Why I recently bought CSL

An articulate curmudgeon in a wrinkled grey suit passionately advocates for value investing. He once drank six martinis with Ben Graham. Most likely wearing the same suit. But he tells us his approach has been successful over the long-run and is perfect for the current environment. Fair enough.

Except for the fact that simultaneously a perfectly tailored automaton is pontificating on factor investing. Following a 4am wake-up, 90k bike ride and 30-minute meditation this master of the universe designs a model to use 113 different share characteristics to deftly place a portfolio on the efficient frontier. She makes a compelling case despite making you feel like you are failing at life.

I could go on with caricatures of spokespeople for different investing styles. And there are a lot. But you get the point. We get bombarded by opinions. China is a great opportunity. China is imploding. Emerging markets, listed real estate, small caps, passive investing, private debt, alternatives and digital images of monkeys have been touted as great investments opportunities. All this noise makes it hard for new investors to get started. It makes it hard for all investors to resist churning their portfolios while pinballing between different strategies.

How to invest successfully

Well I’ve got a secret. There are multiple approaches to investing that work over the long-term. But none of them work at every moment in time. There is one thing that doesn’t work. Switching back and forth between strategies while naively comforting yourself that you are being nimble and responding to the current environment. That is why the average investor is trailing the average investment by 1.7% a year.

It is the process that matters. Not every investment is going to work out. In the long run most of your investments don’t even need to work out. The ones that do just need to perform so well that they overcome the mistakes. In any probabilistic pursuit future events that are unimaginable will shape individual outcomes. However, the sum of those individual outcomes should still succeed. Investing is a probabilistic pursuit.

There is one more element needed for success. Time. In the short-term there are multiple drivers of investment returns. Most of them have little to do with the actual investment strategy or the individual investment. Over the long-term the investment process will drive results.

My recent purchase of CSL

I bought a share recently. It may not work out. And the fact that I did this is not an endorsement of the investment that I made. This is not a disclaimer. That is in the fine print at the bottom of the article. It is an acknowledgement that we all need to have a strategy that is based on the unique goals that each of us have. And the strategy also needs to align with our world view and temperament. That will ensure we stick with the strategy over the long run.

I bought CSL (ASX: CSL) about a month ago. The company is a cross between a vampire and an alchemist. They take blood and turn it into gold. At least historically they have. I am banking on that continuing into the future.

Source: Morningstar

Before getting into CSL we need to start with my investment strategy. The point of this article is to demonstrate how to align an individual investment with an investment strategy. Once again, the process is what matters.

I have an investment policy statement (“IPS”). It starts with my goals, defines my overall portfolio strategy and asset allocation, and outlines the criteria I will use to pick individual investments. My IPS is not War and Peace. It is short and direct.

My strategy: I want to own low business risk companies to build a portfolio with a dividend yield that is higher than the overall market. I want to own companies that are trading at reasonable valuations and lower the long-term volatility in the equity portion of my portfolio. I am looking to generate a consistent and growing income stream while earnings returns that exceed my required rate of return of 6.5% after taxes and fees.

My competitive advantage as an investor: I don’t have information that is unique and I don’t believe I can analyse the available information better than top investors. In other words, I don’t have an informational or analytical edge. One source of my edge is behavioural and is derived from my temperament and the structure I’ve put around my investing process. The other source of my edge is structural which I exploit by being a buy and hold investor.

Investing criteria: I will purchase ETFs with a focus on quality and income and shares with non-cyclical earnings, low debt, high and / or growing dividends and sustainable competitive advantages that will accrue to me over the long-term.

How does CSL stack up against my criteria?

Business risk: A share is an investment in a company. And companies have different levels of business risk. Some nascent industries with emerging technology have lots of players competing for market share. It is unclear who the ultimate winners will be because the technology is unproven and nobody knows what attributes of the good or service will ultimately resonate with consumers. Contrast that with mature industries with a few established players who have captured significant market share. The range of outcomes is far wider in the nascent industry. Lots of companies will fail. Some will succeed spectacularly.

That is just one example of business risk. Highly leveraged companies are riskier than companies in sound financial shape. Cyclical industries are riskier than non-cyclical industries because economic conditions will have a bigger influence on the outcomes on the former. A company selling multiple products into multiple markets is less risky than a company producing a single product that is sold in a single market. There are multiple measures of business risk. It is captured in the Uncertainty Rating that our analysts assign to each company they cover.

CSL’s Uncertainty Rating is medium which is our second lowest rating. It operates in an oligopoly with two other competitors who have collectively captured 80% of the market and have cost advantages over any emerging threats. Barriers to entry are high given the institutional intellectual capital inherent in creating plasma-based treatments. The company is vertically integrated meaning they control sourcing of the plasma used to create the treatments. Healthcare is non-cyclical as people prioritise treatment in any economic environment.

There is always a risk that alternate treatments will develop for haemophilia, immune deficiencies and for influenza vaccines. There is little risk the diseases will go away. Every business has risk. I believe the business risk of CSL is at the lower end of the spectrum.

Dividend: CSL does not pay a high dividend and yields 1.28%. The dividend yield is below my overall portfolio and the market. However, an income investing strategy should include companies with high dividend yields and companies where the dividend is expected to exhibit high levels of growth. Over the past 10 years the average annual increase in the dividend was 13.50%. Our analyst Shane Ponraj expects the dividend to grow 11% next year and 19% the year after. Not a perfect match for my criteria but good enough.

Low debt: The company receives an Exemplary Capital Allocation from Ponraj which takes the balance sheet into account. He believes the financial risk is low and debt levels are reasonable.

Sustainable competitive advantage: CSL receives a narrow moat rating which indicates Ponraj’s belief that a competitive advantage can be maintained for at least 10 years. The source of the moat is cost advantage and intangible benefits. And the impact of the moat can be seen in the financial statements. The return on invested capital (“ROIC”) has been over 19% for the last 8 years. That means that the company is earning high returns on investments in the business. That is a good sign the business can keep profitably growing and puts the low dividend in perspective. Without a moat those returns would be eroded over time as the impact of competition takes hold.

Valuation: There are lots of things to like about CSL. Revenue growth has averaged 10% over the last decade. And the net margin has averaged over 20% during that time period meaning much of that growth in slaes flowed to the bottom line as earnings. But the company has run into challenges recently as the margin has dropped due to higher costs of sourcing plasma during the pandemic. And the share price has reflected these issues by dropping from a 1 year high of over $310 a share to the low $260s.

Ponraj expects the net margin to recover to pre-pandemic levels and that is reflected in his fair value estimate of $330. That makes the shares undervalued by 20%. Not shockingly cheap but it is a level that hasn’t been consistently reached since 2016.

How will my investment in CSL perform? Who knows. Check back in after a decade. For now, I believe I’m getting a great company at a reasonable but not dirt-cheap price. I do know that CSL fits into my investment strategy and I believe I’ve followed a structured process in evaluating the company. And it is the process that I’m banking on over the long-run to help me achieve my goals.

First published on the Firstlinks Newsletter. A free subscription for nabtrade clients is available here.

Mark LaMonica is Director of Product Management, Individual Investor, Morningstar Australia. Analysis as at 30 August 2023. Analysis as at 30 August 2023. This information has been provided by Morningstar Australasia (ABN: 95 090 665 544, AFSL 240892), for WealthHub Securities Ltd ABN 83 089 718 249 AFSL No. 230704 (WealthHub Securities, we), a Market Participant under the ASIC Market Integrity Rules and a wholly owned subsidiary of National Australia Bank Limited ABN 12 004 044 937 AFSL 230686 (NAB). NAB doesn't guarantee the obligations or performance of its subsidiaries or the products or services its subsidiaries offer. Whilst all reasonable care has been taken by WealthHub Securities in reviewing this material, this content does not represent the view or opinions of WealthHub Securities. Any statements as to past performance do not represent future performance. Any advice contained in the Information has been prepared by WealthHub Securities without taking into account your objectives, financial situation or needs. Before acting on any such advice, we recommend that you consider whether it is appropriate for your circumstances.