Rudi's View | Aug 16 2017
In this week's Weekly Insights:
-How To Invest In All-Weather Stocks?
-Shorter Format During Reporting Season
-Rudi On BoardRoomRadio
-2016 – L'Année Extraordinaire
-All-Weather Model Portfolio
-Rudi On TV
-Rudi On Tour
How To Invest In All-Weather Stocks?
By Rudi Filapek-Vandyck, Editor FNArena
It has taken this long, nine years since the 2008 GFC bear market, but investors nowadays are starting to address me with the moniker (or hashtag) "allweatherman".
This is excellent news given the concept of "All-Weather Performers" has been a dominant feature in two eBooklets I published in early 2013 and late 2014 respectively, as well as in the subsequent two books "Change. Investing in a Low Growth World" (2015) and "Who's Afraid of the Big Bad Bear" (2016).
All four publications are still included in paid subscriptions (6 or 12 months) to FNArena. Plus, of course, I wrote I don't know how many updates on the theme throughout the period; stories that remain available on the dedicated section of the FNArena website.
There is one constant factor that bothers many an investor, including loyal subscribers and readers here at FNArena, and that is the fact that my selection of All-Weather Performers in the Australian share market tends to trade on what seem to be elevated valuations. Hence the ever recurring question is: how does one invest in All-Weather stocks?
Below is my attempt to provide a comprehensive answer to the ever present dilemma.
First up, not a day goes by without me witnessing with a bleeding heart how talking heads on TV rattle off Price-Earnings (PE) ratios for stocks as if these numbers distinguish the good from the bad, the silly from the obvious, the "cheap" from the "expensive" stocks. This is by no means the case, certainly not in the way these numbers are being quoted by most market commentators.
When using PE ratios as a tool, it is imperative to understand that both earnings projections and the share price are fundamental to the calculation of the PE ratio, which is derived from dividing the share price by projected earnings per share next year or the year thereafter. Hence the outcome is a multiple like 14x or 32x or 8x.
Because both factors exert a dramatic influence on the calculated outcome, a falling share price in combination with lowered expectations does not automatically make a given share price "cheaper", even though the share price weakens. And vice versa for an upward moving price on the back of rising expectations.
It also means that when BHP's share price tanked to below $13 last year, the PE ratio had risen to 100x on Macquarie's forecasts, and to circa 65x on most other analysts' profit projections. Hold this thought for a moment, because this is key to what I am about to explain.
Most commentators use PE ratios in the same manner as builders use meters or grocers use kilograms. A 100 meter high building is "huge", a two meter high construction is merely "small". An object of 0.5kg is "light", but make it 25kg and it becomes "heavy". We all understand those base principles, but does this equally mean that a PE of, say, 6x automatically implies a given stock is "cheap" whereas a number of "100x" (see BHP) means we're talking extremely expensive?
Intuitively, you already know the answer. BHP shares briefly traded below $13 during the early 2016 market sell-off but they have recovered nearly 100% since. Hence the PE of 65x or 100x at that time was not indicating that BHP shares were expensive, to the contrary; BHP shares at that level were extremely cheap instead.
Confusing, isn't it?
It becomes a whole lot less so once one starts using PE ratios within their context of: what comes next? PE ratios should never be used as a static tool. They also should never be used backward looking. BHP's high PE ratio from early 2016 has since fallen to circa 15x. Guess what? The share price more than doubled, before retreating somewhat to where the shares are trading at today.
Had the share price remained at say, $15, the PE ratio would have fallen to a ridiculously low 11x. But are BHP shares at 15x cheap or expensive?
It all depends on what likely follows next.
Current market consensus has it BHP's EPS outlook is for a decline by -9.7% by June 30, 2018. This implies the real PE is not 15x but merely 17.3x. Now consider the share market's FY18 average PE is circa 15.7x. If we exclude financials and REITs that average rises to 17.5x.
It appears BHP's PE is smack bang in line with the underlying market average. Since valuation doesn't leave much room for opportunity, it is likely the outlook for the shares are now closely entangled with the direction of commodities prices and thus analysts' forecasts.
BHP will never be included in my selection of All-Weather Performers. The Big Australian is variously labeled "high quality", but the reasons behind the accolade have little to do with the company's inability to control prices for its products, and thus there often is little consistency in the company's performance.
Consider BHP's reported profits over the past three years: down -86%, then further down -36%, now this year probably up by more than five fold, but next year EPS is projected to retreat by -9.5%.
Compare this to one of the most consistent performers on the ASX, IT services provider TechnologyOne ((TNE)), whose annual gowth pace has been in double digits (10%+) every single year since 2004. Company management is yet to discover a valid reason as to why this track record will not remain unblemished in the years ahead. All analysts who cover the stock agree.
This is where things get genuinely interesting. How much does one pay for an automobile that never breaks down? For a pair of jeans that keeps its colour for ever and ever? For a piece of jewellery of the highest clarity that never loses its shine? It's difficult to exactly pin down how high/low the price for each should be, but one thing cannot be denied: one should pay more for these products than for comparables who do not last or carry serious flaws and inconsistencies.
Funny how people accept that a genuine Gucci costs more than your average blouse, or that a Mercedes Benz carries a higher price tag than your average vehicle, or that Ronaldo is one of the highest valued athletes on the planet, yet in the share market cheap trash is meant to be attractive, high quality consistency is not.
Standing in front of an audience of retail investors in Australia, I can ask every time: who owns bank shares and the whole room will show raised hands. Or BHP shares. But if I ask who owns CSL only a few hands will be raised. Yet, since December 2013 BHP shares have generated a negative return of -38% (up until June 30), ex-dividends but that's more like a bandaid for those who consider themselves long term, buy-and-hold investors.
Not that banks have genuinely performed either. National Australia Bank ((NAB)) shares are down -15% over the period, ANZ Bank ((ANZ)) shares are down -11%, Westpac ((WBC)) is down -5.7% and -finally- sector outperformer CommBank ((CBA)) achieved a grand gain of 6.5% over the 42 months until June 30th, 2017; not per annum, for the whole period.
Admittedly, these numbers improve considerably when we add in the dividends and franking that shareholders have received over the 3.5 years. But here's the rub: CSL shares, constantly deemed "too expensive", gained more than 100% over the same period, ex dividends. The aforementioned TechnologyOne shares appreciated by some 150% over the period, ex dividends and franking.
The point I am trying to make is that if shares for the likes of CSL and TechnologyOne are too expensive for investors to buy, but the others, while more attractively priced, generate a considerably lower return, then surely something is wrong with how investors make their assessment about which stocks are cheap and attractive, and which ones are expensive and unattractive?
The ugly truth about a share market obsessed with finding cheaply priced opportunities is that most cheaply valued companies come with a serious problem. Either the cycle is working against them, or the competition is, or their business model is flawed, or something else. And whatever caused the share price to tank to exceptionally low price level often returns at a later stage, again pulling back the share price, potentially as low as where it was.
This shouldn't be a problem, as long as investors get in and out in time. But let's face it: many don't. Thus the registers of sunken U-boats like The Reject Shop, Slater and Gordon, Lynas Corp, and Myer remain populated with dreamers in obstinate denial, hoping that one day, one day (when pigs can fly and Santa Claus sells his estate on the North Pole).
Admittedly, investing in the high quality growth stocks that truly deserve to be labeled "All-Weather" can be a little daunting. Price Earnings ratios tend to be well above market average, and it's not like the share market won't inject an unhealthy dose of day-to-day volatility at precisely the wrong time, and probably for an uncomfortable duration too.
But herein lies true opportunity.
When the flea shop owner presents you with a genuine Salvador Dali, you don't blame him for not knowing what the true value of the art work is. You buy and praise yourself lucky.
Ever since I began directing my research towards All-Weather Performers, my recommendation has been for investors to keep a list of those stocks they'd like to own; Amcor ((AMC)), CSL, Ramsay Health Care ((RHC)), TechnologyOne, et cetera. You keep a close eye on them. And when the market spits them out because it temporarily fails to appreciate the build-in characteristics of quality, adaptability and consistency, you think about the ignorant flea shop owner, and you buy with a big smile.
Next thing you know, you start reflecting on what would have happened if you'd included such stocks much earlier in your portfolio, and that's when you really realise the financial industry is one big marketing apparatus, focused on pointing out the next cheap "opportunity" in the share market, not necessarily to help you make the best return from your investments longer term.
In case anyone wondered, the ASX200 between January 1st 2013 and June 30th 2017 advanced the grand total of 6.8%, ex franking and dividends.
So what makes a true All-Weather Performer and how does one feel confident enough to step on board?
In practice, this is all about a resilient business platform which helps fend off threats from competitors, business cycles and changing consumption patterns. Of course, nothing is ever fully risk-free, not with central banks mingling and governments looking for easy targets. Markets are constantly in flux and potential disruption is always around the next corner.
But companies like Amcor, CSL, TechnologyOne, et cetera have the legacy to prove their resilience is not just a marketing spiel, every single year their results show the true virtue of the ability to consistently perform. To put it in Peter Lynch's lingo: these are such good businesses, any idiot can run it, and it'll still be a good business. If you like Warren Buffet more: replace with your idiot nephew, but keep the part about what makes a good business.
This doesn't mean things cannot change. Once upon a time I would have included Monadelphous, Woolworths and Wesfarmers. It can even be argued pre-2013 the major banks should be included too. Right now there are genuine question marks hovering above Domino's Pizza ((DMP)), Ansell ((ANN)) and Brambles ((BXB)).
But none of this should deter investors from aiming to include resilient, consistent and high quality performers if only for the simple fact growth consistency has proved to be more mirage than reality for the overwhelming majority of ASX-listed corporate Australia, and the years ahead don't seem like they will be fundamentally different.
The first two weeks of the August reporting season have already shown extreme volatility. Mayne Pharma is down -35%. Mesoblast is down -32%. Australian Pharma is down -30%. Myer is down -21%. Select Harvests is down -17%. Skycity Entertainment is down -13%. Coca-Cola Amatil is down -13%.
While there is a natural reflex for investors to zoom in on potential opportunity among these early casualties, longer term investors, in my view, should direct their focus towards companies like Orora ((ORA)), Carsales.com ((CAR)) and REA Group ((REA)). Any weakness in these share prices has proved short term and fleeting.
Just like I would have predicted.
Shorter Format During Reporting Season
A tsunami of corporate reports, and stockbroking analysts subsequently updating their views and projections, turns FNArena temporarily into a Chinese sweat shop experience. I am sure FNArena subscribers and regular readers of Weekly Insights appreciate the fact that Weekly Insights is in a shorter format in the coming three weeks.
Rudi On BoardRoomRadio
My latest interview, a preview on the August reporting season, can be accessed here:
2016 – L'Année Extraordinaire
It was quite the exceptional year, 2016, and I did grab the opportunity to write down my observations and offer investors today the opportunity to look back, relive the moments and draw some hard conclusions about investing in the world today.
If you are a paid subscriber to FNArena, and you still haven't downloaded your copy, all you have to do is visit the website, look up "Special Reports" and download your very own copy of "Who's Afraid Of The Big Bad Bear. Chronicles of 2016, A Veritable Year Extraordinaire" (in PDF).
For all others who still haven't been convinced, eBook copies are for sale on Amazon and many other online channels. You'll have to visit a foreign Amazon website to also find the print book version.
All-Weather Model Portfolio
In partnership with Queensland based Vested Equities, FNArena manages an All-Weather Model Portfolio based upon my post-GFC research. The idea is to offer diversification away from banks and resources stocks which are so dominant in Australia, while also providing ongoing real time evidence into the validity of my research into All-Weather Performers.
This All-Weather Model Portfolio is available through Self-Managed Accounts (SMAs) on the Praemium platform. For more info: email@example.com
Rudi On TV
This week my appearances on the Sky Business channel are scheduled as follows:
-Tuesday, 11.15am Skype-link to discuss broker calls
-Thursday, Skype-link around 12pm
-Friday, 11.15am Skype-link to discuss broker calls
Rudi On Tour
– I will be presenting in Adelaide on November 14th to members of Australian Investors Association and other investors, 7pm on November 14th inside the Fullarton Community Centre, 411 Fullarton Rd, Fullarton. Title of presentation: Investing In A Slow Growing World – An Update
(This story was written on Monday 14th August, 2017. It was published on the day in the form of an email to paying subscribers at FNArena).
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.
In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: firstname.lastname@example.org or via the direct messaging system on the website).
BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS
Paid subscribers to FNArena (6 and 12 mnths) receive several bonus publications, at no extra cost, including:
– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
– Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow.
– Who's Afraid Of The Big Bad Bear? eBook and Book (print) available through Amazon and other channels. Your chance to relive 2016, and become a wiser investor along the way.
Subscriptions cost $380 for twelve months or $210 for six and can be purchased here (depending on your status, a subscription to FNArena might be tax deductible): https://www.fnarena.com/index2.cfm?type=dsp_signup