of this, mostly due to not having had more than two consecutive negative quarters of economic growth (technically a recession) since June 1991 (26 years+). Businesses have been able to prosper in a fairly stable environment.

In particular, the best example of compounded returns can be seen in the performance of the banks. The following is a table of the average earnings growth of each of the “Big 4” banks since June 1994 (24 years).

 

IM graph average EPS growth

 

It has been this strong and ongoing earnings growth that has taken the banks to be four of the five largest companies listed in Australia today.

Which endorses the idea of buying and holding growing businesses.

Today however, on the back of such long and strong (largely credit led) expansion), it is highly unlikely that similar performance will be again be delivered by the same group of companies over the next ¼ century.

But the idea and lesson is right, and therefore it pays now, more than ever, to be looking down the market for the next “banks”.

In the First Samuel case, we have used our collective size, financial strength and ability to “get amongst it” to find and help grow several businesses that we think could have long-term futures like the banks, and be still part of investors’ portfolios in the next decade or two.

Two such companies that we are particularly happy to note as “portfolio” (i.e. long term) holdings are: Paragon and CML Group.

Whilst prima facie very different businesses (Invoice financing and healthcare medical equipment/ service provider), both are in growing or underpenetrated industries, have a niche advantage and a targeted longer-term business strategy, and both are well managed and not aggressively financially leveraged. 

Whilst these businesses are today considered “small caps”, we believe with the right window of time (and a bit of luck and discipline) they can rise to become mid and even large caps over time.

Whilst both have quietly delivered excellent returns to date to clients’ portfolios as a result of strong and steady business growth (Paragon EPS has increase +28%pa over the past five years and CML has +17%pa) it’s the future prospects out over many years that excites us, and means that whilst they will likely remain boring and relatively unappreciated positions they will also likely remain core holdings for many years to come.

We may not like the “banks” today as investments, but we like the lesson they provide about long-term investing.