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.