I once again call upon Peter Lynch to illustrate a point. In his book, One up on Wall Street, Lynch lists a number of good traits to bear in mind when searching for equity investments. Lynch's dry writing style fails to mask the excitement he must have felt when he thought he was on to a winner.
The first three characteristics of what he calls the perfect stock concern dullness and undesirability - both in terms of the company's name as well as its activities.
It was the fourth characteristic - spin-offs - that rang a bell when I read Astral's statement last week that its earnings growth for the year to September 2005 will increase by between 30 and 40 percent.
Spin-offs are divisions or parts of larger companies that are given a separate listing. The rationale for the separate listing is often part of strategic refocusing by the parent company.
There are a few reasons why spin-offs are good for you, the investor.
Firstly, spin-offs provide you with the clear choice of a specific investment, as opposed to a conglomerate. In the case of Astral, the company was spun out of Tiger Brands in April 2001.
Incidentally, Lynch's dull-and-undesirable characteristics certainly apply to Astral, whose name belies the nature of its main business: chickens and animal feed.
Another reason spin-offs can be good for shareholders is that it's likely the parent company will only list divisions that are in good financial health with strong balance sheets - failure will reflect badly on the parent.
Thirdly, many divisions do well when management is granted the independence that accompanies a separate listing.
Finally, there is a little word that managers of large funds seem to fixate on every now and then: rationalisation. This term describes what happens when fund managers "clean up" small holdings in a portfolio in order to achieve a higher level of focus.
For example, a decision may be taken to sell out of all holdings which constitute less than one percent of the fund individually, because it may be either impractical or unattractive to buy enough of those shares to build up a substantial stake.
For fund managers, time is money, and often a small investment can be discarded in favour of a larger, more tradable one, even though the small investment may have the potential to provide better returns.
It takes just as long to wade through the investment bumph about a share that may form one percent of your clients' funds (with a potential return of, say, 50 percent) as it does to read about an investment in which you can buy five percent (with a potential return of 20 percent).
Many fund managers reason that they can either make 0.5 percent on the smaller investment, if they manage to buy enough of that stock, or one percent on the larger investment, of which they are more certain of buying sufficient shares.
A share's contribution to a portfolio's overall return is calculated by taking the weight of the share and multiplying it by the movement in its price since the share was bought. So, a small share, with a weight of one percent, times a 50 percent return contributes 0.5 percent to the overall return, while a larger share, with a weight of five percent, times a 20 percent return contributes one percent.
Fuelling the custom of selling out of, or rationalising small positions, is clients' expectation that they will receive at least the same return as other clients who are with that manager.
So, the manager is often prohibited, either by clients or a code of ethics, from giving a large holding in a small investment to one client or a select group of clients, where it could make a difference. A harsh way of putting this is that either everyone with the same mandate must share in the super returns or everyone must not share in any returns.
This behaviour is understandable on the part of the fund manager, but this is where smaller investors have an advantage over larger fund managers. Smaller investors can buy enough untradable shares to give them a meaningful stake in their portfolio.
Let's look at how great an investment Astral has been. The share started trading at about R8 in 2001 and soon moved up to R15. Over the next four years, it moved to its current level of R73, some eight-and-a-half times higher than where it first traded. So, in capital return alone, investors made over 800 percent during that time. Most of this return came from a re-rating of the share (that is, the market awarded it a higher price:earnings ratio), as earnings growth over this period was 135 percent. The price:earnings ratio moved from four to over 10.
Incidentally, the All Share index gave you 80 percent return during that period. I suppose you could be tempted to say that you could easily have put all your chickens in one basket with Astral and forgotten about diversification. Just imagine the simplicity of a one-stock portfolio...
Let's not forget about the total of nearly R5 that investors have received in dividends over the past four-and-a-half-years from Astral - recouping more than half the purchase price on listing day if you scooped up shares from the temporary supply caused by larger fund managers rationalising their portfolios.
Spin-offs often result in share lots becoming untidy, and larger investors who want to tidy up their portfolios place many small selling orders. This keeps the price of spin-off shares down and gives smaller investors an opportunity to build up a position by buying them.
More recent examples of spin-offs include Spar (also unbundled from Tiger Brands in 2004) and Consol (unbundled from AVI earlier this year).
So, the next time you feel irritated after receiving a pile of corporate papers and a fraction of shares due to a spin-off, resist the urge to sell them and take a good look at the opportunity they may offer.