Rudi's View | Nov 08 2017
In this week's Weekly Insights (published in two separate parts):
-Australian Equities: Angels, Falling And Rising
-The Many Joys Of October
-Conviction Calls: Morningstar, UBS, Ord Minnett, Wilson, GS, Bell Potter, DB, Morgans
-RBA Rate Hikes: Slip Slidin' Away
-No Weekly Insights Next Week
-Rudi On BoardRoom.Media
-2016 – L'Année Extraordinaire
-All-Weather Model Portfolio
-Rudi On TV
-Rudi On Tour
[Note the non-highlighted items appear in part two on the website on Thursday]
Australian Equities: Angels, Falling And Rising
By Rudi Filapek-Vandyck, Editor FNArena
It is a popular sport around the traps of the Australian share market to tear down popular growth stocks trading on high Price Earnings (PE) multiples. But as I like to repeat, time and time again, Price-Earnings multiples are misunderstood by most investors and equally so by most analysts and market observers.
Any PE without additional data and insights about share prices and earnings growth past, present and future is misleading under the best of circumstances, and simply useless in all other scenarios. A low PE does not automatically imply a given stock is low risk or great value, just like a high PE does not equal a given stock is "expensive", or high risk, or suitable for short term momentum trading only.
It remains true that investors can fall in love too deeply with a stand-out performer, and as a result the share price can rise for way too long, and way too high, until that moment of reckoning arrives. But it is also my observation such "Icarus" stories attract far too much attention. Think Domino's Pizza between late August last year and early September. Excessive coverage of "fallen angels" deter investors, professional fund managers included, from owning solidly performing, high quality growth stocks such as Cochlear ((COH)), ResMed ((RMD)), Treasury Wines ((TWE)), Altium ((ALU)) and WiseTech Global ((WTC)).
The fact that many of the stocks I have identified as All-Weather Performers trade on above market PE multiples, yet the fact they outperform the broader market in most years, including the lower PE stocks over mid to longer term horizons, is a regularly occurring observation that cannot be reconciled with how most experts talk about investing in the share market.
And so it is that I often marvel at the sheer simplicity, and the blatant absence of much intelligence, when journalists, commentators and analysts alike are launching yet another attack to tear down high PE stocks, as if High PE is one universal label that fits all stocks that are trading on, at face value, elevated multiples.
This time last year the ruling mantra in the share market was "sell High PE stocks", and thus NextDC ((NXT)) shares were abandoned alongside Aristocrat Leisure ((ALL)), Domino's Pizza, Cochlear, CSL ((CSL)), Corporate Travel ((CTD)), Transurban ((TCL)), Goodman Group ((GMG)), REA Group ((REA)), and many others.
Yet, today, with the notable exception of Domino's Pizza, most of these stocks are trading at much higher levels (most have paid at least two dividends in the meantime too). Transurban is not, but despite the natural headwinds of rising bond yields, it is not that far off from last year's share price.
I am willing to bet more losses are being generated each year by investors trying to scoop up cheap looking stocks like Telstra ((TLS)), Vocus ((VOC)), TPG Telecom ((TPM)), iSentia ((ISD)), Mayne Pharma ((MYX)), Brambles ((BXB)) and the likes, rather than through adding High PE champions to their portfolio that would have brought along significant outperformance, not just over the past year, even including Domino's Pizza and Ramsay Health Care ((RHC)); both had one bad year among many more fortuitous ones.
I have yet to see the first research report that genuinely sings the praises of the High PE stocks mentioned above, which is not a small feat considering I have been reading analyst research in Australia for more than seventeen years now. Also consider that many of those stocks are among the top performers in the local share market post 2010.
FNArena subscribers who would like to educate themselves on this gap between the ruling share market mantra and the reality of owning reliable, solid, performing High PE growth stocks can do so via the dedicated webpage on All-Weather Stocks on the FNArena website as well as through downloading my writings and analyses on the subject via the Special Reports section. I suggest you start with "Make Risk Your Friend. Finding All-Weather Performers", volumes one and two.
The investment strategy team at Credit Suisse is the latest to issue research not in favour of owning High PE stocks, in this report named as "market darlings". When to dance with a darling? asks the report. The answer is pretty straightforward: you own a market darling before the stock becomes a darling.
Easier said than done, of course. We'd all like to go back in time and, with the knowledge we have today, buy as many shares in Aristocrat Leisure, CSL, Cochlear, et cetera as we can lay our hands on. It goes without saying investment returns are greatest during the process of expanding PE multiples.
But from here onwards, the Credit Suisse strategists reveal their inherent bias. Once a stock becomes a market darling, relative outperformance against the broader market becomes a lot smaller. According to the research conducted, we're now talking about a mere 1% per annum above the market's return.
Hence their conclusion is: there is no need anymore to own market darlings once they officially are a darling.
I disagree. And I have some clout in this discussion since the portfolio I run owns shares in CSL, REA Group, Aristocrat Leisure, and the likes. Nobody would deny any of these names the status of "market darling", and neither would they have twelve months ago, or the year before, or the year before that year.
Yet, as anyone can see once they start lining up the hard data/evidence, in most years these stocks beat total market return, and often by quite a margin too. And that's not even taking into account that research done, as in the case of Credit Suisse's, uses passive data (like all calculations rum from January 1st till December 31st) while investors can adapt to a more flexible approach, like selling shares when PEs run out of oxygen and buy a lot more when share prices fall and bottom out.
REA Group shares are an ideal example. After last year's FY16 result, the shares fell from circa $62 to $50, yet this week they are trading above $73. Forget about the dividends for now, shareholders who held on at last year's peak, are today enjoying a gain of more than 17.5% (what do you mean a slight beat of the broader market only?). That instantaneously improves significantly when new shares were added near the $50 level, nearly -40% below today's share price.
It's not a one-off either. In 2015 the shares fell from $49 to below $39. In 2014 they fell from above $49 to $43.
Admittedly, the gains are a lot higher when darlings are in the process of becoming a darling and PE multiples are steadily increasing. On Credit Suisse's numbers, the average outperformance achieved is some 23% above the market's return. The problem is, of course, that in most cases it's a lot easier to identify market darlings in hindsight than it is before or during the process.
The strategists have nevertheless compiled a list of stocks they believe could become tomorrow's darlings. Tomorrow's potential glamour stocks all have large profit margins, little, if any, debt on the balance sheet, while enjoying solid sales and earnings growth momentum.
Credit Suisse has made the effort to identify today's market darlings, with the underlying suggestion that these stocks should from now onwards be best avoided. These are:
The analysts are supported in their belief by the observation that a similar list of market darlings from two years ago, has seen the majority perform disappointingly since. Market darlings in October 2015, since dominated by fallen angels, were:
The obvious observation here is that most of the nominees two years ago were beneficiaries from monetary stimulus and falling bond yields, a theme that has since reversed, at least in underlying trend terms. Take out those examples, and all of TechnologyOne, Aristocrat Leisure and Cochlear still managed to significantly outperform the broader market.
Thus while Credit Suisse's observation stands tall, in that returns are much higher during the process of becoming a market darling, my own experience and the three examples from the October 2015 selection equally prove one should not categorically avoid high PE market darlings simply because the better returns belong to the past.
Time to zoom in on the characteristics required to become a future glamour stock. According to Credit Suisse, the following three items are stand-out requirements:
1. Future market darlings enjoy large profit margins. Two-thirds have EBITDA margins of more than 20%. A third has margins of more than 40%;
2. Future market darlings have strong balance sheets. More than a fifth are in a net-cash position. While almost half have net-debt to EBITDA of less than 1x;
3. Future market darlings already enjoy solid profits momentum. They are often stocks past their infancy stage and enjoying the steep part of their development curve.
In summary: future market darlings are stocks that are listed on the equity market, but do not need the equity market. They already generate plenty of cash via their large profit margins and can tap creditors if need to.
In addition to the five names mentioned earlier, and clearly Credit Suisse has shown its preference by putting those forward in a small selection, the following candidates have been put forward for potential future market darling inclusion:
All this just goes to show how important are one's interpretation and definition of a widely used concept like "market darlings". Personally, I'd consider stocks like Carsales, ARB and ResMed already as part of the glamour stock community in Australia. These stocks already trade on above market PEs, and they have been for an extended period of time.
One clear deterrent for stocks to become a high PE market darling, in my view, is there cannot be any lingering questions about the outlook for the stock or the sector in which it operates. Given this I am surprised to see inclusions like Mirvac, Iluka and GPT. But we all have to be open minded about these things, so I'll happily review all of this in one or two year's time, and see where we're at then.
The Many Joys Of October
Follow financial markets long enough and eventually that one conclusion pops up: nothing, no matter how long the odds, is impossible.
Share prices across the board falling by more than -20% from the moment the market opens? We've all been reminded last month that's exactly what happened in 1987. Old hand stockbrokers will tell you they are still dealing with the mental scars of that experience today.
Equally, if someone would have told me shares in Bellamy's ((BAL)) would rise 59.9% in the space of one month, I would probably have shown some resistance to the idea. Adding that a2 Milk ((A2M)) was to accumulate a further 30%, and Afterpay Touch ((APT)) a further 24.4%, and WiseTech Global ((WTC)) a further 34% would simply be seen as soliciting a forced mental check up.
Yet, this is exactly what happened in October.
After five months of frustrating even the more experienced investors in Australia, the Australian share market sprung to life with a Big Bang from the moment funds managers had closed the books on Q3 and the calendar entered a new month. Including dividends the ASX200 added 4%, effectively doubling the calendar year's total return thus far, with two more months to run.
As per always, the gains were not equally spread out across the field. The Top 50 in the local market only gained 3.5%; Financials 3.3%; the Top 20, 3.1%; the telecom sector only 2.8%. For once the Australian market performed better than most of its offshore peers.
Best performing sector was Info Tech where high flyers like Altium ((ALU)), Afterpay Touch and Aconex ((ACX)) contributed to an average gain of 9.3% for the sector over the month. Energy, long a laggard among peers, sprung to life with double digit performances for Beach Petroleum ((BPT)) and Santos ((STO)).
Instead of basking in the unexpected fortunes that October has brought upon Australian investors, it might be a better idea to look underneath the bonnet to determine what are the likely drivers behind this sudden reversal in trend, and what is the most probable outlook?
For five long months it seemed nothing was going the Australians' way. Corporate results failed to excite. Political impasse all too regularly turned into comedy and farce. The RBA was misunderstood. The Aussie battler too expensive. The property cycle is turning. Amazon is going to wipe out local retailers and if that doesn't happen then surely the tightening squeeze on household budgets will do just that.
Meanwhile, over in the land of covert Russians, Yellen and Trump, the economy is humming just nicely; corporates are reporting healthy profits, taking advantage of global momentum, a weak greenback and tectonic changes in technology, energy and manufacturing processes.
The Federal Reserve is on a gradual tightening policy, there's no inflation so the bond market behaves and the Trump administration, no matter how distracted and disorganised, is keeping the promise alive of significant reductions to corporate taxes and of levies for foreign imports (let's not forget the second ingredient of the Great Grand Tax Plan for the Future), and investors are lapping it all up with great delight.
It doesn't matter what the exact definition says; we all recognise a bull market when we see one.
In Australia, strategists at Macquarie probably summed it up best when they concluded Australian equities have been dragged along by a global bull market. And yet, this is only part of the explanation of what caused the local share market to explode upwards since the 1st of October.
The other explanation marks a key difference between professional wealth managers in Australia and their peers overseas. In the US average cash levels are near historically low levels and concerned analysts are wondering where the next buyer will come from (funds switching out of bonds is one option).
In Australia, funds managers found themselves in late September with more cash than necessary and a moribund share market that did not weaken as prescribed by the usual seasonal pattern. Australia also still has a problem at the top end of the market where profit growth remains benign and of low quality (cost outs). Prospects are not seen as highly promising. Share prices are not exactly cheap either, which translates into questions about further sustainable upside potential for blue chip equities.
The struggles for the top end of the Australian share market are once again highlighted by the major banks reporting in November. With the exception of Macquarie Group ((MQG)), none of the financial releases was able to inject any excitement into the sector. Most releases attracted investors selling as the immediate response. Target prices are little moved. Share prices are not far off.
Given non-excitement for the top end, and with too much cash on the sidelines yearning to be employed, the Australian share market has turned into a pressure cooker for second and third tier growth stocks. One look at the share price chart for the stocks mentioned earlier instantly reveals how fresh money flowing into the share market has kept chasing popular ideas ever higher. With the odd exception, momentum behind many of such stocks remains solid.
Shares in mid- and small-cap favourites such as a2 Milk ((A2M)), BWX ltd ((BWX)) and NextDC ((NXT)) cannot possibly absorb all of the fresh funds put to work, which is why many of the laggards have started moving. Even Telstra shares are off their lows.
One of such laggards is Link Administration ((LNK)), currently a heavy weight in the FNArena/Vested Equities All-Weather Model Portfolio. We like Link because of its sticky client base (Australian superannuation funds), its fee based, market independent recurring revenues and its admirable, technological edge when offering services.
Link is one stock that is typical on a funds manager's radar with the aim of owning it for the long term. There are never questions about the quality of the business, or of the operations, or the technology. Because the shares only listed in late October 2015, Link remains largely unknown across the broad investment community, in particular for retail investors.
There is no natural link (pun intended) to popular themes like electric vehicles or technological disruption, and more often than not market commentators will put the stock down as a mini-Computershare, because both operate share registries. But Link is more different than similar when compared to Computershare, even after a significant acquisition in the UK which has transformed the risk profile.
As is typical with quality companies, and in line with Link's life as a publicly listed entity thus far, the UK acquisition has already generated positive news flow. This is important as many an investor would have at least some hesitation given overseas acquisitions is what killed the upward trend for iSentia and for Mayne Pharma, not to mention Slater & Gordon. On my observation, Link has been included in several lists of stock tips and Conviction Buys in recent weeks.
No surprise thus, the share price has started moving upwards and the gap with stockbroking price targets is closing.
Another laggard that is proudly held in the portfolio is Bapcor ((BAP)), whose management at the recent AGM repeated guidance for this year in that non-core businesses in New Zealand will be sold off and core operations over there smoothly integrated and on schedule, with core operations overall to grow profits by 30%.
Bapcor shares are being held back, I believe, out of fear for what Amazon can possibly inflict once it arrives in Australia, while part of the business is consumer facing and this, with big question marks about consumer budgets and spending, is treated as yet another item for potential negative surprise.
We treat Bapcor as a long term investment and believe the market's scepticism will evaporate at some point, allowing the share price to rise to levels that better reflect the quality and the resilience of the operations.
A similar context/conviction surrounds our investments in Webjet ((WEB)), TechnologyOne ((TNE)) and Viva Energy ((VVR)). The latter remains undervalued because of added fear for rising interest rates in the US.
Overall, the FNArena/Vested Equities All-Weather Model Portfolio has been enjoying solid upward momentum post October 1st. Total return for the month was 5.88% and for the calendar year to date it has now surpassed 10%. Both numbers are better than the ASX200 which is being dominated by exposures we typically avoid: banks, sideways moving old economy icons, and resources stocks.
On a broader view, many of the stocks that have performed well this year look stretched and are oft trading well above analysts' valuations. Even though short term momentum remains strong, we cannot but wonder how much further many of these share prices can extend their upward trajectory.
Last week I reported there was one final ticket still available for An Evening With Rudi in Paddington on November 22. That ticket has now been sold.
Truly looking forward to sharing my latest insights, alongside various genuinely revealing tables and price charts, big trends and personal observations.
But first I will travel to Adelaide to share all of it with local members of Australian Investors' Association, and guests.
No Weekly Insights Next Week
Next week (Nov 13-17) I am visiting Adelaide to present to the local chapter of the Australian Investors' Association (AIA) on Tuesday. As I will be traveling on Monday, there shall be no Weekly Insights for the week. No doubt, I will have plenty to write about the following Monday.
My presentation in Adelaide is the final event locally for the running calendar year, and as such there will be bickies and drinks afterwards. If you are a regular reader or paid subscriber attending the event, please say hello whenever the opportunity arises. My ear is always available for both praise and for constructive criticism. This year's newly launched website is an eternal work in progress. All ideas are welcome.
I intend to take an overdue break in December, thus the number of Weekly Insights this year post this week will be limited to a maximum of three.
Rudi On BoardRoom.Media
Audio interview from Tuesday last week:
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
-Wednesday, 7-8pm, hosting Your Money, Your Call
-Thursday, Noon-2pm, Trading Day Live
-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 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 6th November, 2017. This first part was published on the day in the form of an email to paying subscribers at FNArena, and will be again on the following Wednesday as a story on the website. Part two shall be published on Thursday).
(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