Potential takeover target, page-33

"All true but to properly value a business you can't just ignore their vulnerability to market movements, especially when their earnings are significantly derived from said market movements."

Indeed, there is a very explicit element of Challenger's P&L, stated below the line, called "Investment Experience" (It arises from the accounting standards that require a marking-to-market of the company's Life Assets. Note: this does not apply to all assets such as its bond and equity portfolios, just its actuarial assets held under its Life cover business). Don't ask me why; its just one of those quirks of actuarial accounting rules).

And in just about every year, that number is a quite material in the context of the company's underlying profitability.

However, sometimes that number has a positive value, and sometimes it is negative, depending on what capital markets are doing.

But when anyone buys Challenger, they should know full well that what they are buying is a capital market derivative.

And it very difficult to know what capital markets will do from one period to the next, i.e., it is very difficult to know exactly what Challenger's "Investment Experience" will look like from one period to the next.

But over the life of the business, the summation of all those annual "Investment Experiences" will not be negative (providing Challenger's team of actuaries and financial minds are competent, which one must assume they are if one is to become a shareholder in the company in the first place).

So, over time, it doesn't matter one bit for Challenger's financial performance, what markets do. (Well, that's not perfectly true: because markets to go up over time, and when they do the market impact on Challenger's financial performance is actually positive. But the point being made, is that it is not negative.)

(By my use of the phrase "over time", I think you might be able to see where I am heading with this line of thought.)


"Potentially long term, it took the better part of 6 years for CGF to recover after the GFC. I don't want my capital impaired for 6 years, even if I plan on holding for 30+ years. So my question is - how do YOU value the risk."

Well, your capital was temporarily impaired, but - clearly - it was not permanently damaged.

Therefore, if you are a long-term owner of the business, because you believe in it's long-term growth prospects, then who cares what happens to the share price over 1, 2, 3, 4, or 5 years?

And, providing you didn't need that capital for any emergencies or to fund any living expenses (if you did, you shouldn't have had it invested in the stock market in the first place), what did that matter in the scheme of things if the share price dipped for a certain period of time? It's not as though you would have suffered a big opportunity cost, either, because the value of all securities was similarly affected during the GFC.

So, to your answer about how I personally value risk:

There are plenty of risks to which I try to pay attention; such as financial risk, operational risk, capital allocation risk, execution risk, regulatory risk, etc.

But, as I said earlier, I pay no attention to market risk. For the simple reason that, for the long-term investor - which is what I am - market risk does not matter one bit.

Put another way, when I buy shares in a publicly-listed company, I do so with the exact same mindset I would apply if I was investing in a small, private business which I was buying outright for myself.

If I was going to be buying a small business for myself, e.g., a local butcher or pool supplies shop or an accounting practice, I would do so with the view to growing the intrinsic value of that business over time. And not just over one or two years, but over 8, 9 or 10 years (or for whatever period of time that particular business is capable of having its intrinsic value increased).

In other words, the focus on my investment is on the business, as opposed to the share price (in the case of a business that happens to be listed).

Because if the intrinsic value of the business goes up over time, the share price will surely follow.

Sure, the share price might follow all sorts of random and interesting (sometimes scary) paths along the way, but it will eventually reflect the underlying value of the business.

Which is exactly what has happened with Challenger over the past 10 years; its intrinsic value has risen as the underlying financial performance (i.e., excluding the randomness of market movements) has improved. (Refer graph below).

Someone a lot smarter than all of us here once said, "You should be happy to buy a share even if you knew that the stock market would be closed for the next 5 years."

The problem is that the vast majority of investors - both individual and institutional - are invested more in the share price, than they are in the business itself. In other words, they spend a great deal of time watching what the share price is doing and take share price movements as a measure of the performance of the investment they have made, instead of ignoring the share price and focusing just on the company they own.

For obvious reasons, the mindset of share price watching is a very difficult habit to break; I don't think anyone ever really is able to do so completely (unless, possibly when they are worth a few hundred million dollars or are billionaires, when it would make no difference to them).



(Note: Forecast profit bars are merely indicative, rather than prescriptive.)


Of course, as an ongoing investment proposition, the question one needs to ask oneself now is whether the financial performance of Challenger Group since its listing will continue in the future, or whether there will be something that will derail the business model.

Given what I see in terms of some of the structural forces at play which have a bearing on the demand for the sorts of products Challenger sells, and the services it provides, combined with the track record of management when it comes to prudent and astute stewardship of the capital of shareholders, I have quite a firm conviction about which direction I expect that blue arrow on the right-hand side of the graph to face... pretty much as I have presented it is my expectation.