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Value Versus Growth – The Uncomfortable Truth

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Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | May 30 2018

In this week's Weekly Insights (published in two parts:

-Value Versus Growth – The Uncomfortable Truth
-Conviction Calls (1)

-Compare The Pair: REA vs DHG
-Conviction Calls (2)
-Pressure-Points In Aussie Staff Costs
-Rudi Talks
-Rudi On TV
-Rudi On Tour

-At The AIA Conference

[Note the non-highlighted items appear in part two on the website on Thursday]

Value Versus Growth – The Uncomfortable Truth

By Rudi Filapek-Vandyck, Editor FNArena

Very few occurrences can be as testing as a falling share price. And let's be honest: it happens to the best of us, irrespective of how much research and preparation we put in before jumping on board.

Last year, a falling share price for Eclipx ((ECX)) caught my attention. For those not familiar with this company: this is the same core management that once was responsible for success at FlexiGroup. Today CEO & MD Doc Klotz and his team are building a sophisticated financial services company including fleet leasing, equipment hire and consumer motor vehicle financing.

But the share market has been a harsh judge on early news flow and potential risks from stripping down and integrating Graysonline, despite management's assurances everything is converging and growing according to plan. While the share price has recovered from recent lows near $3, it is but a fair assessment the inclusion of Eclipx in my equities portfolio has to date fallen well short of expectations.

Another inclusion that has failed to perform recently is TechnologyOne ((TNE)), in my view one of the absolute super stars in the local IT sector. Up until mid-2017 there was little management at the Brisbane-headquartered enterprise software company could possibly do wrong, and the returns for shareholders were commensurate. Since then, it seems, the market has turned in sentiment and now prefers to punish first, then ask questions later.

All the while, the company is steadily migrating its customer base into the cloud, and increasing annually recurring revenues. Management anticipates in a few years time it will be able to lift the annual growth guidance to 15-20% from 10-15% at present. Again, the share price is off its recent bottom, but it has been a rocky slide south over the past year or so.

Reflecting upon both stocks brings back memories about two other stocks that have been in my portfolio for quite a while: Bapcor ((BAP)) and Hansen Technologies ((HSN)). The latter fell out of favour between October 2016 and September last year, for various reasons, but the stock has made a strong come-back since. Bapcor is one of the best performing portfolio inclusions this calendar year. Shareholders had to wait until April. Nobody knows why.

These four examples touch upon one of the most difficult dilemmas to solve for investors in the share market: at what point exactly does one throw in the towel and declare enough is enough?

The question is one that haunts every investor, from time to time. Once upon a time I owned shares in iSentia ((ISD)) and in Vocus Group ((VOC)) but, by gosh, am I glad I waved goodby to both long time ago. It helps when one has a deep understanding of what exactly makes a company tick, and what doesn't, and where are the risks. But things are never this easy, of course. Negative surprises aside, businesses go through changes on a daily basis; corporate life never is but a static concept. And then there is the share market itself. Piping hot one day, Antarctic cold the next.

Whereas every day a trader tells himself: the market is always correct, we, the investors, we know that is simply not true. We observe the CSL share price getting smacked to $92.25, and then it adds 100% in the following 1.5 years. Equally astounding, between October and late November last year shares in Big Un quadrupled -yes, that is multiplying by a factor four- but everyone still on board the company register today is trying to come to terms with the probable loss of -100% of all capital invested in the shares.

Plenty of dilemmas for professional investors too. Most funds managers in Australia are 'value' investors, which means core strategies are built around cheap looking share prices, and as they become cheap-er, portfolio allocations widen further into overweight positions in anticipation of the upward correction that surely must follow. Such strategies have had an incredibly tough time in the past four to five years, in particular post May 2015.

Even with Australian bank shares going through one of the longest, and most pronounced, periods of underperformance in Australia, many Australian equities funds barely manage to beat the share market's overall lacklustre performance. This is because most run a large allocation to those same banks. Luckily, for some, returns have been exceptionally good for miners and energy producers; at least until recently.

Just how much of a hard time these professional funds managers (and many a self-managing SMSF) have had can be deduced from the fact the ASX20 Accumulation Index (including dividends) has generated no more than 3% per annum in total return over the three years since 1st June 2015. This compares with 6% (twice as much) for the broader ASX200 Accumulation Index, and with 8% p.a. for FNArena's All-Weather Model Portfolio.

Of course, in a share market that is predominantly 'value'-oriented, momentum-driven, and myopic in attention span, the big conversations around the traps as we approach the final month of the financial year are: when might the Telstra share price (finally) stop falling? Are the banks finally ready for that big rally? Shouldn't we stop fretting about the potential impact from Amazon and higher bond yields on local retailers?

With High Quality, Modern Era Champion Stocks (CSL, REA Group, et al) outperforming in significant fashion, all these questions can be summarised as: when is the bottom of the share market ready for a come-back?

The last time we saw such a large disparity in valuations for top performers and bottom dwellers in the Australian share market was in mid-2016 after which money flowed out of the first segment into the second, causing a serious correction for High Growth and a fierce come-back for the share market laggards. But here we are, two years later (actually, less) and we, investors, find ourselves again confronted with the same dilemma.

Note that while many among today's share market laggards are by now trading on lower share prices in comparison with two years ago, stocks like CSL, Aristocrat Leisure ((ALL)), REA Group, ResMed ((RMD)), Cochlear ((COH)), et cetera have surged to new all-time highs.

Maybe investors, large and small, have been too focused on price, and on relative valuations, and not enough on how much is changing in today's economy, impacting in particular on large cap Australian quasi-monopoly operators that have been lulled into boardroom hubris and management over-confidence that all shall be alright, just like it always has been in the past.

Instead of being bamboozled by short term impacts such as the NBN and/or the Royal Commission, maybe a more correct way of viewing share market stragglers such as AMP, Telstra, CommBank and Scentre Group (among many others) is through the prism of market leaders that have rested on their laurels for way too long, while the world kept changing around them. Now that the Day of Reckoning has arrived, these businesses are not ready for today's changing landscape, let alone for tomorrow's challenges.

If this assessment proves correct, these businesses need to switch course, and pretty quickly too. But adaptation requires fresh ideas, new structures, new products, additional investments (probably lots of it) and time. Meanwhile, how patient are you as an investor? How much underperformance are you willing to stomach, relative or otherwise? Does the promise of ongoing dividend payments outweigh the prospect of little to no capital appreciation, or worse?

In a share market that is increasingly dominated by automated execution and short-term momentum strategies, there is always the risk investors are willing to pay too much for growth and certainty, in the short term, but maybe the real question here is how much sustainable upside is there, realistically, from under-priced share prices in companies that have very little to offer, other than a cheap looking share price?

That is the $64m question that will distinguish the winners from the losers in the Australian share market in the year ahead, and beyond.

Conviction Calls (1)

The most recent update on Conviction Calls at Goldman Sachs certainly has a bias towards under-priced shares ("value'), but with a few strong growers added as well. The current list consists of twelve Conviction Buys ranging from ANZ Bank ((ANZ)) and Telstra ((TLS)), to Aristocrat Leisure ((ALL)), Netwealth Group ((NWL)), Bingo Industries ((BIN)), BWX ltd ((BWX)), Huon Aquaculture Group ((HUO)), Lifestyle Communities ((LIC)), Origin Energy ((ORG)), Propertylink Group ((PLG)), Sims Metal Management ((SGM)), and Suncorp ((SUN)).

More Conviction Calls in Part Two on Thursday.

Rudi On TV

This week my appearances on the Sky Business channel are scheduled as follows:

-Monday, Money Talks with Peter Switzer, 7.30-8pm
-Tuesday, 11.15am Skype-link to discuss broker calls
-Thursday, from midday until 2pm
-Friday, 11am, Skype-link to discuss broker calls

Rudi On Tour

-Presentations to ASA members and guests Gold Coast and Brisbane (2x), on 12 & 13 June
-ATAA members presentation Newcastle, 14 July
-AIA National Conference, Gold Coast QLD, June 29-August 1
-ASA Presentation Canberra, 3 August
-Presentation to ASA members and guests Wollongong, on September 11
-Presentation to AIA members and guests Chatswood, on October 10

At the AIA Conference

As stated in the overview above, I will be presenting at the AIA National Annual Conference at the Marriott Resort and Spa Surfers Paradise, from 29th July til 1st August 2018.

This year's theme is SYNCHRONICITY, Identifying opportunities in a world growing in sync…

 For the first time in over a decade, the world’s major economies are growing in sync.

What does a world that is structurally awash in capital look like?

What will it mean for investors?

http://www.investors.asn.au/events/aia-national-investors-conference/

(This story was written on Monday 28th May 2018 and on Wednesday the 30th. Part One was published on the day in the form of an email to paying subscribers at FNArena, and again on Wednesday as a story on the website. Part Two will 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: info@fnarena.com or via the direct messaging system on the website).

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BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS

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– 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.
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(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.)  

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ALL ANZ BAP BIN BWX COH ECX HSN HUO ISD LIC NWL ORG PLG RMD SGM SUN TLS TNE VOC