REPORT FIRST PUBLISHED 15 SEPTEMBER 2010, UPDATED 1 DECEMBER 2010

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Dear Value Investor,
If youre like me, you dream of accumulating a portfolio of high quality businesses purchased at
attractive prices. Now, exactly what constitutes an attractive price or a high quality business is, of course,
subjective.
Last year (after profit reporting season) we set out some criteria, crunched the numbers and produced
a special report titled Australias 10 Best Businesses. This year weve built on that concept and you now
have the results in your hands.
There are a few things to note before we kick off. Firstly, weve expanded the initial starting line-up from
the Top 100 listed companies to the Top 200. This has made the results more competitive and resulted in
a new number one placegetter. Weve loaded in lots of additional value this year, too.
Youll find a special Directors Cut feature (see page 2) which addresses the crucial question of what all
of this analysis means for your portfolio. Gathering and crunching the data is one thing, interpreting it in a
way thats useful for your own portfolio is quite another.
On page 15, theres a how to Investors College describing how you can calculate the relevant numbers
yourself. Using the information there, youll be able to see how a particular company you might be researching
measures up against the finest businesses in the land. Weve even created a downloadable Excel spreadsheet
to help you on your way.
In addition to this report, updated from September, you also have access to an online site which holds
valuable additional content (see page 16). The extra features on this site include a podcast discussion
with myself and Rakesh Tummala (who did a lot of the heavy lifting this year), a video series and podcast
interviews with several chief executives whose businesses made the Top 10.
At this reports heart, though, lies a valuable watchlist of very high quality stocks. Itd be great if all of
these stocks were always available at attractive prices. Unfortunately, thats unlikely to ever be the case. And
thats why, on page 9, youll find several updated pages of analysis on the stocks we still believe offer the
best value. I hope you enjoy the report.
Best Regards
Greg Hoffman, Research Director
CONTENTS
PAGE
The Directors Cut 2
The Four Filters Explained 4
Sifting through the contenders 5
Australias 10 Best businesses 7
Best buys amongst the best 9
Applying the four lters yourself 15
The Intelligent Investor
2

Establishing Australias 10 Best Businesses is an exciting task, though one fraught with
danger. What criteria should be used? Over what period should the contenders be
measured? How do you adjust for differences between industries or cyclical swings?
These are all valid questions and weve settled them on a purely numerical basis. That
solution has the benefit of simplicity and clarity. But its not the whole story.
The numbers provide a useful measure of a businesss past results and perhaps even
a pointer to what the future might hold. But its in the interpretation of their predictive
power that we must be most careful. Our caution must span two fronts; future business
results and, secondly, expectations of future investment returns.
Past and future
The first point is made by a company like Cabchargea business which, on the
numbers, almost made the grade. In the case of Cabcharge, its next decade may look
very different from the last because of the likelihood of increased competition and the
potential for regulatory intervention.
Another analogy might be drawn with a company like Fairfax 10 years ago; on the
previous decades numbers, it looked like a great business. But the world was changing
and the next decade proved a difficult one for management and a particularly unpleasant
one for shareholders. So we must start with our numbers but not finish with them.
The second point is that even if stellar historical numbers are indicative of future
impressive business results, they may not translate into great returns for investors. This is
a more subtle but nevertheless crucial point.
In certain cases, excellent profit growth does not lead to share price appreciation because high
expectations are already built in. Flick to page 8 and cast your eye over the chart which plots the
total shareholder return (which assumes dividends are reinvested) delivered by Computershare
against the All Ordinaries Accumulation Index (which incorporates dividends).
Despite Computershare recording impressive profit growth over the past decade, anyone
who bought the shares at the start of the decade has fared worse than the general market.
At the time, the stock was trading on a price-to-earnings ratio (PER) of more than 100, a
figure which required monumental profit growth to justify.
Excessive expectations can sink returns
So we must beware of excessive expectations. From an investment perspective, they are
capable of sinking the returns provided by even a rapidly growing, top-performing business.
That Computershare has managed to deliver something in the ballpark of monumental growth
since 2000 explains why those who paid such a lofty price 10 years ago havent lost their shirts. In
fact, theyve recorded modest positive returns. In share price terms, the gigantic returns were made
in the five years prior to the beginning of our measurement period. Between 1 July 1995 and 30
June 2000 Computershare investors enjoyed a more than 40-fold rise in the share price.
The Computershare example highlights the issue with the timing of this exercise. Youd
think that a 10 year period would be long enough to iron out most quirks. But if the starting
or ending points are extreme, then the results can be skewed.
While Computershare owners were marvelling at their good fortune between 1995 and
2000, BHP shareholders suffered a much weaker performance. Over that same five year period,
The Big Australians share price inched forward at less than 3% a year and dividends failed to
grow at all. But the investment outcome changed significantly between 2000 and 2010.
Like a puppy growing into its skin, Computershares business effectively grew into its
share price over the past decade. BHP, meanwhile, benefited from an almighty resources
boom. After five stagnant years, BHPs share price proceeded to quadruple over the
noughties decade.

Special report | Australias10 Best Businesses

3
Mining boom lends a hand
Apart from BHP, the almighty change for the better in the mining industry helped propel
three other companies on to our list; Monadelphous (number 1), Fleetwood (number 3)
and Leighton Holdings (number 10). These businesses have all benefited from a version
of the time-honoured strategy of selling picks and shovels to miners.
This tectonic shift in the investing landscape should be at the front of our minds. Is
it particularly flattering to these businesses? And, if so, how much should we temper our
enthusiasm for them as a result?
Excesses are important
Watch for the excesses, successful corporate raider Floyd Odlum counselled John
Weinberg (an important figure in Goldman Sachss history). Referring to these excesses,
Odlum explained to Weinberg that No one is going to tell you what they are or when they
will arise; each time they will look different.
Odlum also gave Weinberg a copy of Charles McKays book Popular Delusions and the
Madness of Crowds, making the investment banker promise to keep it throughout his career,
Read it once and then from time to time refresh your memory with the table of contents.
(These quotes come from Goldman Sachs: The Culture of Success by Lisa Endlich).
While the rest of us wont usually receive personal gifts or advice from corporate raiders,
we can try to learn the same lessons. Each boom has its own logical-sounding underpinning;
the internet did change the world; American house prices hadnt had a significant nation-
wide setback in living memory; China is industrialising at a breathtaking pace. The key is to
recognise if and when the prices associated with an investment theme have broken free
of rational economic gravity and are floating on a breeze of confidence and hope.
Im under no illusion that doing so is easy. In the current climate, for example, the logic
around Chinas industrialisation seems almost irrefutable. But we must remain vigilant. A
powerful global economic change is not justification for paying any price for investments
related to that change.
Sustainable competitive advantage
In most cases, the key to great long-term investment returns is some kind of sustainable
competitive advantage. This might be a strong brand (such as David Jones), a powerful
distribution network (Woolworths and Metcash) or patented technology (Cochlear).
Sometimes a competitive advantage can be built through reliably delivering results to
clients over a long period (Leighton and Monadelphous). But this is potentially a weaker
type of advantage and one that could be lost more readily than other kinds.
Over a short period (say one to three years), its impossible to distinguish between
profits which are the result of a strong competitive advantage and profits which are the
result of a powerful industry upswing.
Another point to be mindful of is that a strong competitive advantage may not turn
out to be a sustainable one. Shareholders of Tattersalls and Tabcorp have learned this
the hard way in recent years. Exclusive government licences provide a strong advantage
but they have a finite life and most of the excess value they generate will probably be
competed away in the new licence bidding process.
Bringing it together
Examining the kind of figures that appear in this report can give a good indication of a
competitive advantage in the past. But one of our key tasks as investors is to apply our minds
to the question of whether the advantage is likely to remain in place for a long time into
the future. In the phrase sustainable competitive advantage, the first word is the key.
If you can locate a company which you are highly confident has a sustainable competitive
advantage, then you can turn your attention to the price. If there arent too many expectations
built into it, then you may well have uncovered a winner.
It all comes back to two variables; price and value. And establishing the true, or intrinsic,
value is a value investors number one job. The numbers in this report are a great starting
point and our list of 10 Best Businesses for 2010 provides a handy watchlist of stocks
which might make great additions to your portfolio at the right price.
History has provided opportunities to pick up each of these stocks on the cheap and
were confident the future will hold more of the same. Its simply a matter of patiently
waiting for those situations to arise.

AUSTRALIAS TOP 10 BUSINESSES

1 Monadelphous
2 Cochlear
3 Fleetwood
4 CSL
5 Woolworths
6 Computershare
7 Metcash
8 BHP Billiton
9 David Jones
10 Leighton Holdings
The Intelligent Investor
4
The Four Filters Explained
Like most best of lists, theres an element of subjectivity in determining Australias 10
Best Businesses. In deciding how to identify the best businesses for our inaugural report last
year, we quizzed our analytical team and reviewed their responses. The recurring themes
that emerged formed the basis for our four filters approach.
Weve retained those filters this year, but the process has been fine-tuned to better
account for the complexities involved in the task at hand. With that in mind, lets discuss
each of these filters.
Filter 1: Sustained double-digit dividend growth
The first of the four filters is simple yet powerful: To have grown dividends per share by
more than 10 per cent per annum over both the past five and ten years. This may appear to
be a simplistic metric to judge a business, but its rather potent when applied over the course
of a full decade. Few weak businesses can sustain double-digit dividend growth over a 10 year
period. This first filter is likely to weed out those companies built on shakier foundations.
Dividends arent just relevant to separate the best from the rest. In fact, dividends have
provided almost half of the total return from the Australian sharemarket over the past 20
years. Thats an important fact to keep in mind when searching for opportunities, as the
best companies tend to generate (and pay out) increasing amounts of cash.
Filter 2: Return on Capital Employed (ROCE)
The second filter is Return on Capital Employed (ROCEcommonly pronounced
roh-kee); a key ratio our analysts consider in evaluating businesses. This metric provides
an indicator of the economic strength of a business; a company with a high ROCE is more
likely to generate superior investment returns over the long run.
Our report does not make any adjustments to reported numbers, with the idea being
that the effect of using a decade of data should smooth out most irregularities.
Calculating ROCE involves taking the reported Earnings Before Interest and Tax (EBIT)
and dividing it by the combined amount of capital provided by shareholders and lenders
(including both short and long-term debt):
From those stocks that made it into the second filter, weve eliminated those that failed
to provide an average return of at least 12% on their capital (debt and equity). For a quality
business, this hurdle shouldnt prove difficult to clear.
Filter 3: Return on Incremental Capital Employed (ROICE)
Our third filter is Return On Incremental Capital Employed (ROICE), a measure of how much
extra profit is generated compared to the additional capital (both debt and equity) thats been
kicked in over a given period (the past 10 years, in this case). When it comes to equity, much of this
extra capital tends to come from retained earnings (that is, profits not paid out as dividends).
Were after those companies that have used extra capital wisely and profitably over
the past decade, something that ROCE alone does not adequately capture. In fact, the
difference between the average ROCE and ROICE can give us an insight into the success
of a companys strategy and direction.
In a similar fashion to our second filter, we set a hurdle rate. In this case it was 15%.
If a business cant deploy additional capital at more than a 15% rate of return, it almost
certainly doesnt deserve a place on the list of Australias best businesses.
Filter 4: The Great Business Index
The fourth and final filter is, effectively, a ranking system. Using the stocks that are still
standing, we rank them all based on the results of each of the prior filters. This differs from last
year, where we somewhat arbitrarily added the results of the three previous filters together.
For example, the stock with the highest 10-year dividend growth would be ranked
number 1 in that category, the runner-up number 2 and so forth. We then add together the
ranks for each stock across each of the three filters. This gives a possible minimum score
of 3 (if a business ranked 1 on every filter). The stock with the lowest score is crowned
the top business, and so on down the list until we have our top ten.

Special report | Australias10 Best Businesses

5
First Filter: DPS growth
Last year, we produced the Australias 10 best businesses report starting with stocks
listed in the S&P/ASX 100 index. This year weve raised the bar. The pursuit of Australias
best businesses has extended to those in the S&P/ASX 200.
Putting these 200 stocks through our dividend filter, its not surprising that the majority
failed to make it through. Whats of particular interest, though, is the number of well-known
blue chips that dropped out at this early stage. The major banks, much loved for their
dividends, would usually rank high on many investors lists, but theyre missing on ours.
A number of stocks didnt make the cut simply because they werent listed long enough
to meet our stringent criteria. That may seem tough, but were most interested in the very
best businesses that have stood the test of time.
Chart 1 showcases the 23 stocks from the S&P/ASX 200 index that passed the first
step and ranks them by their 10-year dividend growth rate. Topping the list is Metcash,
blowing the competition away with an annual average dividend growth rate of more than
48%, though it was boosted by an increasing dividend payout ratio over the period.
The range was certainly wide, with Downer EDI rounding out the list with annual
growth slightly above 10%. And while the banks may be missing in action, some of the
countrys big resource and mining services companies met the first test, including BHP
with annual dividend growth of more than 14% over the past decade. The global miner
didnt progress through the first filter last year but, along with eight new contenders, it
made the cut in 2010.
The comparison to last years result reveals eight stocks have been dropped, with
Aristocrat Leisure the most notable (it was previously ranked sixth). Other notable exclusions
included Westfield Group, News Corp, ASX and Bendigo and Adelaide Bank.
With the first stage sorted, its off to the next round.
Second Filter: ROCE
With 23 stocks making it through the first filter, we calculated the average ROCE for each
over the past decade, with a hurdle rate of 12% required to progress to the next stage.
The 12% hurdle proved easy enough for the majority of the stocks, with 19 making
it through to the next round. Top of the class was Monadelphous with a decade average
ROCE of almost 45%, just ahead of last years leader, Cochlear.
Woolworths was the only other stock to boast a ROCE above 30%, though Woodside
Petroleum, Flight Centre and BHP Billiton came close. The mid-twenties featured Leighton,
last years fourth best business, along with newcomers Fleetwood and Cabcharge.
A host of second-round businesses racked up ROCE figures in the teens. These included
Harvey Norman, CSL, Computershare and QBE Insurance. All of these companies featured
in the top ten last year, but newcomers pose a serious threat to their positions.
Also through to the next round are UGL, David Jones, Origin Energy, Coca-Cola
Amatil, with Toll Holdings just sneaking through. It was at this point last year that we
bid farewell to David Jones and Origin Energy but, coincidentally, theyll head to the next
round this year with the same ROCE.
Dropping out of contention, however, were Ramsay Health Care and Sonic Healthcare.
These stocks were joined by two stocks which have earned avoid recommendations from
The Intelligent Investor; Downer EDI and Newcrest Mining.
The axing of the four stocks failing to meet our requirements leaves 19 high quality
contenders to test further in the next round.
Third Filter: ROICE
In the third round we turned to a popular metric among The Intelligent Investor team;
return on incremental capital employed (ROICE). Its a sibling to ROCE which measures how
profitable the extra capital thats been injected into the businesses has been. In seeking
only the best, we selected a hurdle rate of 15%, which we expect quality businesses to
easily surpass.
Of the remaining stocks jumping through this financial hoop, David Jones came out
on top (though some financial engineering over the years helped). Monadelphous posted
0% 10% 20% 30% 40% 50%
DOW
FLT
CCL
ORG
BHP
SHL
QBE
HVN
DJS
WPL
LEI
WOW
NCM
RHC
FWD
COH
TOL
UGL
CAB
MND
CSL
CPU
MTS
CHART 1: STOCKS WITH 10%+ ANNUAL
DIVIDEND GROWTH
0% 10% 20% 30% 40% 50%
NCM
DOW
SHL
RHC
TOL
CCL
ORG
DJS
UGL
QBE
CPU
CSL
HVN
MTS
CAB
FWD
LEI
BHP
FLT
WPL
WOW
COH
MND
CHART 2: RETURN ON CAPITAL
EMPLOYED
The Intelligent Investor
6
another strong result in this category, with Fleetwood, the only debt-free company on our
list, polling in third position.
As you can see from the results, theres a large gap between third and fourth place.
Leading the remainder, CSL posted an impressive increase in its ROICE from last years
report. Positioned in CSLs slipstream are several blue chips including BHP, Cochlear and
Woolworths. Many stocks produced an ROICE above 20%, with Cabcharge sneaking
through to the next round by narrowly exceeding our hurdle.
Comparisons to last years results reveal that Leighton Holdings has experienced a big
drop in its ROICE, though at more than 23%, its still an impressive result.
Our 15% cut-off mark meant we bade farewell to seven stocks, including two that
made it into the top ten last yearHarvey Norman and Woodside Petroleum. Woodsides
10.9% ROICE result is in stark contrast to last years figure of almost 45%. It was squeezed
at both ends, with EBIT falling and capital employed surging.
Other big blue chips to drop out of contention were Coca-Cola Amatil, Toll Holdings,
Origin Energy, and UGL. With those contenders not making it over the ROICE hill, our
remaining 13 stocks ride into the final round.
Fourth Filter: The Great Business Index
The final round combines the prior performances of each of the thirteen stocks into a
single great business index. The index is calculated using the relative ranking of each of
the thirteen stocks over the prior filters. A final figure is achieved by summing the ranks for
each filter to determine the stocks position in the final list of Australias 10 best businesses.
The lowest overall score is deemed the best business.
Using this index, engineering maintenance provider Monadelphous is hereby crowned
Australias best business for 2010. Monadelphous ranked no worse than fourth in any
index, making it the clear winner. Last years top business, Cochlear, put up a valiant fight
to finish second.
Though finishing equal on points, we decided to award the bronze medal to caravan
and temporary accommodation manufacturer Fleetwood, with CSL taking fourth place.
Our decision was based on Fleetwoods higher ROICE, the key metric among the prior
three in this report.
Woolworths claimed fifth spot, down two from last year. Its not often that such a quality
business is available at an attractive price, but thats the situation weve found ourselves
in this year (to find out more, head to page 13).
Moving further down the list, we have another tie on the rankings but share registrar
Computershare claimed sixth position (fifth last year) due to its superior ROICE. This means
newcomer Metcash is deemed the seventh best in Australia. The grocery distributor posted
the highest annual average growth rate in dividends among the S&P/ASX 200 over the past
decade. Whats more, its recently been in the discount bin (find out more on page 11).
The Big Australian, BHP made its presence felt this year by taking out eighth place. The
global miner has produced strong ROCE and ROICE figures over the past decade, with a
gusty tailwind from the commodities boom.
Our final pair producedyou guessed itanother tie. Though with the higher ROICE,
20% 0% 20% 40% 60% 80%100%
CCL
ORG
TOL
WPL
HVN
UGL
CAB
QBE
MTS
FLT
LEI
CPU
WOW
COH
BHP
CSL
FWD
MND
DJS
CHART 3: RETURN ON INCREMENTAL
CAPITAL EMPLOYED
TABLE 1: AUSTRALIAS TEN BEST BUSINESSES
RANK STOCK 10 YEAR DIV. GROWTH RANK ROCE RANK ROICE RANK TOTAL
1 MND 23.57% 4 44.53% 1 75.45% 2 7
2 COH 20.89% 6 39.56% 2 33.27% 6 14
3 FWD 19.45% 7 25.20% 7 63.93% 3 17
4 CSL 26.42% 3 17.26% 10 39.77% 4 17
5 WOW 17.46% 8 33.10% 3 25.29% 7 18
6 CPU 39.55% 2 16.77% 11 25.22% 8 21
7 MTS 48.46% 1 18.30% 9 21.22% 11 21
8 BHP 14.25% 12 29.11% 5 33.50% 5 22
9 DJS 14.98% 10 14.65% 13 82.63% 1 24
10 LEI 16.35% 9 26.82% 6 23.77% 9 24

Special report | Australias10 Best Businesses

7
upmarket retailer David Jones takes out ninth place. Our tenth and final spot goes to
Leighton Holdings. The construction and contracting company came in fourth last
year and, despite slipping down the list, it still remains among Australias 10
best businesses.

As a provider of engineering services, you might think Monadelphous earned its

place at the top of the class by virtue of its exposure to the resources boom. Providing
the engineering grunt behind mining projects has no doubt been a handy business as
commodity prices have taken off, but Monadelphous is more than just a company in the
right place at the right time.
Monadelphous has managed to eke out a rare competitive advantageits reputation
for operational excellence. The companys commendable conservatism, and its cash-rich
balance sheet, has spared it the woes of some of its peers. With performance metrics
well above average and a formidable track record, Monadelphous deserves first place as
Australias Best Business.
Cochlears hearing implants are the industrys gold standard. But its the companys
willingness to spend millions of dollars each year on research and development that keeps
it ahead of the competition. Cochlear implants are sold across the globe, which means its
relatively small native market hasnt hindered its growth.
That public health authorities provide funding for recipients has also meant that the high
cost (over $20,000) hasnt prevented the widespread adoption of Cochlear implants. In
addition, Cochlears reputation for quality and reliability reflects its technological edge. The
company hasnt been responsible for any major health scares unlike some of its rivals.
More recently, the company has expanded its product suite and is driving strong returns
from the acquisition of Baha. Few companies, particularly in the technology field, can boast
Cochlears consistent and rapid growth trajectory over such a long period.
Through good luck or good management, Fleetwoods star has been hitched to
two important wagons over the past decade; the resources industry and Australias
ageing population.
Among other things, the companys manufactured accommodation division
runs Searipple Village in the town of Karratha in Western Australias Pilbara region,
providing single-person accommodation for up to 1,500 inhabitants. Karratha has boomed
due to its strategic location close to the nations key iron ore deposits and the North West
Shelf project.
Fleetwood has also profited from the growing herd of grey nomads buying caravans
0
500
1000
1,500
2,000
2,500
3,000
3,500
4,000
Aug 10 Aug 08 Aug 06 Aug 04 Aug 02
MND XAOAI *TSR = Total shareholder return | Base = 100
MND: TSR* VS ALL ORDS ACCUM.
50
100
150
200
250
300
350
Aug 10 Aug 08 Aug 06 Aug 04 Aug 02
COH XAOAI *TSR = Total shareholder return | Base = 100
COH: TSR* VS ALL ORDS ACCUM.
0
300
600
900
1,200
1,500
Aug 10 Aug 08 Aug 06 Aug 04 Aug 02
FWD XAOAI *TSR = Total shareholder return | Base = 100
FWD: TSR* VS ALL ORDS ACCUM.
The Intelligent Investor
8
and setting off around the country for the retirement trip of a lifetime. Youve probably
been stuck behind one of its Coromal or Windsor vans at some point.
Directors, presumably cognisant of Fleetwoods good fortune, dont seem to harbour
any grand plans to become the next Wesfarmers. Excess profits have been paid out to
shareholders via a number of hefty special dividends over the past decade.
Computershares initial success reflected its ability to replace manual share registry
maintenance with computerised systems. After acquiring a number of different registries from
accounting firms that wanted to concentrate on their core businesses, Computershare came
to dominate the Australian share registry market. As its size increased and its technology
improved, Computershare was able to reap enormous profits from customers that recognised
it was far more efficient for Computershare to manage their share registries than do it
in-house.
Computershare has had enormous success rolling out its systems around the globe,
particularly in the US. But its also managed to greatly expand its suite of services. While
the share registry business is fairly stable, Computershares profits have surged following
periods of frenetic corporate activity. With an owner-manager in charge, the company is
well-managed and continues to make inroads into developing countries.
Long known as the Big Australian, BHP Billiton has grown to overshadow even that impressive
moniker. Admittedly, BHPs growth owes much to the growth of China, but the success of this
commodities colossus is also testament to the quality and diversity of its assets.
Iron ore, coal and petroleum have been key divisions for BHP, generating sensational
margins. And its diversified business model helps to smooth out volatile prices. Few
companies can match the size and quality of what BHP produces from some of the largest
and lowest cost mines in the world. If the China story remains intact, then prepare for BHP
to get even bigger.
After languishing for a number of years, upmarket retailer David Joness fortunes were
revived by now-departed chief executive Mark McInnes. While the grubby circumstances
of McInness departure marr his memory, the financial outcomes he achieved were truly
remarkable.
In the early part of the past decade, Australias department stores were struggling
financially and groping for a clear strategic approach. McInnes brought that approach, while
rival Myer took more time to find the right leadership team.
Under McInness reign, David Jones nabbed exclusive distribution agreements with many
key brands and re-focused the business on its core demographic. The companys iconic store
card was also handed over to American Express, which freed up tens of millions in working
capital for other purposes, while retaining some exposure to the profits through a deal with
Amex. In an operational sense, McInness successor Paul Zahra has big shoes to fill.
Leighton Holdings is a diversified business with operations spanning the fields of contract
mining, infrastructure construction, property development and building. Its also diversified
by geography with businesses throughout Asia and the Middle East.
0
100
200
300
400
500
600
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800
Aug 10 Aug 08 Aug 06 Aug 04 Aug 02
BHP XAOAI *TSR = Total shareholder return | Base = 100
BHP: TSR* VS ALL ORDS ACCUM.
0
200
400
600
800
1,000
1,200
Aug 10 Aug 08 Aug 06 Aug 04 Aug 02
LEI XAOAI *TSR = Total shareholder return | Base = 100
LEI: TSR* VS ALL ORDS ACCUM.
0
100
200
300
400
500
600
700
800
Aug 10 Aug 08 Aug 06 Aug 04 Aug 02
DJS XAOAI *TSR = Total shareholder return | Base = 100
DJS: TSR* VS ALL ORDS ACCUM.
0
50
100
150
200
250
300
Aug 10 Aug 08 Aug 06 Aug 04 Aug 02
CPU XAOAI *TSR = Total shareholder return | Base = 100
CPU: TSR* VS ALL ORDS ACCUM.
Special report | Australias10 Best Businesses
9
This diversity has allowed Leighton to follow the money as various sectors and
geographic areas have waxed and waned over the years. The companys growth has been
underpinned by huge financial strength and a track record of delivering for clients (apart
from a couple of simultaneous hiccups back in 2004).
The company recently announced that its long-standing chief executive Wal King
would be handing the reins to another company veteran, David Stewart, next year. Such
transitions can mark turning points in a companys history, so shareholders will need to
decide whether theyre comfortable with Stewarts stewardship; an important task given
the lofty growth expectations built into Leightons current share price.
With earnings at record levels and a PER at its lowest point in years, is it time to
join the CSL team?
Competition is in Brian McNamees blood. His brother Paul was the worlds number
one doubles tennis player in 1981, winning both the Australian Open and Wimbledon
doubles championships twice. Their uncle is Essendon Football Club legend Dick Reynolds,
who won the leagues highest individual honour, the Brownlow medal, three times in an
illustrious career that also included four premierships as captain-coach.
Though McNamee wont be immortalised in bronze outside the MCG like his uncle, his
performance as chief executive of blood products company CSL puts him in elite company.
Since 2000, CSL has returned 12.9% per year including dividends, with earnings per share
compounding at a remarkable 27.1% per year.
Born of necessity
Established in 1916 as Commonwealth Serum Laboratories, CSL currently has three
divisions. CSL Biotherapies is the Southern Hemispheres only commercial manufacturer of
flu vaccines, including an H1N1 (or swine flu) vaccination. It also helped develop Gardasil,
a breakthrough which protects women against cervical cancer.
CSL Bioplasma provides blood fractionation services for Australia, New Zealand, Hong
Kong, Malaysia, Singapore and Taiwan (see Shoptalk 1). Contracts are generally struck on
a cost plus margin basis, so the division acts like a toll road attendant collecting fees from
drivers. Its a decent business, despite the commoditised nature of the products.
However, as you can see in chart one, CSL Behring is the companys heart and lungs,
dwarfing the other divisions. Following several shrewd acquisitions, it boasts one of the worlds
largest and most efficient plasma collection networks (see Shoptalk 2, over the page).
CSL immunised against competition
Both CSL and larger US rival Baxter own their own plasma collection networks. This
has tightened their grip on supply, with the firms together controlling between 50% to
60% of the US plasma market.
CSL also benefits from a two-tiered market. In developed countries with large health
budgets, CSL draws high prices for innovative products. The companys generous cash
flow gives it ample scope to fund research and development, spending $317m in the area
in 2010. But though new medical treatments can offer windfall gains, long lead times and
0
100
200
300
400
500
Aug 10 Aug 08 Aug 06 Aug 04 Aug 02
CSL XAOAI *TSR = Total shareholder return | Base = 100
CSL: TSR* VS ALL ORDS ACCUM.
CSL | CSL
PRICE AT REVIEW $35.04
REVIEW DATE 1 Dec 2010
MARKET CAP. $19.4bn
12 MTH PRICE RANGE $30.00$37.60
FUNDAMENTAL RISK 2
SHARE PRICE RISK 3
OUR VIEW LONG TERM BUY
SHOPTALK 1
Blood fractionation
The Intelligent Investor
10
high rates of failure can also deliver windfall losses.
Thats why CSLs solid balance sheet and the fact that it controls the blood supply from
donation to infusion inoculate it further against competition. Small companies might develop
a nifty product, for example, but with shallow pockets, they may not survive long enough
to get it to market. And theyll struggle to compete with CSLs comprehensive product line
up and global production and distribution network. Small players therefore frequently opt
to license their intellectual property to larger rivals, or get swallowed by them.
CSLs lack of debt means financing these kinds of acquisitions should be easily achievable.
In fact, growth-by-acquisition was the backbone of McNamees strategy that turned a $23m
government refugee into a dominant $19bn global healthcare company. Its for these reasons
that were not panicking over a new plasma product being developed by US company Virdante
Pharmaceuticals thats potentially 10 times more virulent than existing treatments.
In developing markets, CSL flexes its manufacturing muscle selling commodity products at
prices that deter competition (see Shoptalk 3). McNamee is notoriously frugal, and exercising greater
control over the supply chain lets CSL tailor production to maximise the revenue from every litre
of plasma collected while minimising waste; its known in the jargon as increasing the yield.
As developing markets expand their health budgets, CSL will also have broad opportunities
to sell a litany of higher margin products. CSL has recently developed Privigen, for example,
an IVIG solution with a long shelf life that doesnt require refrigeration. Though it provides added
safety features like vehicle airbags, for example, its difficult for competitors to imitate.
CSL pushes the envelope
CSLs experience with world health regulators is also a major weapon. In fact, regulatory
barriers have increased over the past few years, reinforcing CSLs formidable industry
position. However, unlike the gaming restrictions that currently fortify Aristocrats market
position, CSLs success has recently drawn unwanted attention
McNamee retracted CSLs $3.5bn bid for US fractionator Talecris following staunch opposition
from US health regulators in June 2009. Spanish rival Grifols stepped into the fray and acquired
Talecris for a premium of over 50%, potentially creating a third major player. To rub salt into the
wound, CSL subsequently received lawsuits alleging that it fixed prices in cahoots with Baxter.
The outcome is impossible to predict, and CSLs high returns make it an easy target.
Though we dont want to downplay the potential impact, that the public is the prime
beneficiary of CSLs life saving research and development should offer some protection
against further regulatory action, provided CSL isnt found guilty of contravening the law. And
weve had success in the past buying a high quality biotech blue chipCochlearwhen it was
under a regulatory cloud (see Cochlears latest challenge on 18 Mar 04 (Buy$19.04)).
In the near term, the strong Aussie dollar and falling Gardasil and H1N1 sales will
also impact earnings. And US health care reform continues to create headwinds. But its
comforting to see that, despite fears of another plasma supply glutwith Swiss fractionator
Octapharma forecasting global supply will outstrip demand over the next few yearsprices
have held up. That a rival product was recently taken off the shelves should also support
prices, and allow CSL to slightly increase its market share.

Its in the blood
We expect underlying profit growth (excluding currency effects) of between 5% and
10% in 2011, but the forecast PER based on the reported numbers could be as high as
21.8 if exchange rates on 8 October prevail for the rest of the financial year. The fact that
the strong Aussie dollar is masking CSLs progress means were not overly concerned by
the misleadingly high PER: McNamee has created enormous value for CSL over 20 years,
and the company boasts a formidable balance sheet.
Were also comforted that management is returning free cashflow to shareholders, rather
than being pressured into making a rash acquisition. And though its growth is slowing, todays
buyer doesnt need CSL to replicate the growth rates of the past two decades to do well.
In summary, CSL would help diversify a risk-tolerant or blue chip portfolio for those
prepared to pay up for quality, thoughgiven the clouds of uncertainty currently weighing
on the share priceits not one for investors requiring high dividends or a large margin of
safety. We recommend you allocate no more than 4% of a well-diversified portfolio to
CSL at the current price. LONG TERM BUY.
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
2010* 2009 2008 2007 2006 2005
CSL Behring CSL Biotherapies CSL BIoplasma
Source: CSL annual reports
* CSL Bioplasma merged with CSL Biotherapies on 1 Jan 2010
CHART 1: DIVISIONAL REVENUE SPLIT ($M)
TABLE 1: CSLS INCREDIBLE
GROWTH SERUM
YEAR TO 30 JUN 2006 2007 2008 2009 2010
REVENUE ($M) 2,849 3,172 3,557 4,622 4,456
EBIT (NORM.) ($M) 540 819 1,002 1,432 1,397
EBIT MARGIN (%) 19.0 25.8 28.2 30.1 30.9
NET PROFIT
351 539 702 1,146 1,053

(NORM.) ($M)
EPS (C) 61.4 97.8 126.8 191.7 185.2
PER (X) 51.0 32.0 24.7 16.3 18.9
DPS (C) 22.7 34.7 46.0 70.0 80.0
FRANKING (%) 0 26 50 0 0
YIELD (%) 0.7 1.1 1.5 2.2 2.3
SHOPTALK 3

TABLE 2: CSLS 2008 MARKET POSITIONS

MARKET SHARE (%)
CRITICAL CARE 38
IMMUNOGLOBULINS 22
COAGULATION 21
ALPHA-1-P1 10
CSL RECOMMENDATION GUIDE
BUY Below $28
LONG TERM BUY Up to $35
HOLD Up to $50
TAKE PART PROFITS Above $50
SHOPTALK 2
Blood plasma

Special report | Australias10 Best Businesses

11

Metcash is trading within spitting distance of its lowest ever price-to-earnings

ratio; its time to step up.
When US discount club retailer Costco opened its maiden Australian warehouse
in Melbourne on 17 August 2009, some members travelled five hours to be among the first
through the doors. Armed with industrial-sized trolleys, ravenous bargain hunters helped
set a new company opening day sales record outside the US; US$841,000.
Costcos appeal isnt just low prices, though; where else can you find pallets loaded
with 1.36kg jars of peanut butter resting 20 metres from a display cabinet boasting a
$157,000 diamond ring? The key lesson is that if you want to take on the might of Coles
and Woolworths, you have to offer something different.
The rejuvenation of Coles under Wesfarmers stewardship has recently captured
the markets imagination, leaving top-shelf rival Woolworths hanging on the bargain
rack. However, theres a high quality niche retailer sandwiched between these bitter
rivals thats also trading near a decade low price-to-earnings ratio, despite forecasting
increasing profits.
Remember my name
If youve never heard of Metcash, dont be surprised. Like Woolworths resurrection
following a near-death experience in the 1980s, Metcash rose from the ashes of ambitious
retailer Davids, which almost collapsed under a weight of debt in 1997 following an
acquisition binge.
Metcash is a great Australian success story, boasting total shareholder returns (capital
gains plus dividends) of 20.2% per year since 2001 to November 2010, out-doing the
still-impressive 14.8% enjoyed by Woolworths shareholders over the same period, as we
recently explained in Woolworths keeps Metcash at Bay (see issue 285). Yet despite this
performance, Metcash has rarely looked as cheap as it does today, as Chart 1 illustrates.
Metcash commands a 19.9% share of our national grocery market, as you can see in
Chart 2 (over the page), but it doesnt own a single store. Instead, it licenses the IGA brand
to private operators and then supplies them with more than 60% of their stock, which
includes the Black & Gold home brand range.
The IGA network boasts 1,320 supermarkets, which arms Metcash with bulk buying
power over suppliers. In turn, the savings allow operators to drop shelf prices and compete
in the same ballpark as Coles and WooliesMetcash chief executive Andrew Reitzer has
said that Metcashs bottom line would double if it competed on a level playing field with
Coles and Woolies.
Size doesnt matter
Unlike Coles and Woolworths, which typically boast large stores, IGA stores come in a
variety of shapes and sizes, including SUPA IGA and IGA X-press. This means they can squeeze
into smaller, convenient locations where shoppers are prepared to concede higher prices to
get in and out quickly. Though the average shopping list is also much shorter, this is Metcashs
point of difference; competing head on with its larger rivals would be financial suicide.
That Metcash is merely a supplier and doesnt own or lease any bricks and
mortar is both a curse and a blessing. It means Metcash is less profitable than Woolworths,
or example, as you can see in Chart 3 (over the page), as it splits the margin between the
cost and shelf price with store owners (Woolworths and Coles keep every dollar); this allows
operators to earn a healthy return and reinvest in their stores. But theres always a risk that
renegade shopkeepers join an alternative buying group or bravely choose to go it alone.
METCASH TRADING | MTS
PRICE AT REVIEW $4.25
REVIEW DATE 1 Dec 10
12 MTH PRICE RANGE $3.84$4.74
FUNDAMENTAL RISK 2.5
SHARE PRICE RISK 3
OUR VIEW LONG TERM BUY
0
5
10
15
20
25
30
35
10 09 08 07 06 05 04 03 02 01
EPS (cents) DPS (cents) PER (x)
Source: Metcash annual reports
CHART 1: PERFORMANCE VS PRICE
0
500
1000
1,500
2,000
Aug 10 Aug 08 Aug 06 Aug 04 Aug 02
MTS XAOAI *TSR = Total shareholder return | Base = 100
MTS: TSR* VS ALL ORDS ACCUM.

The Intelligent Investor

12
On the flipside, however, Metcash has grown quickly because it hasnt developed
its own store network, which takes time and large licks of capital; Metcash can add new
stores at the cost of a phone call. That IGA carries a relatively narrow product range also
means Metcash deals with fewer suppliers and products, which creates storage and
distribution efficiencies.
Better still, management is shareholder friendly. Though Reitzer typically cashes
in his company options, he runs Metcash like he owns every share. For example,
practically all profits are distributed as fully franked dividends and, in a far-sighted move
reminiscent of Woolworths, Reitzer recently served notice that he will retire in three years
to ensure theres a smooth transition at the top (though wed prefer it if he stayed).
No free lunch
So why is Metcash trading at a knock down price? Firstly, analysts prefer growth stories,
like Coles, as theyre far easier to sell to brokerage clients. Metcashs recent growth streak
is also unsustainable, as the supermarket industry is mature and suitable locations are
diminishing. But todays investor doesnt need much growth to do well given the fat 6.1%
forecast dividend yield.
However, like rinsing grey hair with Restoria Express, Reitzer is aiming to stall the ageing
process with acquisitions. Wed take stock and reassess if the company announced a
mooted overseas acquisition, and were also sceptical of the $55m paid for a 50.1% stake
in hardware co-operative Mitre 10 (Metcash also has an option to purchase the remaining
49.1% in 2012 or 2013).
Mitre 10 has buckled under the weight of Bunnings Warehouses lowest price guarantee,
and it might be squashed flat by an aggressive joint venture recently created between
Woolworths and US hardware retailer Lowes. We are, on the other hand, extremely comfortable
with Metcashs intention to acquire the New South Wales Franklins grocery chain.
Metcash expects the deal to add between 1.5 cents and 2.0 cents to earnings per
share. If the deal does get the green light, we expect Metcash to breathe new life into the
underperforming supermarkets and add plenty of value for shareholders.
The ACCs ruling against the acquistion has meant the matter will now head to court.
METCASHS MAGNIFICENT RUN
YEAR TO 30 APR 2006 2007 2008 2009 2010
REVENUE ($M) 8,214 9,695 10,116 11,067 11,608
EBIT ($M) 174 283 335 352 402
EBIT MARGIN (%) 2.1 2.9 3.3 3.2 3.5
NET PROFIT ($M) 81 159 197 202 230
EARNINGS PER SHARE (C)

13.7 21.0 25.9 28.7 32.0
PER (X) 30.2 19.7 16.0 14.4 11.2
DIVIDEND PER SHARE (C) 11.5 17.0 21.0 24.0 26.0
FRANKING (%) 100 100 100 100 100
YIELD (%) 2.8 4.1 5.1 5.8 6.1
Counting the cash
During the credit boom, decent income opportunities were sparse. But were now adding
Metcash to a growing list that includes Woolworths and property group Australand, for example,
which both sport defensive revenue streams and relatively strong balance sheets.
On a 6.1% forecast dividend yield (fully franked), Metcash will likely appeal to income
investors as fat fully franked dividends will make up the bulk of our overall return. Though
were comfortable with leisurely earnings growth, provided Metcash defends its competitive
moat and the dividend cheques keep turning up, our greatest fear is that Reitzeror his
replacementdoes something drastic and risky to stoke the growth fires, but well cross
that bridge if and when we come to it.
Theres very little growth implied in the companys share price at present, and the
dividend yield is an attractive 6.1%. With the stock rising 2% since 1 Dec 10 (Long Term
Buy$4.17), it remains one of our better buys. LONG TERM BUY.
0
5
10
15
20
10 09 08 07 06 05 04 03 02 01
Source: Metcash annual presentations
CHART 2: METCASH GROCERY
MARKET SHARE (%)
0
5
10
15
20
25
30
35
40
10 09 08 07 06 05 04 03 02 01
MTS - ROA WOW - ROA
MTS - ROE WOW - ROE
Source: Metcash and Woolworths annual reports
CHART 3: METCASH VS WOOLWORTHS (%)
MTS RECOMMENDATION GUIDE
BUY Below $3.60
LONG TERM BUY Up to $4.50
HOLD Up to $6.00
TAKE PART PROFITS Above $6.00

Special report | Australias10 Best Businesses

13
Woolworths is a ne company that, nally, is trading at an attractive price. And
there are good reasons for that.
In Good to Great, author Jim Collins says, Level 5 leaders channel their ego needs
away from themselves and into the larger goal of building a great company. Its not that
Level 5 leaders have no ego or self-interest indeed they are incredibly ambitious. But their
ambition is first and foremost for the institution, not themselves.
In stark contrast to former Coles managing director John Fletcher, who boasted that he
hadnt set foot in a supermarket for 25 years prior to his appointment, Woolworths chief
executive Michael Luscombe spent almost three decades climbing the executive ranks;
from Mt Buller trainee to leader of Australias largest retail company. That Luscombe still
views himself as a shopkeeper reflects his focus on results, and not his ego.
On 19 Jul 06 (Hold$19.99), we canvassed Woolworths future under Luscombe;
back then, the forecast price-to-earnings ratio (PER) of 24 reflected high expectations,
and they were spot on.
When Luscombe turned in his annual report card on 26 August, it showed that earnings
per share (EPS) has almost doubled since then; a remarkable feat for what was then a
$22bn company managed by a debutante chief.
Woolworths 2010 full year result showed net profit growth of just under 10%, reflecting
the companys maturity and the fact that the prior years comparisons included unsustainable
stimulus-induced profit growth. But it marks the first time that Woolworths has delivered
single digit profit growth since before the turn of the millennium.
However, Luscombe disappointed analysts recently announcing full-year sales figures
that were impacted by fading government stimulus. Luscombe still expects annual profit
growth of between 8% to 11% for 2011, but Woolworths hasnt delivered single-digit profit
growth since before the turn of the millennium.
Woolworths PER of 16.2 is as low as its been for many years. But with an equally
attractive dividend yield of 4.3%, were not about to pass up the opportunity to buy one
of Australias finest businesses at a decent price. But companies of Woolworths calibre
dont sell this cheaply without a few flies in the ointment.
Blue ribbon quality
The list of reasons to own Woolworths is long. Its Australian supermarkets are among
the finest businesses in the land, generating obscene returns on capital of around 77%;
what Woolworths loses in pricing power selling everyday products, it recovers by selling
huge volumes of them.
Its world-class distribution system means it can afford to roll back prices to attract
more customers. As volumes increase, Woolworths extracts lower prices from suppliers
and passes the savings on to shoppers. This virtuous cycle, and an irreplaceable portfolio
of conveniently located supermarkets, is a daunting barrier to competition.
Woolworths also owns strong brands in discount variety (Big W), consumer electronics
(Dick Smith) and liquor (BWS and Dan Murphys), and its Everyday Rewards program and
fuel discounts help funnel loyal customers back to its supermarkets.
Woolworths produced $2.7bn of operating cashflow in 2010, and is in rude financial health.
The company also reinvested $1.8bn refurbishing stores and expanding its network, leaving $1.4bn
for dividends; Luscombe knows that todays refurbishment is tomorrows dividend increase.
Put plainly, this company is a gargantuan cash machine. So why has the share price
fallen recently?
0
100
200
300
400
500
600
700
800
Aug 10 Aug 08 Aug 06 Aug 04 Aug 02
WOW XAOAI *TSR = Total shareholder return | Base = 100
WOW: TSR* VS ALL ORDS ACCUM.
0
0.30
0.60
0.90
1.20
1.50
1.80
2010 2008 2006 2004 2002
EPS (LHS, $) DPS (LHS, cents) PER (RHS, x)
0
5
10
15
20
25
30
Source: Woolworths annual reports
CHART 1: WOOLWORTHS:
PERFORMANCE VS PRICE
WOOLWORTHS | WOW
PRICE AT REVIEW $26.60
REVIEW DATE 1 Dec 2010
MARKET CAP. $32.2bn
12 MTH PRICE RANGE $25.19$30.57
FUNDAMENTAL RISK 1.5
SHARE PRICE RISK 2.5
OUR VIEW LONG TERM BUY
PORTFOLIO POINT
The Intelligent Investor
14
Price of success
Woolworths has become a victim of its own success; size is an impediment to
growth and it takes large investments to move the needle on profits. For example, for
Luscombe to repeat his magic by doubling net profit again in the four years between
2010 and 2014, sales would also have to double to over $100bn (assuming a constant
net profit margin, which was 3.9% in 2010). In comparison, revenue has only increased
a relatively paltry 37% ($13bn) between 2006 and 2010, with improving margins
predominantly responsible for doubling profits (this wont be repeated without massive,
miraculous acquisitions).
Luscombe is keen to find new growth avenues. Woolworths operates a joint venture
in India, but this is small beer, and Luscombes operatives have also been sizing up targets
in the US.
Were wary of a major offensive on foreign soil, given theres a track record of
Australian companies blowing up billions of dollars and returning home with their tail between
their legs. However, the current economic malaise may produce a bargain; Woolworths
of ten teams up with local players, too, which reduces the chances of get ting
hoodwinked.
Were also sceptical of the local joint venture with US hardware retailer Lowes, which
will compete head on with Bunnings Warehouse. Even if Luscombe mollifies the
doubters, overall returns on capital will likely fall due to dilution of the wonderful
supermarket business.
Lastly, store rollouts are also waning due to Australias abundance of supermarkets and
reduced property development following the credit crisis. Woolworths faces stiff competition
from Coles, Costco, Aldi and private operators, including IGA, for suitable locations.
Road Map
Woolworths enormous success has created high expectations, and its currently being
punished because the stockmarket generally prefers companies that are growing quickly.
However, wed be content if Woolworths grew earnings relatively safely by 5% to 6% a
year, which equates to a total annual return of around 10% (including dividends).
This would likely be achieved if Woolworths sticks to its strengths, which are cutting
costs, processing higher volumes through its distribution network and incrementally rolling
out new stores. So well be watching for any signs that might cause us to reconsider
our investment.
A major overseas acquisition would certainly grab our attention, particularly if it were
funded with debt. Well also be following the roll out of the hardware joint venture closely.
However, it will be difficult to spot a poor outcome before the market and its a five-year
investment, so things could change substantially in the interim.
Management cant afford to drop the ball with its cash cow businesses, either. If
Luscombes forthright commentary were replaced by corporate guff that glossed over poor
results, then it would be a red flag for investors.
Greatness within
According to Jim Collins, 10 out of 11 good-to-great CEOs [that his research identified]
came from inside the company. Level 5 leaders are fanatically driven, infected with an
incurable need to produce sustained results. They are resolved to whatever it takes to make
the company great, no matter how big or hard the decisions, and display a workmanlike
diligence, more plow horse than show horse.
Luscombe is a company man who appreciates the legacy hes inherited; Woolworths
gets results without the fanfare that has plagued rival Coles, for example. Were also
comforted that Luscombe takes a long-term view and has been an excellent steward of
shareholders capital so far.
Woolworths is perhaps more suited to conservative portfolios at the current share price,
as were not banking on a total annual return over 10%. We also recommend restricting
Woolworths to 5% of your portfolio, which leaves room to increase your stake if the price
falls further.
In the search for cheap stocks, its easy to miss the bargain right in front of you.
Woolworths faces challenges, but theyre not insurmountable. Weve laid out our road map
and were not about to look a gift horse in the mouth; Woolworths is a wonderful business
trading at a fair price. LONG TERM BUY.
LUSCOMBES A+ REPORT CARD
YEAR TO 30 JUN 2006 2007 2008 2009 2010
REVENUE ($BN) 37.8 42.5 47.0 49.6 51.7
NPAT ($M) 1,015 1,294 1,627 1,860 2,038
EPS (C) 90.9 108.8 134.9 150.7 164.0
PER (X) 28.6 23.9 19.3 17.3 16.2
DPS (C) 59 74 92 104 115
FRANKING (%) 100 100 100 100 100
YIELD (%) 2.3 2.8 3.5 4.0 4.3

WOW RECOMMENDATION GUIDE

BUY Up to $25
LONG TERM BUY Up to $30
HOLD Up to $40
TAKE PART PROFITS Above $40
0
$5
$10
$15
$20
$25
$30
$35
Dec 10 Dec 09 Dec 08 Dec 07 Dec 06
CHART 2: WOW 5 YEAR SHARE PRICE
Special report | Australias10 Best Businesses
15
The process of determining Australias 10 best businesses produced much
blood, sweat and tears, but weve been well rewarded with a watchlist of quality
companies. While the analysts at The Intelligent Investor are battle-hardened to
such tasks, it may be daunting if youre newer to company analysis.
Heres where this Investors College comes in. Well walk you through the three key filters and,
hopefully, by the end of the process youll have the skills and confidence to apply these tools in
your own research. To help you along, weve prepared a spreadsheet which you can download
from our website. So pop the kettle on, open the spreadsheet, and lets get under way.
Garbage in, garbage out
The first step is obtaining the required financial data. In this case, were after Telstras
2010 financial results. Numerous sources provide company financials, including online
brokers, but these numbers often lack detail or contain errors.
The best way to avoid traps is to go straight to the sourceannual reports and ASX result
announcements. Its a bit more work but youre assured of working with the right numbers.
The two most common places you can obtain the figures you need are company
websites and the ASX website. Lets start with company websites.
While most websites are intended for customers, theres often an investor centre or about
us link thatll allow you to search for annual reports and company announcements.
In Telstras case, its website contains an About Telstra link. Selecting Investor Centre, and then ASX
Announcements, youll be able to scroll down and find the financial results dated 12 Aug 2010.
The alternative path is to open up the ASX website and select Announcements from
the left hand menu of options. Thisll allow you to type in a stock code (TLS for Telstra),
and the year (2010).
Keep a look-out for the Annual Report, and if its not yet released, you can use the year end
results. Since Telstras 2010 Annual Report hasnt been released, lets open up its financial results
released on 12 August 2010. Now that weve found our source, lets crunch some numbers.
First Filter: Counting the dividends
For the first ingredient of our data pie, were after the dividends per share (DPS) for
the year, usually found in several spots in annual reports and year-end result documents.
Turning to Telstras 2010 results, page 3 states total dividends per share of 28 cents.
You can enter this number into the spreadsheet under Current DPS.
To produce the 10 best businesses list, weve also noted down the DPS both five and
ten years ago by opening up the required years Annual Reports. For Telstra, its DPS five
and ten years ago were 40 cents and 18 cents respectively.
As Telstras 2005 DPS included special dividends totalling 12 cents per share, we should remove
them, as they are one-offs by nature and could skew our results. Stripping out the special dividends, lets
pop 28 cents into the spreadsheet under DPS 5 years ago, and 18 cents for DPS 10 years ago.
With that dividend data entered, you now have enough to calculate the results for our first
filter. Using our Telstra numbers, you should get a 4.52% annual dividend growth rate; well below
our cut-off rate of 10%. So with our first filter done and dusted, lets turn to the second.
Second Filter: Digging deeper with Return on Capital Employed (ROCE)
The second filter involves digging deeper into the companys numbers. Here were
looking for the companys Earnings Before Interest and Tax (EBIT) and Capital Employed
(CE) for the year. For this, we need to turn to the Income Statement and Balance Sheet.
The Income Statement, also referred to as the Statement of Financial Performance,
shows the profit or loss for the year. Youll find the important EBIT figure here.
Telstras 2010 Income Statement on page 5, shows EBIT of $6,501m for the year. Had

The Intelligent Investor

16
the figure not been provided, we could calculate it by taking Profit before income tax
expense and adding net finance costs.
There are some intricacies around this calculation. In presenting their finance (or
interest) costs, some companies will net off interest received on their cash balance. Others
will include interest earned as income and simply show the total interest cost paid.
This can make a meaningful difference in some cases, so its something to be aware of.
The most conservative course is not to net the figures off but to present them separately.
The other side of the ROCE equation is capital employed (CE), the sum of shareholders
equity and total debt. For these figures, lets turn to the balance sheet, sometimes known
as the Statement of Financial Position. From here we can calculate total debt; simply add
long and short term debt.
Using Telstras balance sheet on page 7, the short term debt is $2,540m (listed under
Current Liabilities as Borrowings). Add the long term debt (see Borrowings, under Non
Current Liabilities) of $12,370m, giving total debt of $14,910m. You can punch this number
into the spreadsheet next to Total debt.
Our next step is to move further down the page to the Total Equity figure. In Telstras
case, its $13,008m. Combining this with our total debt, we arrive at CE of $27,918m.
To calculate ROCE, we need to divide EBIT by CE (refer to page 4 for the formula). Computing
for Telstra, we come up with 23.3%; a result up there with the 10 best businesses this year.
While the ROCE for one year gives us a glimpse of a business fortunes, we need several
years of data to better understand how its faring. For this report, we calculated the ROCE
for each of the past ten years.
If ten years seems a bit laborious, five years should provide a reasonable indication
(though bear in mind the caveats highlighted on page 2). You may like to give this a go
with Telstra but, to save time, simply refer to the accompanying tables.
Third Filter: Wrapping up with ROICE
Our final filter involves calculating the return on incremental capital employed (ROICE).
Fortunately, all we have to do is plug numbers weve already found into our formula (cue
sigh of relief). Referring to the ROICE formula on page 4 of this report, our calculation for
increase in EBIT involves taking the latest EBIT figure (2010 for Telstra) and subtracting the
earliest one (2001). Using Telstras numbers in tables, the result is $565m. Calculating the
incremental capital employed involves a similar process, and we arrive at $206m.
Using our formula, we get a ROICE for the decade to 2010 of 274.3%. This means
that for every dollar kicked in over that period, EBIT actually declined by more than two
dollars; a very poor outcome for shareholders. Telstras performance fell well short of our
15% hurdle, reflecting the decline in its core business.
On the watchlist
Though the filters effectively remove many low-quality businesses, theres no guarantee
that the ones remaining will prove excellent investments. But the process does provide us
with some quality businesses to place on a watchlist. As weve seen, Telstras numbers arent
impressive, though as discussed in The Directors Cut (see page 2), the numbers dont really
tell us why. To better understand how a business works, we need to delve even deeper.
In Telstra on the stand: Your guide to an industry in turmoil, Greg Hoffman applied The Intelligent
Investors research framework and placed the business under the microscope. The report highlights
many important issues which should help you uncover sharemarket gems and avoid landmines.
The principles of value investing are simple but their application can often be complex. We
hope this article has helped to de-mystify some rather daunting but very important figures.
IMPORTANT INFORMATION
The Intelligent Investor
PO Box 1158 | Bondi Junction NSW 1355
T 1800 620 414 | F (02) 9387 8674
info@intelligentinvestor.com.au
www.intelligentinvestor.com.au
WARNING This publication is general information only, which means it does not take into account your investment objectives, financial situation
or needs. You should therefore consider whether a particular recommendation is appropriate for your needs before acting on it, seeking advice
from a financial adviser or stockbroker if necessary. Not all investments are appropriate for all people.
PERFORMANCE Past performance isnt a reliable indicator of future results. Our performance figures are hypothetical and come from the
recommendations made by The Intelligent Investor. Transaction costs havent been included. We encourage you to think of investing as a
long-term pursuit, as stocks can fall and you can lose money on the stockmarket. To read our performance report, go to www.intelligentinvestor.com.au.
DISCLAIMER This publication has been prepared from a wide variety of sources, which The Intelligent Investor Publishing Pty Ltd, to the best of
its knowledge and belief, considers accurate. You should make your own enquiries about the investments and we strongly suggest you seek
advice before acting upon any recommendation.
COPYRIGHT The Intelligent Investor Publishing Pty Ltd 2010. The Intelligent Investor and associated websites and publications are published by
The Intelligent Investor Publishing Pty Ltd ABN 12 108 915 233
(AFSL No. 282288). PO Box 1158 Bondi Junction NSW 1355. Ph: (02) 8305 6000 Fax: (02) 9387 8674.
DISCLOSURE As at 1 December 2010, in-house staff of The Intelligent Investor held the following listed securities or managed investment
schemes: AAU, AAZPB, ABP, ACK, AEA, AEJ, AGIG, AHC, ALL, ALZ, ANZ, ARM, ARP, AVG, AVO, AWC, AWE, AYT, BBG, BER, CAH, CBA, CCK,
CFE, CHF, CIF, CLS, CMIPC, CNB, CND, COH, COS, CRC, CSL, CVW, DVN, EBT, EFG, ELDPA, FGL, FLT, FXL, GNC, GRB, HNG, HVN, IAG, IDT, IFL,
IFM, IMF, IVC, KRS, LMC, LWB, MAP, MAU, MFF, MLB, MNL, MQG, MTS, NABHA, NBL, NWS, OEQ, ONT, PIH, PLA, PTM, QBE, RFL, RHG, RNY,
ROC, SDG, SDI, SFC, SGN, SGT, SHL, SHV, SKI, SOF, SRH, SRV, STO, STW, TAN, TGP, TIM, TIMG, TIMHB, TRG, TWO, WBC, WDC and WHG.
This is not a recommendation.
DATE OF PUBLICATION 1 December 2010
TELSTRA FINANCIALS (M) 20012005
YEAR 2001 2002 2003 2004 2005
EBIT 7,066 6,216 5,723 6,560 7,005
EQUITY 13,722 14,106 15,422 15,361 14,881
DEBT 13,990 13,726 12,555 12,260 13,334
CE 27,712 27,832 27,977 27,621 28,215
ROCE 25.5% 22.3% 20.5% 23.8% 24.8%
TELSTRA FINANCIALS (M) 20062010
YEAR 2006 2007 2008 2009 2010
EBIT 5,497 5,779 6,266 6,558 6,501
EQUITY 12,832 12,580 12,245 12,681 13,008
DEBT 13,378 14,362 15,499 17,323 14,910
CE 26,210 26,942 27,744 30,004 27,918
ROCE 21.0% 21.4% 22.6% 21.9% 23.3%
AVG. ROCE 22.70%
ROICE 274.3%
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