FYI | Apr 26 2017
By Peter Switzer, Switzer Super Report
How to pick quality stocks, and here are a few
Let’s sum me up. We’ve been hanging out for five years now, ever since the Switzer Super Report was created and I’ve always been a great believer in the Jim Rohn advice that: “Success is nothing more than a few simple disciplines practiced every day”.
So what are my simple disciplines that influence my educational messages to you? Try these:
- Buy the dips, which has worked out nicely for stocks like CSL, BHP, ANZ and more. It has also worked for buying the index, with the likes of [ETFs] IOZ and STW.
- Buy quality companies at low prices, which really is just another version of buy the dips.
- Time in the market is better than trying to time the market, though if you can do the latter better than most, you will be better off but it’s damn hard.
- Don’t buy airlines or insurance companies because there are too many curve balls.
I could go on but with every piece of ‘advice’ I give, you can see that I recommend that you stick with quality companies. Of course, even with these you can lose out but the chances of losing decrease when you deal with ‘best of breed’ businesses.
Sure, if you bought CBA at $95, you might be disputing my point, but in this case you were buying a quality company at a high price. You weren’t buying the dip but near the top.
A few simple disciplines practiced every day.
When a lot of investors lost 50% of their portfolio value in the GFC crash of late 2008, the ones who simply bought IOZ — the 200 quality companies in the S&P/ASX 200 index — you are up 75% plus dividends minus a small fee, so let’s call it a 110% gain!
Those who started investing then using this strategy may well be thinking: “How good is this?” They will learn that stocks can also disappoint but, as long as they stick to their strategy, they will beat term deposits and bonds.
It’s all about quality companies and that’s why I asked George Boubouras of Contango Asset Management to select 30 or more quality dividend-paying and dividend-growing companies for my Switzer Dividend Growth Fund.
But if you’re not a 24/7 pro like George how can you pick quality companies at good prices? Last week, Morgan Stanley’s pointy-headed experts, led by Stephen Ye, targeted a few quality companies that look underpriced.
They reckon we’re talking bargain basement prices for quality performers.
According to the number-crunchers “the valuation premium for quality stocks is below its five-year average, so top businesses such as Star Entertainment Group and Trade Me can now be purchased without paying the full premium that normally accompanies buying such quality stocks.” (SMH)
Ye reckons “junk stocks” have outperformed A-graders over the past year, so we might say: “Gather ye rosebuds while in May.”
Let’s clear up what Morgan Stanley (MS) thinks represents “quality stocks”.
Morgan Stanley defines quality stocks as “those in the top quartile of companies when ranked according to profitability, fundamentals stability, dividend payout and safety.”
Junk stocks are in the bottom quartile of this ranking.
The argument Morgan Stanley advances is that junk stocks have done better than quality ones — you could argue the big miners and banks are exceptions to this overall view — and so we’re looking at a ‘buy the dip’ opportunity for quality companies.
Looking at the stable of quality stocks, Morgan Stanley says their forward price-earnings ratio is 18 times earnings but the junk stocks stable is 16.6 and the 1.4 difference is too skinny!
Morgan Stanley has gone looking for quality companies that have value characteristics. Quality companies are often favoured when times are risky, like now, while value companies do well as interest rates rise.
So if you can find companies with a bit of both — quality and value — then you could be on a winner or two.
According to Morgan Stanley, the following have the sweet spot of value and quality.
- Star Entertainment Group (SGR)
- Resolute Mining (RSG)
- Super Retail Group (SUL)
- Trade Me Group (TME)
One step down here are some quality companies that are rated “neutral” on value but these were all tagged with “overweight” by Morgan Stanley:
- Goodman Group (GMG)
- GPT Group (GPT)
- Sonic Healthcare (SHL)
- Charter Hall Group (CHC)
- BT Investment Management (BTT)
In coming weeks, I will get expert views on these companies on my TV show but I wanted to let you know ASAP.
The one company that surprised me that got a jersey was Super Retail Group. I thought Amazon was going to crush retailers! The smarties at Morgan Stanley must think differently and it undoubtedly underlines that retailers, possibly, have been oversold. More on that next week.
Morgan Stanley isn’t the first to highlight the sweet spot many quality companies are in. At its investor briefing last month, Bennelong Australian Equity Partners senior analyst Neale Goldston-Morris, noted that while the reflation trade had mostly run its course, it had left quality stocks undervalued.
“The premium for quality is now the lowest it has been in a very long time,” he told investors.
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
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