In Search Of ‘Value’, Avoiding ‘Cheap Junk’

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 | Jul 18 2019

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

-In Search Of 'Value', Avoiding 'Cheap Junk'
-All-Weather Portfolio Update
-Unveiling The US Corporate 'Secret' - Three Charts
-Conviction Calls
-Rudi Talks
-Rudi On Tour
-Rudi Talks

In Search Of 'Value', Avoiding 'Cheap Junk'

By Rudi Filapek-Vandyck, Editor FNArena

The sharp division between investors in "Growth" and in "Value" has added yet another chapter over the past six months, despite a notable resurgence for banking stocks and iron ore miners throughout the half.

But, as highlighted in the graphic below from a recent market analysis released by Morgan Stanley, there is more to the persistent market division between "winners" and "losers" than simply the concept of investors continuing to buy Growth Stocks because, well, they are growing strongly, while largely ignoring the companies that are struggling.

Morgan Stanley correctly points out today's popular Go-To Stocks do not simply comprise of "Growth" stocks like a2 Milk ((A2M)), Altium ((ALU)) or Nearmap ((NEA)), they equally include "High Quality" names such as CSL ((CSL)), REA Group ((REA)) and TechnologyOne ((TNE)).

And on the losing side, among the laggards while share market indices have done nothing but surge higher, the story is not just about "Value" having fallen out of fashion against "Growth"; this is equally about the division between "Low Quality" and "High Quality" companies.

For most investors, professional or otherwise, the concept of using a "Quality" mark for listed equities is a rather uncomfortable one. No stockbroking analyst will ever put on paper that the company under scrutiny is of Low Quality because management at the helm will take offence, leading to negative consequences for the analysts or their employer.

Similarly, there's no value investing funds manager in the country, or elsewhere, who runs the marketing slogan: we buy the lowest quality of listed businesses, but only when their stock looks really cheap. While, in reality, that is exactly what buying "deep value" translates to in the share market.

High Quality names such as CSL, REA Group and TechnologyOne might be just as susceptible to market sentiment and equally be impacted by market volatility, their equities are never as "cheap" as, for example, AMP ((AMP)), Retail Food Group ((RFG)), EclipX Group ((ECX)), Speedcast International ((SDA)), iSentia ((ISD)), Freedom Insurance ((FIG)), The Reject Shop ((TRS)), and many, many others.

While cheap, beaten down share prices can potentially start a rally anytime, and at a moment's notice -just look at Retail Food Group recently, or Eclipx Group- the experience of the past years shows these rallies are rather unlikely to stick around for long.

Witness how shares in Myer ((MYR)) more than doubled between February and April this year, but they've subsequently lost half of that rally. In the case of AMP, the end destination has continually remained a share price at a lower level. Now speculation is rife a dilutive equity raising might be unavoidable.

But the Morgan Stanley graphic makes a good point in highlighting today's share market laggards do not solely consist of Low Quality operations with a gigantic chip on the shoulder. There are plenty of listed companies out there that are regrettably operating inside the wrong sector at the wrong time, or battling temporary set-backs that won't hold them back forever and ever.

The steep come-back for Ramsay Health Care ((RHC)) shares over the past seven months would be one such fine example, as is the even steeper recovery enjoyed by InvoCare ((IVC)) shares. Let's not forget that prior to June last year, nobody seemed very much interested in owning shares in TechnologyOne. Or try Cochlear ((COH)) shares up until April.

The timing for such a share price recovery is never easy to predict. Most investors who own "value", deliberately or through misfortune, don't sell when the timing for recovery is delayed, unless the investment case changes. Part of the underperformance of large swathes of professional funds managers can thus be traced back to sectors and stocks that seem undervalued, but for whom the time to shine has not arrived just yet.

Another way of looking at this is through the concept of a rolling, evolving and shifting bear market in today's share market. When I published Who's Afraid Of The Big Bad Bear?" in December 2016, the final page of the book contained the following conclusion:

Whereas most market participants still carry lively memories (and possibly traumas) about what happened between late 2007 and early March 2009, and maybe about the period 2000-2002 as well, the Grizzly Bear nowadays travels through specific sectors and segments of the share market.

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