In this week's Weekly Insights:

-Opportunities With A Five Year Horizon
-Company Reports: Early Trends
-Company Reports: Inflation
-Company Reports: Conviction
-Company Reports: Technology Sector
-REITs In Focus

By Rudi Filapek-Vandyck, Editor FNArena

Opportunities With A Five Year Horizon

Most investors like to profess they are in it for the long term, but let's be brutally honest: we are all influenced by what happens in the here and now, irrespective of what the consequences might be in the long run.

Which is also why my own investor heart tends to skip a beat whenever an experienced market researcher makes the effort to identify great opportunities with a longer term focus.

At the very least, in my humble opinion, such research offers the rest of us mere mortals with valuable input to think about, detached from the immediate and daily share price movements.

One extra observation to throw in the mix: whenever analysts try to identify great longer-term investments, they mostly end up overlapping each other's selections, with personal preferences often creating the minor differences.

Wilsons' latest effort fits in almost perfectly with my own research into All-Weather Performers on the ASX.

Last week Wilsons published a list of five stocks for the next five years; a small selection of genuine bottom-drawer stocks, that can be owned and trusted to reward shareholders over the next five years, at least. The selection is supported by attractive structural trends such as healthcare innovation, energy transition, cloud computing, and financial industry disruption.

The five companies selected because, in the words of Wilsons, they deserve a place in every investor's portfolio, are CSL ((CSL)), Macquarie Group ((MQG)), Netwealth Group ((NWL)), NextDC ((NXT)), and Worley ((WOR)). Three of those are currently held in the FNArena/Vested Equities All-Weather Model Portfolio.

Other attractive long-term buys, according to the same analysts, include APA Group ((APA)), Aristocrat Leisure ((ALL)), Goodman Group ((GMG)), James Hardie ((JHX)), IDP Education ((IEL)), The Lottery Corp ((TLC)), ResMed ((RMD)), Telix Pharmaceuticals ((TLX)), and Xero ((XRO)).

More overlap.

Paying subscribers have 24/7 access to a dedicated section on the website on my research into All-Weather Stocks:

https://www.fnarena.com/index.php/analysis-data/all-weather-stocks/

Company Reports: Early Trends

The focus of investors will increasingly shift towards corporate earnings and their likely outlook, both in Australia and overseas, though the macro picture consisting of central bank actions, China stimulus, bond yields and economic indicators will still be ever-present.

Thus far in 2023, equity indices like to rally on macro-influences, while corporate earnings have not genuinely followed suit, even though there has been no fall-of-the-cliff experience either.

The Australian share market has seen the return of Confession Season, when companies confess they won't make the target for the financial period, but it hasn't been an all-out tsunami of negative announcements.

Companies that came clean over the weeks past have seen their share price fall in response, at times by -10% or more, including the likes of Ansell ((ANN)), Aurizon Holdings ((AZJ)), ASX ((ASX)), Boral ((BLD)), Cleanaway Waste Management ((CWY)), CSL, Johns Lyng Group ((JLG)), Link Administration ((LNK)), Northern Star Resources ((NST)), and Domino's Pizza ((DMP)).

There have been the occasional good news surprises, including from AGL Energy ((AGL)), Ampol ((ALD)), Fletcher Building ((FBU)), and Megaport ((MP1)).

The two lists might not be complete, but I think it's fair to say the bias is leaning towards the negative.

The mining sector certainly is generating its own negative contributions as also witnessed on Monday with South32 ((S32)) flagging a record -US$1.3bn asset write-down, hot on the heels of IGO Ltd's ((IGO)) substantial write-down in the week prior, and Core Lithium ((CXO)) downgrading production guidance.

Ship builder Austal ((ASB)) has requested a trading halt, potentially to downgrade market expectations.

Most strategists in Australia seem to be cautious at best. See also last week's edition: https://www.fnarena.com/index.php/2023/07/19/rudis-view-low-expectations-not-low-enough/

Over in the USA, EPS forecasts are dropping quite rapidly as early Q2 financial reports are being released. It wasn't that long ago the average EPS forecast for the quarter for the S&P500 was sitting at a negative -7% year-on-year. That percentage has over the past two weeks or so quickly dropped to -9%.

It's still early in the season, of course, but positive surprises thus far amount to 75% of reports versus a five-year average of 77%.

What should genuinely worry investors in Australia is how earnings releases in general are being received on Wall Street and in Europe. Market watchers have been observing the trend tends to favour share prices to underperform when companies miss the mark while companies that beat expectations are not necessarily receiving a reward for it.

It also seems the bias has shifted towards more 'misses' and fewer 'beats'. The punishment for a 'miss' tends to be noticeably larger than the reward for a 'beat'.

If Europe is leading Australia, the following trends should be expected to show up locally:

-Momentum is slowing, feeding into more cautious guidances and ongoing downgrades in earnings forecasts
-Less companies are able to beat market forecasts
-Large cap companies are faring noticeably better than smaller cap peers
-Cyclical sectors Energy and Materials are among segments with the weakest earnings trends, but so are Growth companies

The Q2 season in the US has only just begun, but similar observations have been made.

Reporting season in Australia starts unofficially on Wednesday, when Rio Tinto ((RIO)) sets the early tone, followed the next day by Champion Iron ((CIA)), Garda Property Group ((GDF)) and Sandfire Resources ((SFR)).

The following week sees financial updates released by Credit Corp ((CCP)), Janus Henderson ((JHG)), Block ((SQ2)) and ResMed ((RMD)) but, realistically, the August reporting season only starts ramping up the week after next week.

Even then, as has become the local tradition, Australian companies wait until the middle of the month has passed, and only then a true tsunami of corporate updates will be unleashed upon investors and analysts. Many of the small cap companies, those with not great results in particular, wait until the final days of the season.

FNArena will be keeping a close eye, as has become our own self-made tradition since mid-2013. Our dedicated Corporate Results Monitor will be brought to live by the end of this week:

https://www.fnarena.com/index.php/reporting_season/

(The Corporate Results Monitor also includes a calendar for the season).

Company Reports: Inflation

Blame it on excess government support, a resilient consumer, or a this-time-is-different cycle, but resurgent inflation has equally been a supporting factor for corporate results over the year past.

When inflation runs high, many a company finds it much easier to justify a price increase to its customers, even if the latter feels the pain. And as we all live in a nominal world, high inflation also acts as an artificial growth engine; even when customers are ordering less, the increase in prices tends to still lift overall sales and revenues at the top line.

With inflation deflating, as is undoubtedly happening at the moment, achieving growth becomes more difficult for companies. Many will be facing price decreases instead, and with economic momentum slowing, there no longer is an automatic rise in nominal sales and revenues.

Some industries will be faced with too-high inventories and an urgency to ship out products and services through discounted prices.

At the macro-level, falling inflation should see central bankers relax and pause, and bond yields trend lower, which supports higher valuations for listed assets.

Exactly how this combination of negatives and positives from receding inflation will play out is anyone's forecast, but a worst case scenario would imply that higher valuations are already in place, while slower growth still needs to be accounted for.

The Australian share market is currently trading near or above its long term average PE ratio, depending on whose number crunching we rely on. But strip out banks and resources and Shaw and Partners' CIO Martin Crabb believes the average PE ratio is around 20x next year's forecast EPS - not cheap by anyone's account.

All else being equal, companies might have to convince the market they are truly worth the multiple they are trading on, even with lower bond yields potentially providing valuation support (in a general sense).

Company Reports: Conviction

It's never easy or straightforward to know in advance which companies won't disappoint in August, but Morgan Stanley analysts have identified ten ASX-listed companies that come with High Conviction attached:

-Atlas Arteria ((ALX))
-Cleanaway Waste Management
-Corporate Travel Management ((CTD))
-CSL
-Goodman Group
-McMillan Shakespeare ((MMS))
-Medibank Private ((MPL))
-Orora ((ORA))
-Telstra ((TLS))
-NextDC

****

Strategists at Morgans suggest corporate earnings look vulnerable ahead of August, with investors' attention not simply focused on FY23 results, but probably more so on the outlook for FY24.

Key themes to watch, according to Morgans, are the underlying trend for earnings, higher interest costs, cyclical signposts (consumer demand, industrial margins), small cap performance, short selling and investor positioning in resources.

Morgans has lined up a number of key tactical trades for the season at hand (positive outcomes expected):

-Flight Centre ((FLT))
-Lovisa Holdings ((LOV))
-Medibank Private
-Orora
-QBE Insurance ((QBE))
-ResMed

As debt financing costs will come under scrutiny, Morgans sees risk rising for:

-Amcor ((AMC))
-Aurizon Holdings
-Costa Group ((CGC))
-Cleanaway Waste Management
-Cromwell Property Group ((CMW))
-Domino's Pizza
-Star Entertainment Group ((SGR))
-Wagners Holding Co ((WGN))

Also at risk for delivering disappointment:

-APA Group
-ARB Corp ((ARB))
-Treasury Wine Estates ((TWE))
-Transurban ((TCL))

Have been identified for potential upside from capital management:

-Computershare ((CPU))
-Suncorp Group ((SUN))
-Super Retail Group ((SUL))

Costa Group and Iress ((IRE)) have been singled out for potential balance sheet risk.

Company Reports: Technology Sector

One sector that might have to justify this year's share price performances more than others is the local technology sector.

One exception, possibly, suggest analysts at Jarden, are the payment processors with share prices for the likes of Zip Co ((ZIP)) and Tyro Payments ((TYR)) still suffering from prior Afterpay-led exuberance.

Jarden believes investor focus will be on delivery of cash flows and specific outlook commentary, including cost containment and the way to reaching break-even.

As things stand towards the end of July, Jarden only has one Buy rating left for the sector in Australia, for SiteMinder ((SDR)). Four other stocks are rated Overweight (one step below Buy): WiseTech Global ((WTC)), Xero, REA Group ((REA)) and Seek ((SEK)).

Sector analysts at Goldman Sachs recently used an update specific to IT services to reiterate their preferences for Macquarie Technology ((MAQ)) and Data#3 Ltd ((DTL)).

REITs In Focus

One market segment that has experienced a tough time during covid and lockdowns, and then on higher bond yields, under-utilised offices and a slowing in consumer spending are real estate investment trusts.

AREITs are not immune to rising costs, including for servicing debt, and many might find themselves without much organic growth for the year(s) ahead. One can see the general theme already: stockpicking is critical!

Sector analysts at Jarden's preference lays with those who appear to have the strongest growth prospects; Goodman Group, Scentre Group ((SCG)), National Storage ((NSR)), Arena REIT ((ARF)), Vicinity Centres ((VCX)) and Lifestyle Communities ((LIC)).

General apprehension towards the sector has made a few looking very cheap, which is equally attracting Jarden's attention: Region Group ((RGN)), Charter Hall Retail REIT ((CQR)) and HomeCo Daily Needs REIT ((HDN)).

****

Analysts at Macquarie, where the in-house view remains that Australia is facing economic recession, remind investors REITs typically underperform in the early contraction stage of the market cycle. Hence Macquarie's preference for the more defensive exposures in the local sector.

Macquarie's preference lays with Goodman Group, GPT Group ((GPT)), Dexus ((DXS)) among large caps, and Centuria Industrial REIT ((CIP)), Arena REIT and Qualitas ((QAL)) for smaller cap exposures.

For investors worried about potential balance sheet risks, Macquarie is most cautious on Charter Hall Long WALE REIT ((CLW)), Scentre Group, and Lendlease.

****

Ord Minnett remains cautious on office assets, with property valuations in general (read: devaluations) potentially a key factor in August, together with debt profiles and tenant demand in the wake of higher costs. AREITs will need to show fresh initiatives to convince investors they are not ex-growth, suggest the analysts.

Ord Minnett is supportive of landlords of convenience shopping assets, expecting Charter Hall Retail REIT, HomeCo Daily Needs REIT and RAM Essential Services Property Fund ((REP)) to report solid operating results.

The broker's Top Picks are Waypoint REIT ((WPR)), Dexus Convenience Retail REIT ((DXC)), and RAM Essential Services Property Fund.

****

Morgan Stanley states AREITs were traditionally seen as providing relatively steady outlooks for investors, but this has changed in recent times. Hence, those who still can provide stable outlooks are likely rewarded with a valuation premium, the broker suggests.

AREITs best placed to present investors with a stable performance plus outlook in August, according to Morgan Stanley, include Goodman Group, Scentre Group, and Vicinity Centres.

Risk to specific guidances are considered for Mirvac Group ((MGR)), Stockland ((SGP)), Charter Hall ((CHC)), Dexus, and Centuria Office REIT ((COF)).

****

UBS's sector preferences reside with "REITs with business models suitable for either a 'higher for longer' rate environment or with robust cash flow growth in a period of economic weakness."

UBS's most preferred exposures are Goodman Group, Mirvac Group, GPT Group, Lendlease, HomeCo Daily Needs REIT, Centuria Industrial REIT, and Lifestyle Communities.

The broker's list of least preferred REITs include Scentre Group, Vicinity Centres, Dexus, Charter Hall, Region Group, BWP Trust ((BWP)), and Ingenia Communities Group ((INA)).

FNArena Subscription

A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (20 since 2006); examples below.

(This story was written on Monday, 24 July, 2023. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).

(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: contact us via the direct messaging system on the website).

In this week's Weekly Insights:

-Earnings Forecasts: Slip Slidin' Away
-FY23 Returns: Details Matter
-Small Caps In Focus

By Rudi Filapek-Vandyck, Editor

Earnings Forecasts: Slip Slidin' Away

The Australian share market has been doing it tough in July, following a rally in June that nobody was genuinely able to properly explain, except, of course, those market commentators that are always brimming with optimism, no matter what the circumstances.

Meanwhile, beneath the surface, the trend in earnings forecasts is accelerating, in the wrong direction.

On UBS' assessment, consensus forecasts are now falling rapidly and markedly, the past few weeks removing -0.6% and -1.4% off the average projected EPS forecast for FY23 and FY24 respectively.

Main victims are resources companies, both materials and energy sector, as well as healthcare (the CSL-effect), real estate and consumer discretionary.

The safest sectors, as things stand right now, are utilities, technology and the insurers.

No surprise, UBS strategists are advising investors to position portfolios in favour of the latter two sectors, accompanied with reliable, stable dividend payers, which includes utilities, insurers, and the infrastructure sector.

According to UBS, the consensus EPS forecast for FY23 has now landed at 3%. That number stood at 6.5% six months ago. In similar fashion, the general forecast for FY24 is now a negative -3.2%. Six months ago this number was a minimally positive 0.3%.

The biggest culprits for the below-average growth forecast for FY23 are Materials and Healthcare and, to much lesser degree, communication services and real estate. For next year, Energy is shaping up as the biggest loser, with Materials and Financials equally in negative territory.

The strongest prospects for growth in FY24 seem to be for Utilities and Healthcare. But as always, stock selection will be all-important.

The UBS research also reveals Australia is yet again seriously lagging the rest of the world when it comes to EPS growth forecasts with the FY24 forecast for developed markets sitting at 9.5%.

For Emerging Markets the corresponding number is 18.2%. Even the US forecast still sits at 11.3%, though that remains the subject of heavy debate the world around as many remain convinced there's too much optimism baked into that number.

Companies that have enjoyed upgrades to forecasts locally include AGL Energy ((AGL)), Coles Group ((COL)), Collins Foods ((CKF)), Core Lithium ((CXO)), Johns Lyng Group ((JLG)), Metcash ((MTS)), and Woolworths ((WOW)).

Among the many more that have seen analysts taking a knife (or worse) to estimates are 29Metals ((29M)), CSL ((CSL)), Domino's Pizza ((DMP)), Liontown Resources ((LTR)), Seek ((SEK)), TPG Telecom ((TPG)), and Woodside Energy ((WDS)).

FNArena publishes weekly updates on changes in local analysts' forecasts and projections affecting ratings, valuations & targets, and forecasts.

This week's update:

https://www.fnarena.com/index.php/2023/07/10/weekly-ratings-targets-forecast-changes-07-07-23/

FY23 Returns: Details Matter

I came across the following eye-witness report a number of years ago.

A fund manager is presenting his fund's performance and proudly announces: average return over the past two years is 25% per annum.

One disgruntled attendee in the audience stands up from his chair and shouts: I'm calling BS! I personally have invested in your fund and I can tell everyone the fund hasn't gone anywhere since.

Fund manager, unperturbed, moves to the following slide showing his fund gained 100% in year-1, then declined by -50% in year-2. 100 minus 50 = 50, divided by 2 = 25%.

I've never established whether this anecdote actually took place in real life, but the underlying message remains unchanged: investors should remain cognisant of how finance generally is covered and reported on, while always trying to ascertain whether the finer details do not contradict the headline impressions, or offer a much more insightful background and context.

Those among you who may not be great with mathematics might now be thinking: what's wrong with the story above? Who's correct and who's not?

The straightforward answer is there's a lot wrong with that story, but also: both the fund manager and the angry investor are correct. The fund manager, however, is using the audience's dislike for maths and details to his own advantage, like a good old snake oil salesman.

Like with so many things in finance; one needs both a broader context and the finer details to get to the true picture.

In the example above: if an investor had invested from day one in Year-1, say $30,000, then that capital would have first doubled to $60,000 (100% gain) but subsequently reverted back to the original investment as that is what a decline by half (-50%) amounts to.

The result is a great outcome for marketing purposes (25% per annum!) but not great at all for the investor whose capital went backwards because of fees and inflation.

****

In the never-ending debate between actively managed investment funds and passive ETFs and other listed instruments, it is my observation many a professional investor knows how to outperform the broader market during times of plenty of sunshine (Risk On, bull markets) when taking on risk gets rewarded in spades, but things can go off the rails quite quickly, and quite devastatingly so, when the overall market environment deteriorates.

Investors might keep this in mind over the coming weeks as fund managers and industry consultants are no doubt preparing for a Good News marketing story.

The ASX200 Accumulation index, which includes the dividends paid out throughout the year, has generated a return of no less than 14.78% for the year ending on June 30. Some foreign indices have even done significantly better.

A few things to keep in mind:

-In Australia, the market performed best in H1 while in H2 the bulk of returns were generated in the June rally, which subsequently evaporated again in July

-Such environment usually emphasises the importance of dividends, but banks have been weak in 2023, with the market preferring insurers instead

-While the lists of top performers all contain small caps, it's been a heavily polarised landscape and large caps, as a group, have outperformed their smaller peers

-FY23 has once again highlighted the sweet spot in the Australian share market lays inside the MidCap50; effectively the ASX100 minus the Top50

-The final month of FY22 saw markets take a deep dive into the abyss, creating a low point from which this year's 12 month returns are being calculated

The importance of not simply staring oneself blind on twelve month's performance numbers shows up in many forms and disguises. Take Perpetual's global innovation fund, for example.

With a return of 44%, the fund is sitting on top of Morningstar's performance rankings for FY23. No questions about it, this is a fantastic outcome, but it looks a whole lot less impressive when we take into account this fund lost nearly -50% in the previous year.

Let's assume our angry investor in the opening anecdote had taken his $30,000 and given it to the Perpetual fund to manage two years ago. Today, his capital would have eroded to $30k minus 50% = $15,000 times 44% = $21,600, meaning he effectively lost -$8,400 over that period.

****

When FNArena started the All-Weather Model Portfolio back in early 2015, we promised investors we'd manage the downside by investing in Quality growers and reliable, sustainable dividend payers.

But markets are never 100% predictable and while Quality on average falls a lot less than the majority of listed equities, the past eight years have shown plenty of occasions when extreme volatility ruled the landscape, leaving no protection at all for equities, no matter the Quality, resilience or growth prospects.

How best to deal with these circumstances remains a never-ending dilemma.

Some investors put their faith in that all shall be okay in the long run, buying more at substantially lower prices if they have the means to do so. Certainly, it's great to buy shares at beaten-down prices, but what if the bottom's not in until -25%, or even -50% lower?

The opposite approach is to reduce the portfolio's exposure, so that losses remain smaller. The consequence of that approach is that subsequent gains are likely to be smaller too, as, let's face it, we're unlikely to reallocate funds back at the absolute bottom of the sell-off.

But here's the rub: a portfolio that doesn't fall as much, needs only smaller gains to keep the overall return positive. I think the merits of building up a sizable level of cash during times of extreme duress have been well and truly proven in the past couple of years.

This time around last year, the All-Weather Model Portfolio held 35% in cash and thus managed to limit its losses to -3.93% in June and -2.59% for FY22.

In comparison, the ASX200 Accum lost -8.76% in June last year and -6.07% for FY22.

Yes, the All-Weather Portfolio proudly outperformed throughout those testing, extremely volatile times. But the portfolio's performance for the year thereafter is measured off a higher base, which creates an extra hurdle when measuring the performance for the following year.

To illustrate the importance of the starting point, consider the following: up until mid-June the All-Weather Portfolio, even with 20% in cash, was outperforming the broader index on 3, 6 and 12 month comparison but then a strong rally ensued in resources and market laggards, and the comparison shifts to a much lower point (for the index) by the end of June last year.

In the end, the All-Weather's performance remains better on 3 and 6 month comparisons, advancing 2.91% and 8.91% respectively versus 1.01% and 4.46% for the ASX200 Accum. For the full twelve months, the All-Weathers added 12.71% against 14.78% for the index, suggesting 'underperformance'.

Though the irony of the difference in starting points should not go lost: the index started -3.48% lower than the All-Weather Portfolio and subsequently only performed better by 2.07%. It might seem I am making a big deal out of minor details few others appear to be concerned about, but consider the importance of it when a fund reports it has gained 15% over FY23 after losing -22% in the year prior, to name but one example.

Ultimately, any assessment of success or otherwise needs to be made over a longer horizon. One prediction we made at the time of establishing the All-Weather Portfolio is that investment returns would amount to 7%-8%, on average, over time.

The average per annum return achieved for the All-Weather Portfolio since early 2015 is circa 9.25% - meaning we've done better than promised over the past 8.5 year period.

For reasons of comparison: the average annual advance for the ASX200 Accum is 7.16% for the past 5 years and 8.56% for the past decade.

Ultimately, the key purpose of running the Portfolio is to back up my research, but also: to prove that one can invest in Quality companies, irrespective of their premium valuations.

I think we can safely conclude the Portfolio has proved just that over the past 8.5 years, while providing me also with priceless market insights along the way.

****

One intriguing observation is the repeated relative outperformance in Australia of the MidCap50; that segment of companies not large enough to be part of the ASX50 but on average too large to be included with the many smaller caps listed on the ASX.

Talk to any small cap investor this year and they will assure you times have been extraordinarily challenging. The S&P/ASX Small Ordinaries, for example, generated 8.45% in FY23 total return, but only 1.32% for the first six months of 2023.

In comparison, the MidCap50 is up 4.60% for the six months ending June 30, which is similar to the ASX50, but for the full financial year the gain is 17.97%. Over three years (13.50%), five years (8.80%) and ten years (14.40%) - the outperformance from this segment on the exchange is quite persistent.

Do we know why? Are there any conclusions or insights we can draw from it?

My own view is this segment includes those success stories from the small caps space that are able to grow into a much larger size, and ultimately become part of the ASX50 large caps.

Micro caps and small cap companies will always have an attraction, because such companies can grow rapidly from a low starting point, which can translate into outsized share price gains in a short time. But only few can turn that operational momentum into a sustainable, long-term growth story.

In other words: the best out of the bunch eventually end up in the first half of the ASX200, and if they're truly successful they continue advancing through the rankings until they leave this segment through the front door, i.e. they join the ASX50. Another way of approaching it is through the balance between risk and reward.

Since companies that keep climbing through the ranks have proven the merits and success of their products and services, I'd argue they represent a much better risk-reward balance, in between smaller peers that yet have to prove themselves and the larger sized companies that can be quite sluggish in their growth.

I haven't done or seen any dedicated data analysis, but logic tells us companies that have strongly contributed to the MidCap50's relative outperformance in Australia include Cochlear ((COH)), ResMed ((RMD)), Seek ((SEK)), Treasury Wine Estates ((TWE)) and Xero ((XRO)) but also Fortescue Metals ((FMG)), Mineral Resources ((MIN)), and Pilbara Minerals ((PLS)).

All are part of the ASX50 today, but for many years these companies have been growing their business, climbing the ranks of the ASX, to ultimately join the Top50 on the Australian bourse. Before they got there, these companies helped the MidCap50 consistently outperform all other segments on the ASX.

This doesn't mean we should ignore these companies from the moment they enter the Top50, but equally valid: not every member of the MidCap50 will be a generator of long-term outperformance; picking the winners remains important.

A quick glance through my curated lists (further below) reveals this segment is amply represented, even without a specific focus on mid-caps.

Readers familiar with my research won't be surprised to read companies included are Ansell ((ANN)), Carsales ((CAR)), REA Group ((REA)), Steadfast Group ((SDF)), TechnologyOne ((TNE)), WiseTech Global ((WTC)), and others.

As far as general observations go: I think the numbers and the facts speak for themselves.

****

When it comes to investing and the share market, Mike Tyson described the experience of the past years best: "Everybody has a plan until they get punched in the mouth".

Wall Street legend Bob Farrell's rule number ten also springs to mind: Bull markets are more fun than bear markets.

To say that events, extreme polarisations and momentum switches have tested investors to the max in the three years past can only be a grave understatement. While much of today's public discourse is whether equities are still in a bear market or not, a prudent investor would be prepared for challenging times ahead.

Our view that prudence is best in the slipstream of the steepest central banks tightening cycle ever, and still ongoing, has been repeatedly and severely tested over the past 16 months. Oddly enough, it has not relegated the All-Weather Portfolio to significant underperformance, even despite the Portfolio carrying 20%-plus in cash, and 5% in gold.

But not everything has worked out as planned, and at times changes and amendments needed to be made.

Among the newcomers that joined the Portfolio throughout tumultuous and volatile times are Dicker Data ((DDR)), Steadfast Group ((SDF)) and HomeCo Daily Needs REIT ((HDN)). The first two additions have contributed positively, but the REIT has been weighed down by bond market volatility, which we always knew was a key risk.

At some point, the bond market will provide relief. In the meantime, we are enjoying a prospective dividend yield in excess of 7%. Dicker Data shares equally offer a juicy yield, expected to grow to 6% next year. Insurance broker Steadfast has performed better; its shares are trading on a much lower implied yield.

In terms of your typical income-oriented investments, one of the Portfolio's largest exposures remains Telstra ((TLS)), which, apart from a 4% yield, offers upside through asset sales and much improving industry dynamics.

Dialling back the risk-taking, and reducing the overall equity exposure by lifting the percentage held in cash (and gold), has meant saying goodby to some investments that we would have liked to still own today. But as the old expression goes: one cannot make an omelet without breaking some eggs.

Sometimes sacrifices need to be delivered for the higher cause, in this particular case: limiting capital losses and remaining prepared for tougher, challenging times ahead.

Stocks that remain high on the Wish List include Breville Group ((BRG)), Pro Medicus ((PME)), REA Group, Seek, WiseTech Global ((WTC)), and Xero ((XRO)).

The most prominent disappointment in the Portfolio relates to CSL with new management issuing a rare profit warning towards the end of the financial year. Most importantly: the forecast remains for EPS growth in the order of 14%-18% in FY24.

It goes without saying, even the highest Quality growth stock on the ASX is not 100% immune to bad news! But it doesn't by any means imply that CSL's growth story is nearing its end.

With confidence that this year's set-back is just that, a delay in the post-covid recovery, the Portfolio has responded by purchasing more shares on persistent weakness.

CSL is now the largest single exposure, which is likely to act as a bonus once investors start looking for reliability and Quality during times of corporate stresses and duress.

****

The All-Weather Model Portfolio is run in cooperation with Vested Equities through self-managed accounts (SMAs) on the WealthO2 financial platform. For more info: send us an email.

Paying subscribers have 24/7 access to my curated lists, which form the preferred hunting ground for the Portfolio:

https://www.fnarena.com/index.php/analysis-data/all-weather-stocks/

Small Caps In Focus

Last week, I participated in a feature on small cap companies for Livewire Markets.

I offered six names that are worthy of investors' attention; three are owned by the All-Weather Portfolio, the other three are included in my curated lists.

-Dicker Data

Quote: "It was sold down quite heavily last year and as a consequence is today offering a high yield. I have a lot of confidence it will continue to perform in the years ahead."

-Steadfast Group

 "I've done well out of it since purchasing it and used share price weaknesses to add to my position."

-IDP Education ((IEL))

"I bought more when it was sold down. I think the market has been very harsh and there's a lot of shorts on it. That can go either way, prices could stay low for longer. I'm hoping that good news will come out at some point and prices will go up a lot."

Three on my radar:

-Audinate Group ((AD8))

"It's not profitable yet but it's getting there. I think it could be a future success story for the ASX. I'll be watching the August reporting season as I suspect it will be very volatile."

-Objective Corp ((OCL))

"I'm a big fan of TechnologyOne ((TNE)). The stock has been one of the best performers on the stock exchange over the past two decades. I see similar characteristics in Objective, which I tend to describe as mini-TechnologyOne. I think Objective has strong potential."

-Ebos Group ((EBO))

"They'll be on the 'do not touch' list for many for a while because they are going to lose a big contract in 2025. They are a very good operator and I think they deserve the benefit of the doubt that they can come out stronger down the track."

The quote that summarises my view:

"We are now moving into tougher economic conditions. Rate hikes in Australia, Europe and the US are really now starting to hit. Smaller companies are more vulnerable in this environment. Some of them have cheap valuations but are they cheap enough based on the risks?"

FNArena Subscription

A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (20 since 2006); examples below.

(This story was written on Monday, 10th July, 2023. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).

(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: contact us via the direct messaging system on the website).

In this week's Weekly Insights:

-Forecasts Under Pressure
-Which Stocks To Buy?

By Rudi Filapek-Vandyck, Editor

Forecasts Under Pressure

And when all is said and done, the dust has settled, and the verdict is in, we shall all observe it has been a fairly standard central bank tightening process, but one with a greater time lag between tightening and real impact on economic activity.

Financial markets can be prescient and smart, sometimes, but one thing they do not possess is patience. Plus, of course, not everybody is in the market to be reasonable, sensible, and knowledgeable with a longer-term focus.

Ultimately, the share market will do the right thing, but not before it has first tried out all other options available. It's my favourite summary of what a public forum for listed stocks is all about, time and again.

Three attempts to rally this year have ultimately resulted in very little progress made for the ASX, at the index level at least. Meanwhile, companies are issuing profit warnings and cautious/disappointing outlooks, while the trend in analysts' forecasts is negative.

It does beg the question: how many more options are there before local traders and investors take it on the chin and start incorporating this more subdued and challenging outlook in local share prices?

I don't know the answer. Another collective fall-of-the-cliff experience is by no means the only logical outcome, but the elevated risks are there for everyone to see, although thus far share price punishments in response to disappointing market updates remain largely reserved for smaller cap companies.

On Monday it's the turn for one of Tasmania's proud distillers and distributors of whiskey and gin, Lark Distilling ((LRK)), to emphasise increasing challenges and see shareholders' value sink by -16%-plus on the day.

Metcash's ((MTS)) FY23 performance released on the same day proved a slight beat on market forecasts, but management's cautious comments about changing consumer behaviour in the face of multiple pressures is unlikely to trigger significant upgrades for the year ahead.

Metcash is seen as a fairly steady and defensive business, even as hardware sales have an obvious connection with the housing cycle, but market consensus already has penciled in a slight retreat in profits and dividends in FY24. This is probably also why the share price weakened in the lead up to Monday's result, allowing for a positive response on the day.

Market updates by Lark Distilling and Metcash are both indicative of what is trending beneath the surface of the local share market; earnings forecasts are falling, and quite noticeably so. The average EPS forecast for FY24 recently turned negative.

The real reason for caution is this process of general realignment has arguably only just started. Analysts at Morgan Stanley did some data-digging recently and found about half of all ASX300 constituents have not received an update on forecasts for more than 50 days; some 45 companies have not seen an update for up to 90 days.

In line with our own observations here at FNArena, the latter group of companies most likely consists of small and micro cap companies that only receive irregular coverage from stockbrokers, but this only heightens the risks for severe mismatch either before or during the August reporting season for this cohort.

The first rally from last year's bond market quagmire occurred in October. Back then, explains Morgan Stanley, average EPS forecast in Australia was for 9% growth in FY23. By now this has been wound back to 3.6%, with this average falling week after week. One wonders how much will be left by late August?

Equally important, on Morgan Stanley's assessment, the consensus EPS forecast for FY24 is now a negative -2.9%. For good measure, analysts at Macquarie are still working off slightly more positive numbers with EPS forecasts of 4.2% and 1.5% respectively for FY23 and FY24. Those differences can mainly be attributed to Macquarie remaining more positive on the local resources sector.

But the underlying trend remains the same: the few companies enjoying positive revisions to forecasts, such as Adbri ((ABC)), AGL Energy ((AGL)), IGO ((IGO)), Origin Energy ((ORG)) and Webjet ((WEB)), are sharply outnumbered by the many whose forecasts are receiving downgrades, either on more challenging macro dynamics or following a disappointing market update.

Whatever one's view on the ASX's prospects for the months ahead, corporate health and profits should remain top of the list of risks to watch.

FNArena publishes its own weekly update on trends regarding broker ratings, targets and forecasts each Monday morning. This week's update:

https://www.fnarena.com/index.php/2023/06/26/weekly-ratings-targets-forecast-changes-23-06-23/

Which Stocks To Buy?

There is an argument to be made that while markets like to rally on a positive interpretation of macro developments, such as a pause in central bank tightening, the main anchor for equities in 2023 have been corporate profits - more so in Australia than in the USA, where additional liquidity from the Federal Reserve has been a positive factor too.

But, as also proven by the likes of Metcash and AGL Energy, not every ASX-listed company is trading cum earnings downgrade, and there's always room for a positive surprise.

Equally important: not every temporary set-back spells disaster; in many cases a weaker share price is actually a blessing for those investors looking to get on board at a lower price level. The recent market pullback has been quite indiscriminate with share prices generally trading at lower levels.

Time to put some of that cash on the sideline to work? If so, what stocks should we be looking to allocate to?

If your profile looks anything line mine; cautious, focused on Quality and sustainable growers, with a longer term horizon in mind, then my curated All-Weathers and related lists could be a great starting point. Hence, this might be as good as any other time to share some insights on some of the companies that carry my personal interest.

One of the better performers on my lists has been data centres operator NextDC ((NXT)) whose inclusion along other Emerging New Business Models is closely related to the modern day megatrend in data usage and generation, which in my view always meant supply would find it hard to keep up with explosive growth in demand. A prophecy that has been proven correct over the past eight years or so.

However, in the share market nothing ever moves in a straight line, and with bond yields, currencies, inflation, government policies, competition, charts and market sentiment all playing a role, there's always room for doubt, criticism, worries and shorters congregating around the theme of the day.

Eight months after last October's post-pandemic low of circa $8.50, NextDC shares have left most shorters licking their wounds on less stress from rising bond yields and ongoing confirmation both the business and its supporting megatrend remain in good health. Management is now expanding internationally, which raises the overall risk profile, but the advent of artificial intelligence, shortcut AI, is about to add an extra kicker for growth.

NextDC is included in the local Technology Index, but let's be clear: this is an infrastructure play, a la Transurban, whose outlook shall remain closely tied in with financing and building more data centres and signing contracts with telcos and big, international users to fill up capacity.

As can easily be established from the numbers released by NextDC over the years past; the business is fast-growing; into the double digits annually. If industry indications and projections are anything to go by, rapid growth can potentially continue for many more years to come.

One of such indications came from recent presentations by the much larger, Nasdaq-listed Equinix. With a market cap of circa US$70bn, 248 data centres in 27 countries, including in Australia, and 12,000 employees globally, Equinix is many times larger than the local market leader (market cap $6.3bn), but still growing each year at a targeted pace of 7-9%.

Management at Equinix recently explained to Wall Street analysts AI will likely become a major growth driver in the quarter century ahead. For the coming five years or so, Equinix believes the combination of AI and higher inflation (which is passed on as per contracts with clients) suggests the business can probably grow at 8-10% per annum instead.

Adding 1% growth might not seem like a big deal, but when accumulated, in aggregate over many years, it generates a boost to the valuation and thus the future share price. NextDC is much smaller, and predominantly Australia-based, but this likely also means a relatively larger impact on growth overall.

FNArena's All-Weather Model Portfolio was fortunate enough to double its exposure late last year and has been handsomely rewarded since with the share price today no less than 44% higher. But this is a long-term growth story, as also suggested by the much larger Nasdaq competitor, plus only one broker covering NextDC in Australia has a valuation below today's share price.

One smaller-sized AI beneficiary on the ASX should be Macquarie Technology Group ((MAQ)), formerly known as Macquarie Telecom. As data centres are only one of the company's features, any future benefits should be smaller too. The same principle applies for large cap Telstra ((TLS)), which also operates data centres, among much, much more.

Telstra is still considering asset sales, originally the key motivation to add the shares to the All-Weather Model Portfolio back in early 2021, but industry dynamics overall have turned for the better, and analysts are now projecting those attractive Telstra dividends will continue growing in the years ahead. With all the troubles on the horizon locally, ranging from mortgage cliff to spikes in bad loans coming, Telstra's profile comes with a golden frame in 2023.

The only companies I can think of with an even better dividend profile on the ASX right now are the insurers whose operational momentum is currently so strong that even the forced reimbursement of overpaying customers does not dent their share prices. Insurers have put the banks firmly in their shadow as preferred dividend payers this year.

Investors should note: history shows insurance moves through cycles and the impact from changing weather and climate is never too far off.

****

As also shown in the above example of NextDC, financial market participants taking short positions (i.e. they position for a much weaker share price) are not by default the smartest mind in the room. On my observation, they end up many times over on the wrong side of history, ultimately, scrambling to unwind positions and limit losses.

In recent years, a number of companies of my personal interest have been targeted by shorters. Without one single exception, in all cases share prices have ultimately recovered, and then some, including for Amcor, Seek, TechnologyOne, and WiseTech Global, though this does by no means imply the shorters can never be correct.

Also, in some cases, think TechnologyOne and WiseTech Global, an attack by shorters can cause the share price to remain weak for a prolonged period, further accompanied by negative news flow (shorters also know how to play the media).

The reason why I mention this is because another megatrend company, IDP Education ((IEL)), recently suffered from a decision by the Canadian government to dilute the company's monopoly with more competition, and the share market has taken quite a negative view on the company's outlook in response.

The latter includes a growing interest from shorters. According to the latest update from ASIC, total short positions in the shares have now increased to 10.93%, making IDP Education the most shorted stock on the ASX. Note the number two, Flight Centre ((FLT)), has been on top of the list for many months and it did not stop its share price from rising from below $15 to near $22, but it's all weakness now in line with the market generally.

As a small investor, extra conviction is needed to stand up against shorters, which is a battle many prefer to avoid. The All-Weather Model Portfolio copied the play book for NextDC and increased its exposure to IDP Education in the days following the Canadian announcement.

It might be a while before we find out the wisdom or otherwise behind that decision.

****

Given my research focuses on corporate Quality supported by a so-called long runway of structural growth, it should be no surprise healthcare companies are omnipresent across my lists, as well as in the All-Weather Portfolio.

The healthcare sector has been the best performing on the ASX over the past two decades, with daylight second. Post the 2020 pandemic, however, the sector is carrying more headwinds and question marks than at any other time throughout that period.

Share prices are trending sideways and even an industry stalwarts as is CSL ((CSL)) has been forced into a profit warning this time around. Longer term, AI presents both threats and opportunities while shorter term a lot can be traced back to the 2020 pandemic and societal lockdowns that either hit operations hard or turned companies into temporary giant beneficiaries.

In both cases, the ex machina impact needs to be cycled through. Pandemic winners need to find their old mojo back without the excessive gains and those negatively impacted clearly need more time to genuinely get back to normal business. In both cases, investors today need to look through temporary headwinds and adopt a longer term view.

I'd say this applies to Ansell ((ANN)), Cochlear ((COH)), CSL, Fisher & Paykel Healthcare ((FPH)), ResMed ((RMD)), and Sonic Healthcare ((SHL)). For Fisher & Paykel Healthcare and ResMed there's a new development that is likely to weigh on share prices in the form of appetite-depressing diabetes medicines such as Ozempic and Wegovy, increasingly popular in human society's battle with obesity.

What's easier than a pill a day to wipe the kilos away?

Obesity is one megatrend that has supported multiple sections of modern day healthcare services providers, including treatments for sleep apnoea. The latest "fashion" might offer easy comfort, but it's not without multiple side-effects, including nausea, diarrhoea, constipation, sagging bottoms and faces, hair loss and even thinning fingers.

It will be interesting to find out what companies' response will be to questions asked in August, no doubt.

One healthcare company that has suffered recently through an event outside its control is New Zealand-born Ebos Group ((EBO)). In short: competitor-in-trouble Sigma Healthcare ((SIG)) secured itself a new lease of life through -effectively- selling its corporate soul to the Devil, in this particular case: Chemist Warehouse, and in doing so, snatched a big contract away from the much better run Ebos Group.

The latter now has the challenge at hand to replace this loss, from FY25 onwards, which is likely to weigh on the share price, for now. Based upon the company's track record since listing on the ASX in late 2013, it probably pays to give management the benefit of the doubt, and time.

Note: at the time of the Sigma surprise, Ebos Group shares were trading at an all-time high, which might serve as an indication of how this company was performing, and the market's appreciation of it, including but not solely related to the Chemist Warehouse contract.

****

All in all, what my research into All-Weather Performers tries to achieve is to identify those companies that enjoy enough of structural trend support to continue generating shareholder wealth for many years into the future. The Quality tag usually comes with market leadership and size, as well as a positive track record, on top of a habit of R&D and investments.

All Weather Performers are the antithesis of investing in cheap, undervalued assets, while their track record proves a higher PE ratio is not a deterrent for creating attractive, sustainable wealth for shareholders. But it's a big ask to be extraordinary, and to remain extraordinary, which is why my list of All-Weather Performers is quite condensed.

Since we are living through a once-in-a-lifetime era of new technological developments, my selections of stocks also include Emerging New Business Models and Prime Growth Stories. In all cases, I try to identify those companies that have higher Quality and sustainability in their growth trajectory than the average ASX-listing.

Now that bond yields are becoming less of an influence overall, I have felt more confident to re-include old familiar favourites for dividends in addition to Telstra, but there is no room for any retailers given the context and challenges in Australia.

Apart from the section dedicated to Dividend Champions, changes made have remained few and far between, surely a sign of support for those companies selected?

Maybe worth highlighting: I did remove Ramsay Health Care ((RHC)) not so long ago from my lists, and have now decided to also remove Domino's Pizza ((DMP)). In both cases, shareholders have enjoyed rewarding experiences over extended periods of time, but those halcion years truly ended a while ago already.

There are now way too many question marks about future potential and trajectory. This is an important lesson too: sometimes exceptional companies stop being exceptional. Or maybe they all do, allowing for plenty of time?

Paying subscribers have 24/7 access to a dedicated section on the website: https://www.fnarena.com/index.php/analysis-data/all-weather-stocks/

The FNArena/Vested Equities All-Weather Model Portfolio does not own all the stocks included in my selections, but picks and chooses predominantly from these lists, and only sporadically makes changes.

FNArena Subscription

A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (20 since 2006); examples below.

(This story was written on Monday, 26th, 2023. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).

(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: contact us via the direct messaging system on the website).

By Rudi Filapek-Vandyck, Editor

As investors, we all like to snap up a cheap bargain. But the truth is, cheaply priced stocks tend to provide short-term, temporary pleasures, mostly, while a genuine quality gem is the gift that keeps on giving, and giving, and giving.

Investors need not look any further to find evidence of that statement than last week's interim financial report release by IT services provider TechnologyOne ((TNE)).

While the numbers and metrics were once again of the superb kind, building forth on a remarkable track record and legacy spanning close to two decades and counting, most analysts and market observers would not describe the shares as "cheaply priced".

Trading on a forward multiple of 48x times market consensus forecast for FY24 EPS (54x for FY23), it should be no surprise there is to FNArena's knowledge only one Buy rating left, from a mesmerised Wilsons, alongside an upgraded price target/valuation of $18.12.

Most targets and valuations congregate around $15-$16 while the share price since the H1 release has risen from $15.50 to $16.44 on Monday. Management at the company has stuck with its guidance for EPS growth between 10-15% but just about everyone, including management itself, believes this will prove conservative when final FY23 numbers will be released later in the year.

Already speculation is growing over how much sooner the longer-term target of achieving $500m in annual recurring revenue -still set for FY26- will be achieved. And by how much can the ARR number exceed the target by then?

Some believe $700m by FY26 is not impossible, which implies there's more upside in the share price, irrespective of today's metrics and share price gains already booked.

Herein lays the first major challenge when dealing with a perennially outperformer such as is TechOne: what kind of "valuation" is appropriate?

True Quality 'Values' Differently

If you're a religious disciple of Benjamin Graham's The Intelligent Investor, shares in TechnologyOne have probably never been on your radar.

Sure, they must have been "cheap" at some stage, the years immediately following the Nasdaq meltdown in March 2000 come to mind, but it's only fair to say the company back then was nowhere near the Quality offering we are discussing today.

Having said all of that, the returns for shareholders have been nothing short of exceptional over the past twenty years. Let's ignore for the time being that shares could have been snapped up as low as 7c a piece during the post-2000 bear market.

By early 2008, shares were trading above $1. Five years on, they reached $1.50. Five years after that, we're in 2018 now, the shares approached $5. One year ago, on the 31st of May 2022, the shares closed at $10.50. On Monday, as I write these sentences, shares are creeping up further towards $17.

With the assistance of Harry Hindsight, there's one conclusion that stands above any form of debate: when shares in TechnologyOne sell off, you buy. Preferably, you buy a lot.

If last week's interim report revealed one thing it is that this long-term growth story is still nowhere near ending. If anything, both analysts and investors laud the underlying acceleration that is taking place through customers migrating towards the Software-as-a-Service (SaaS) offering.

SaaS literally creates a win-win for both sides of the ledger. For customers, migrating to the cloud brings increased flexibility and significantly lower costs (reportedly up to -30%), while for TechnologyOne those same benefits accrue into rising margins. Current forecasts are for a gradual increase towards a profit margin of 35%-36% from 30% a few years ago.

Contracts typically allow for price rises in line with inflation which, this time around, is providing an extra-kicker for growth. Equally typical for a rare Quality corporate wealth generator, management at the firm is using this year's additional windfall to spend more on R&D and new product development.

Plenty of companies would be discussing a higher dividend, or a share buyback, or both, but genuine Quality thinks longer term, and realises tomorrow's growth is built on the seeds planted today.

Back in 2008, TechOne's offering consisted of 11 products. Today, the product suite tally stands at 16, with over 400 modules.

How To Be 'Special'

Officially, TechOne is but an IT services provider, conveniently lobbed in the same Software & Services basket with dozens of other ASX-listed "peers". In practice, the company delivers mission-critical products and services, often specifically taylored for corporate clients in targeted sectors of financial services, utilities, government, education, and health.

Clients have proven extremely sticky with annual churn remaining below 1% throughout most of the past two decades. Recently, the percentage of client losses has increased with management indicating it'll probably end up around 1.60% for the running financial year as smaller businesses shy away from migrating to the cloud while clients of UK acquisition Scientia are proving less loyal.

It goes without saying, most management teams at other ASX-listed companies would sacrifice their left arm to be able to operate from such a luxurious position.

Scientia has failed to reach its earn-out set by the vendors, but, ironically, its performance overall has exceeded TechOne management's forecast. The company's first international purchase for GBP12m in 2021 is meant to strengthen market share in higher education while also solidifying expansion plans into the UK, where profits are being booked, but off a low base.

Acquiring Scientia provides TechnologyOne with the opportunity to sell its enterprise resource planning (ERP) solutions to circa 100 Scientia customers in the UK. At the time of the purchase, Scientia was not yet profitable. It is marginally profitable today and contributing positively through a 20% rise in ARR in the UK.

As one would expect, TechOne is highly cash generative, virtually debt-free, and it pays out a steadily growing dividend, though its high valuation means the stock never features for your typical yield/income investor. Financial metrics are persistently with the better performers in the market. Last financial year's Return on Equity (RoE) was above 41%, with Return on Invested Capital (RoIC) above 36%.

Maybe one of the biggest surprises is, after all these years of market-beating performances, the company's market capitalisation only recently surpassed the $5bn as shares responded favourably to the recent financial result. Revenues should end up around $425m this year and possibly around $500m by the end of FY24 with commensurate net profit numbers of (estimated) circa $102m and $122m respectively.

In other words: despite all the accolades, TechnologyOne still is a relatively small fish in a big ocean where multi-national competitors such as ServiceNow, Workday, SAP, Salesforce and Oracle roam around like big whales.

Nothing new here, however. Such has been the situation since day minus. TechnologyOne is still only active on both sides of the Tasman Sea with a tiny operation in the UK. But the company's strategy of developing close relationships with its clientele clearly also acts as an invisible moat.

Late last year, sector analysts at Morgan Stanley acknowledged as much, but they also identified it as a disadvantage as forging in-depth relationships takes time and it thus implies slower growth. Indeed, those who've paid attention over the years past have noticed TechnologyOne's growth is extremely consistent, but never spectacular.

Management usually flags double-digit growth ahead, say between 10%-15%, and extremely rarely disappoints. In fact, so consistent has performance been, it attracted a report from a foreign based short seller in 2020 whose attack was mainly based around the premise that no company is ever able to perform as consistently over such a long period of time.

It proved but yet another nasty failure of short sellers in Australia.

Not that those analysts at Morgan Stanley aren't eating humble pie today, as their report preferenced each of Megaport, Hansen Technologies and Pexa Group above the "ordinary" TechOne.

Apples Versus Prunes And Oranges

TechnologyOne's track record, its size, reliability and predictability in earnings does create a conundrum for everyone attempting to draw "peer" comparisons. Is it really appropriate to put this company next to the likes of Audinate, Altium, Appen, Iress, WiseTech Global and Xero and draw some simplistic, excel sheet data comparisons?

I argue it is not.

And neither does comparing financial metrics with those of Microsoft, Oracle, Datadog, Sage Group, and Palo Alto Networks. The closest analysts locally have come in recent years is by highlighting smaller-sized companies like Objective Corp ((OCL)) and ReadyTech Holdings ((RDY)) share some similar basic characteristics.

Here, recent performances have shown similar characteristics do not automatically translate into similar degrees of resilience and robustness. In both companies' defence, though, the TechnologyOne of twenty years ago would equally not compare well with the company we're describing today.

Becoming a true Quality stalwart, and receiving market recognition, takes time.

Most importantly, investors will be wasting their time if the strategy consists of only buying stocks on a below-market average valuation. Stocks like TechnologyOne don't trade on low double-digit multiples, let alone single digits, unless a meteor hits their headquarters, or aliens just landed, or something extraordinary destroys the business case.

I believe markets have become smarter in distinguishing companies with valuable quality characteristics, as experiences and performances accumulate, and there's more sophistication, and appreciation, for companies supported by a long runway of growth - for as long as the market believes that runway remains intact.

As things are lined up post FY23 interim result, the odds remain in favour of TechOne continuing its pathway of growing at 10%-15% for longer, with FY23 expected to outperform. Most analysts assume EPS growth for FY23 will beat the top of that range and come in at 17% or 18% instead.

Management at the company believes its guidance is probably conservative, but it's better to under-promise and over-deliver, rather than the other way around. Management also has a track record of doubling the business' size every five years; that is the direct result of consistently growing between 10%-15% per annum.

The current forecast, expressed with confidence, is that today's business will be double its current size in five years' time.

The conundrum for today's investor is the shares are now trading at a sizable premium versus the broader market, as also illustrated by the fact upgraded price targets and valuations remain below today's share price, with one exception (Wilsons, $18.12).

But if in five years' time the size of the company will be 100% higher, including the profits accompanied by continuously rising dividends, then the share price will reflect this too. TechOne management is confident economic recession in Europe, the UK or the US will not have a significant impact on the current growth trajectory, which adds yet another reason as to why the shares are unlikely to sell off anytime soon (unlike so many others).

TechnologyOne might be "special", it is truly difficult arguing it is not, the company is by no means unique. Research by W.P Carey School of Business professor Hendrik Bessembinder already established there is a select group of companies worldwide that is able to provide sustainable shareholder rewards over long periods of time.

If ever Bessembinder focuses his research on the Australian share market, there should be no doubt TechnologyOne will feature in his local selection, alongside the likes of CSL ((CSL)) and REA Group ((REA)); larger cap stocks that tend to create similar dilemmas and end outcomes for investors.

In all cases, "value" will always be in the eyes of the beholder rather than in a simple multiple of next year's forecast earnings per share. The question for investors is merely whether they'd like to get on board, and at what price, assuming the market offers them that opportunity.

Those already on board can simply take regular volatility for what it is with the understanding that true Quality beats a cheap price in the long run, plus it also acts as a safe haven when conditions get really, really rough.

****

TechnologyOne is included in my curated list of All-Weather Performers on the ASX. The All-Weather Portfolio selects stocks from the curated lists that are 24/7 available to paying subscribers:

https://www.fnarena.com/index.php/analysis-data/all-weather-stocks/
 

****

For more insights as to how others are weaponising portfolios against potentially more negatives forthcoming:

https://www.fnarena.com/index.php/2023/05/04/rudis-view-rba-hikes-us-recession-portfolio-adjustments/

More reading:

-https://www.fnarena.com/index.php/2023/05/24/rudis-view-dissecting-the-next-share-market-rally/

-https://www.fnarena.com/index.php/2023/05/17/rudis-view-us-recession-debate-is-tightening/

-https://www.fnarena.com/index.php/2023/05/10/rudis-view-markets-weigh-plenty-of-positives-and-negatives/

-https://www.fnarena.com/index.php/2023/05/03/rudis-view-seeking-quality-growth-offshore/

–https://www.fnarena.com/index.php/2023/04/26/rudis-view-investing-in-megatrends-the-other-ones/

–https://www.fnarena.com/index.php/2023/03/22/rudis-view-all-weather-stocks-back-in-fashion/

Conviction Calls and Best Ideas:

-https://www.fnarena.com/index.php/2023/04/19/rudis-view-bond-market-says-regime-change-is-upon-us/

–https://www.fnarena.com/index.php/2023/04/12/rudis-view-wesfarmers-wisetech-worley/

–https://www.fnarena.com/index.php/2023/03/17/rudis-view-dominos-pizza-newcrest-qantas/

–https://www.fnarena.com/index.php/2023/02/10/rudis-view-aub-group-endeavour-lottery-corp-suncorp/

–https://www.fnarena.com/index.php/2023/02/03/rudis-view-csl-mineral-resources-ridley-readytech/

FNArena Subscription

A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (20 since 2006); examples below.

(This story was written on Monday, 29th May, 2023. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).

(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: contact us via the direct messaging system on the website).

In todays Weekly Insights:

-Confession Season... It's Baaaaaack!
-Seeking Quality & Growth Offshore

By Rudi Filapek-Vandyck, Editor

Confession Season... It's Baaaaaack!

Once upon a time the two months preceding the end of financial year, and the subsequent weeks leading into reporting season in Australia, caused more than just a little bit of anxiety among investors as market updates might well translate into that universally dreaded Profit Warning that has the potential to inflict a lot of damage to a company's share price.

Recent years have not seen much in terms of profit warnings ahead of the official results season, but early signals are this year might be different. The past week alone has seen market updates by the likes of AdBri ((ABC)), Bubs Australia ((BUB)), Cluey ((CLU)), Mirvac Group ((MGR)), Synlait Milk ((SM1)) and Insignia Financial ((IFL)) force analysts to downgrade forecasts for the financial year running.

Troubled IOUpay ((IOU)) has effectively gone out of business. Most production updates by miners and energy companies proved disappointing too, marred by project delays, weather impact, lower prices and higher operational costs.

It's not all bad news though, as share prices of Bubs, Mirvac Group and Insignia Financial had already largely accounted for what was coming. Sometimes bad news can actually free-up the next move upwards on the reasonable prospect of less-bad conditions ahead, potentially.

Regardless, investors would be wise to not simply assume today's market laggards are by default a great bargain with Synlait Milk yet again proving there's no bottom when troubles keep accumulating.

Trading around $12 in 2018 and having started the running calendar year above $4, today's share price of less than $1.50 reminds me of the old share market joke:

What's a stock that's down by -90%?

That's a stock that first fell by -80%, and then halved yet again.

It's not all negative news though with corporate market updates to date, on balance, proving more positive than negative. Notable positive surprises have been delivered by Camplify Holdings ((CHL)), Helloworld ((HLO)), Megaport ((MP1)), Perpetual ((PPT)), Reliance Worldwide ((RWC)) and Stockland Group ((SGP)).

Such profit warnings (both negative and positive) are often quite random which makes it difficult for investors to prepare or anticipate. Yet one source of potential weakness is the so-called Second Half Club; companies that need a strong second half to meet guidance or market expectations.

The February results season saw this group of companies swell to nearly 50% of all companies, suggesting there is plenty of potential for a lot more negative surprises in the weeks and months ahead.

Local market strategists at Morgan Stanley offer another potential approach; adopting a theoretical framework developed by their colleagues in Europe to establish which companies have been over-earning due to covid previously, the local strategy team has identified four sectors in Australia in danger of an earnings reset, which in practice means: be careful, here's a higher chance for negative profit warnings.

The Morgan Stanley modeling has identified energy, discretionary retail, staples and real estate as sectors most at risk.

All shall be revealed in the weeks & months ahead.

Seeking Quality & Growth Offshore

The promotors of international markets have a way of making us all feel silly and ignorant: do you realise Australian equities represent no more than 2% of the global pie? If you stay local, you are missing out on 98% of what is out there!

It is difficult to argue with the numbers, but what should equally be front of mind is that Australia is inside the Global Top Three when it comes to long-term average investment returns. At the very least this provides local investors with plenty of reasons not to make any rash decisions.

Ultimately, investing is about sustainable return and there's little value in diluting one of the best performing markets with less-returning alternatives, just for the sake of it.

One such alternative are Emerging Markets; according to some a must-have exposure because of the much higher economic growth that is on offer, but if history shows one thing it is that higher economic growth does not by default translate into better performing equity markets.

Look no further than China where equities have pretty much endured a lost decade (and then some) post-GFC. Even today the prospects for Chinese equities in the years ahead remain one of the hottest debates around.

This is especially important as most exchange traded funds or ETFs that promise Australian investors easy access to above-average GDP growth in Emerging Markets tend to be overweighted towards China.

Take the iShares MSCI Emerging Markets ETF as an example. Its exposure (as per info on the Blackrock website) is 31%-plus China, 14.5% Taiwan, 13.5% India and nearly 12% South Korea.

Does this genuinely look like the right instrument for access to Brazil, Mexico or Indonesia?

Performances and momentum across various EMs can polarise significantly, and in most years that's exactly what happens. The added complication for Australian investors is that during times of local outperformance, the vulnerabilities elsewhere can be quite the painful experience.

Note also with China and Taiwan the two largest exposures, combined circa 45% of total assets for the ETF, geopolitical risk should be front of mind also.

Total return for the iShares ETF mentioned ended on minus -15.07% in 2022, having only returned 2.03% in 2021. US shares also underperformed Australia last year, but major indices are ahead thus far in 2023 mostly carried by a handful of Big Technology companies.

In Europe so far this year the German DAX30 index is close to mimicking the Nasdaq's return, while the gain for Japanese equities is equally above 10%. The Dow Jones Industrial Average, on the other hand, is only narrowly positive year-to-date.

In summary: adding international exposure to Australian equities is by no means an easy route towards better investment returns. It may, on the contrary, turn out a costly lesson during challenging times.

In recent years investors have witnessed an almost relentless outperformance by US markets (2022 not included), which no doubt has created the general impression that US markets simply perform better.

However, according to Credit Suisse's Global Investment Returns Yearbook the long term returns from investing in Australian and US equities are virtually equal, suggesting periods of outperformance by one are followed up by relative underperformance during other times.

Australia and the US are two of the Global Top Three performers since 1900, with South-Africa the only market with even better return, but also with much greater swings between large gains and outsized losses.

The Australian market has the added benefit of superior dividend yields, enlarged through the beneficial tax system of franking, plus it consists of companies that often literally operate in investors' backyard. The latter means much easier access to daily news flow, company officials and updated research.

It's much easier to stick with the Devil-you-know if that delivers some of the best returns available, over time, with the comfort of playing a home game. Life already has plenty of complications on its own.

****

Having said all of the above, there is one strong argument as to why looking beyond Australia might not be a bad idea: the rest of the world offers more options.

At the end of the day, there's only one CSL ((CSL)) available on the local bourse, and the same applies to REA Group ((REA)), Carsales ((CAR)), Seek ((SEK)), ResMed ((RMD)) and Cochlear ((COH)).

And while Altium ((ALU)), WiseTech Global ((WTC)) and Pro Medicus ((PME)) are doing a commendable job in establishing themselves as a global leader in their respective markets, all still are relatively small-sized companies and, equally important, stand-out exeptions among lesser fortuned peers.

The ASX has a broader suite of offerings for investors wanting exposure to iron ore, gold and lithium, but even the local mining sector has some notable gaps including silver, diamonds, platinum, potash and palladium.

Looking beyond the limitations inside Australia's borders thus doesn't sound like too crazy an idea. The service FNArena provides, including ever more data, is specifically designed for investors investing in Australia, but we have equally access to research on foreign markets.

Some of recent reports are worth highlighting for those investors looking offshore.

****

Recent research by UBS zoomed in on sustainable dividend growers, which seems like an obvious focus when the future looks uncertain (which is the general view at UBS).

History shows if/when economic recessions occur, dividend paying stocks outperform, with UBS research showing just that for the years 2001, 2008, and 2020. The best dividend exposures are through companies that combine dividend with rapid growth.

UBS's screening of US-listed companies highlighted the following with at least 10% dividend CAGR between 2022 and 2025 (ranked in line with predicted pace of growth, highest first):

-Fidelity National Information Services (FIS)
-Analog Devices (ADI)
-Houlihan Lokey (HLI)
-DuPont de Nemours (DD)
-American International Group (AIG)
-Intercontinental Exchange (ICE)
-FMC Corp (FMC)
-NextEra Energy (NEE)
-Darden Restaurants (DRI)
-Home Depot (HD)

The following are projected to grow at just below 10% dividend CAGR over the period:

-Bank of New York Mellon (BK)
-CVS Health Corp (CVS)
-Air Products and Chemicals (APD)

One thing Australian investors have to get used to is lower yields on offer relative to the 4%-5% and higher yields that are currently available on the ASX. The highest yield (forward-looking) in the lists above resides with Fidelity National Information Services at 4.5% with all others offering between 1.7% and 3.3%.

If one starts off from the highest yields and then adds the necessity for high growth, we end up with a different list. The stocks below offer between 6.2% at the top and 3.0%:

-Hannon Armstrong Sustainable Infra (HASI)
-Huntington Bancshares (HBAN)
-Fifth Third Bancorp (FITB)
-Fidelity National Information Services (FIS)
-American Electric Power (AEP)
-Public Service Enterprise Group (PEG)
-Exelon Corp (EXC)
-Bank of New York Mellon (BK)
-PPL Corp (PPL)
-Axis Capital Holdings (AXS)
-CVS Health Corp (CVS)
-Darden Restaurants (DRI)
-Cardinal Health (CAH)
-AES Corp (AES)
-American International Group (AIG)

****

A recent strategy update by Wilsons highlighted the relative resilience of the Australian share market, which should this year find ongoing support from a domestic economy that is likely to avoid economic recession.

At the same time, Wilsons warns about complacent asset allocation which, in Australia, almost by definition implies portfolios have too much exposure to dividend-paying banks. Wilsons' model portfolio is underweight Australian banks.

It goes without saying if a recession in the US, and potentially in Europe and elsewhere, weighs on commodity prices this will most likely be reflected in lower share prices for the likes of BHP Group ((BHP)), Rio Tinto ((RIO)) et al.

Wilsons agrees with the philosophy of accessing more choice (through going international) and in particular highlights corporate profit growth ex-Australia has been far superior post-GFC in comparison with local EPS growth. The motivation is thus to look beyond the ASX to access more companies offering superior growth.

Wilsons is not a fan of seeking out any ETFs, instead pointing towards actively managed global equity funds that look best prepared to deliver strong, risk-adjusted returns over a full market cycle, in addition to an actively managed domestic equities allocation.

****

Morgan Stanley is one of few that tries to identify the highest Quality companies that should prove their resilience both through challenging times, as well as over a longer-term timeframe, a la my personal research into All-Weather Performers in Australia.

A recent update is titled 30 for 2025, implying the following thirty High Quality North-American companies should be great to own, at least until 2025:

-Alphabet
-American Express
-Blackstone
-Cheniere Energy
-Costco Wholesale
-Eaton
-Eli Lilly
-Estee Lauder
-Exxon Mobil
-Hilton Worldwide
-Intuitive Surgical
-JPMorgan Chase
-Liberty Formula One
-Linde
-Lululemon Athletica
-MasterCard
-Microsoft
-Motorola Solutions
-MSCI Inc.
-NextEra Energy
-Nike
-Northrop Grumman
-Old Dominion Freight Line
-Prologis
-Raytheon Technologies
-Thermo Fisher Scientific
-T-Mobile US
-UnitedHealth Group
-Visa
-Yum! Brands

When the team in Europe sat down with the same task, they identified 35 Quality stocks for 2025:

-3i
-Air Liquide
-Ashtead Group PLC
-ASML Holding NV
-Biomerieux SA
-CaixaBank SA
-Cellnex Telecom SA
-Coloplast A/S
-Compass Group
-Dassault Systemes SA
-Deutsche Telekom
-Diageo PLC
-Edenred SA
-Endeavour Mining
-Experian PLC
-Intesa SanPaolo SpA
-London Stock Exchange
-Lonza Group AG
-L'Oreal SA

It goes without saying, nothing of the above is investment advice. Investors should always do their own research and consult with an advisor. The above can contain fresh ideas and function as a guide for additional research and further exploration.

****

My personal research into All-Weather Performers is restricted to ASX-listed companies. My curated lists are 24/7 accessible to paying subscribers:

https://www.fnarena.com/index.php/analysis-data/all-weather-stocks/

More reading:

-https://www.fnarena.com/index.php/2023/04/26/rudis-view-investing-in-megatrends-the-other-ones/

–https://www.fnarena.com/index.php/2023/03/22/rudis-view-all-weather-stocks-back-in-fashion/

Conviction Calls and Best Ideas:

-https://www.fnarena.com/index.php/2023/04/19/rudis-view-bond-market-says-regime-change-is-upon-us/

–https://www.fnarena.com/index.php/2023/04/12/rudis-view-wesfarmers-wisetech-worley/

–https://www.fnarena.com/index.php/2023/03/17/rudis-view-dominos-pizza-newcrest-qantas/

–https://www.fnarena.com/index.php/2023/02/10/rudis-view-aub-group-endeavour-lottery-corp-suncorp/

–https://www.fnarena.com/index.php/2023/02/03/rudis-view-csl-mineral-resources-ridley-readytech/

FNArena Subscription

A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (20 since 2006); examples below.

(This story was written on Monday, 1st May, 2023. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).

(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: contact us via the direct messaging system on the website).

In this week's Weekly Insights:

-Investing In Megatrends (The Other Ones)
-Research To Download
-FNArena Talks

By Rudi Filapek-Vandyck, Editor

Investing In Megatrends (The Other Ones)

Investors who felt safe hiding in lithium stocks supported by broad-based belief in the global electrification theme have had a rude awakening over the past four months as the price of lithium has tanked by -50%-plus and share prices in the likes of Pilbara Minerals, Allkem and Liontown Resources are down by -25% or more.

This does not imply the global transition towards greener transport and electric power has been over-hyped. It does highlight that when it comes to industrial chemicals, metals and minerals, the short-term horizon is almost always determined by the balance between supply and demand - and history shows supply has a habit of catching up, eventually, as well as intermittently.

To put it bluntly: commodities seldom, if ever, move in a straight line. A similar observation today very much applies to producers of coal, the ultimate beez neez in 2022, while oil & gas producers are one of few sectors not posting a gain year-to-date. Uranium is widely believed to be part of the Megatrends story for the decade(s) ahead, but it's not apparent from share prices in Paladin Resources or Boss Energy.

Megatrends (Supercycles) or not, commodities move through cycles, with often violent price corrections, in both directions, along the way. The promise of a super-sized gain on the way up will always remain too attractive to resist, while the threat of a Wile E Coyote dive-off-the-cliff is never far off.

To illustrate the dilemma, I have included the thirty year price chart of shares in Alumina Ltd, one of the longest-listed commodity producers on the ASX.



It doesn't take much time to figure out there have been numerous occasions when the share price doubled, plus some, on the way up, only to give it all back, and some, on the way down.

Another, equally important, observation to make is that time does not by definition work in the patient shareholder's favour. While Alumina Ltd pays an annual dividend, its share price has effectively posted no sustainable gains since 2008, when shares tumbled from an all-time high above $6 to below $1. Today's circa $1.50 had never been recorded throughout the 1990s.

Sector mega-caps BHP Group ((BHP)) and Rio Tinto ((RIO)) did record new all-time highs in 2022, but their prior records dated from 2007, and we might well be past the summit in the current cycle for iron ore. As a side note: don't be confused by historical data on free websites including ASX.com.au - all those data have been 'corrected' for dividend payouts, and thus show lower share prices for the past.

BHP shares peaked at $50 in late 2007, despite what is shown today on backward-looking historical price charts. (As per always, details matter, as does a great memory).

Alternative: The Forgotten Megatrends

Investing in Megatrends can be a completely different experience through larger sized industrial companies, on the condition that investors can get past the misguided belief that only shares trading on low PE ratios offer sustainable long-term gains, plus the underlying Megatrend needs to remain in place, of course.

Below is the historical chart for shares in property marketing portal REA Group ((REA)) which, on anybody's observation, shows a fundamentally different trajectory over time.



Admittedly, the global bond market reset has pulled down the share price valuation from its 2021 peak, but the shares have embarked on a solid uptrend in line with the market generally since October for a return of approximately 50% from last year's June low (25%-plus year-to-date).

The property market in Australia has been oft maligned by many over the past decades, but its underlying resilience remains on display even when faced with an unprecedented pace of RBA rate hikes since early 2022. I am not defending anyone's policy or intentions, but merely making the observation.

Most importantly, REA Group's fortunes are intertwined with overall market activity through marketing and the selling and purchasing of properties, independently of falling and rising prices or of the pricing of building materials. As building companies are defaulting in large numbers, and with Australian banks preparing for much tougher conditions ahead, the specific drivers for local market leader REA Group stand out above the rest.

It goes without saying, REA Group is not immune from the many challenges in property markets this year. On current consensus forecasts, its profits will go backwards in the current financial year while most analysts covering the sector believe its share price above $140 looks bloated.

The offset is that current consensus sees both earnings per share and the dividend recovering by 20%-plus in FY24. The latter probably explains why REA shares have performed so strongly already (earnings estimates have been upgraded recently by analysts).

REA is the perfect example of what an industrial market leader, well-managed and carried by at least one long-lasting Megatrend, can deliver for the patient, long-term focused investment portfolio. The return from share price appreciation alone (ex dividends thus) exceeds 1000% since early 2012 (a little over eleven years).

Of all the companies I follow closely, not many can boast an even higher return, but shares in TechnologyOne ((TNE)) and ResMed ((RMD)) have appreciated by 1354% and 1211% over the period respectively.

In comparison, the ASX200 ex-dividends returned 77%. Even if we double that percentage, to (generously) account for dividends and franking tax benefits,... I probably do not need to finish that sentence...

Trading on a forward PE ratio of 41x (FY24) and offering a prospective yield of 1.3% only, shares in REA Group perfectly symbolise the always-present dilemma for investors: when exactly is the ideal time to get on board this Megatrend train? It's a question that has been permanently present throughout the past decade.

Maybe the next pullback on a general retreat in risk appetite as the US recession -finally- shows up in concrete numbers, while Australia suffers the unfolding from the proverbial Mortgage Cliff might assist local investors with solving the REA riddle?

****

Not all Megatrends have been around as long as Australian property. This suggests we might still be witnessing the early stages of trend development.

One such Megatrend relates to global data and its application and storage through data centres. This belief saw me adding more shares in NextDC ((NXT)) when their price sank closer to $8 in October-November last year. In recent times the independent data centres operator has reminded investors, through its largest customer contract ever, there's no end in sight for this Megatrend just yet.

On the contrary, some analysts believe large corporate users of data might be getting a little anxious about future storage capacity in Australia, which should result in more of such large contracts forthcoming for NextDC. The offset here is this also highlights the need for more data centres, which are not cheap to build, and which will require the company raising more capital.

As long as the market understands this dynamic, and remains comfortable with it, this need not be bad news for patient, loyal shareholders. See also, for example, the recent capital raising by Carsales ((CAR)) and where that share price is post execution.

For reasons that only the ASX can explain, NextDC shares are included in the local All Technology Index, alongside genuine technology stalwarts such as Altium, Pro Medicus, TechnologyOne, WiseTech Global and Xero. I believe this causes many an investor to treat NextDC as a non-profitable tech wannabe, while also not understanding its support from a strong Megatrend.

A more accurate approach would be to treat NextDC as a young, emerging next Transurban. Long after the data Megatrend has run its course, and supply and demand across the sector are in reasonable balance, NextDC shares will be revered for its dividend yield and franking, but that picture is still far, far away into the future.

A slowing in global economic growth can certainly instill more pricing pressure on the industry, with consequences for valuations generally, but NextDC's recent contract, on top of broader sector insights, suggest the pendulum is still swinging in favour of independent data centre owners.

Don't try to somehow put a PE ratio on the shares either. That simply does not apply to Transurban & Co. Maybe leave the forward projections and implications for valuation to the experts. FNArena's consensus price target currently sits at $13.56, implying 15%-plus upside from the current level.

****

The most obvious company to mention in this regard remains CSL ((CSL)) - often nominated in the same breath with REA Group as "probably the highest quality company on the ASX".

It is no coincidence both companies have rewarded loyal shareholders handsomely (or should that be "excessively"?) as time passed by - both quality stalwarts enjoy being carried by solid, long-term Megatrends.

What is, or has been, the precise importance of respective management teams at those companies will always remain a point of public debate. But what cannot be denied is that it's far easier to generate healthy returns from a position of market leadership on top of Megatrend support.

In CSL's case, the global demand for blood plasma continues to grow each year, with the global market leader specialising in developing treatments and medicines derived from its core product. CSL is often labeled Australia's largest and most successful biotech, but truly understanding its business requires an appetite for complexity, including putting a 'value' on future products under development.

Australia's third largest index weight spends more than $1bn per annum on R&D, operates with authority on sector-leading efficiency, and has a knack for highly profitable acquisitions. The latest, Vifor, no doubt will add to future growth on the back of what already looks like a robust recovery post covid interruption, similar to what was achieved post acquisition of Novartis' loss-making flu vaccine business in 2015.

What makes CSL's investment case so compelling today is the company's operations are essentially recovering from restrictions, costs and other headwinds endured during the covid pandemic. With sales to grow and margins to recover, market consensus is projecting USD EPS growth higher than 20% in FY23 and FY24.

Similar to the companies mentioned earlier, simply slapping a PE ratio on CSL virtually never whets an investor's appetite, but 27x times FY24 EPS does not look demanding considering the embedded safe haven security with more challenging times on the horizon for most listed companies.

The consensus target sits at $337, still double-digit above the present level, dividend not included.

****

There are plenty more Megatrends available through the local bourse, including a plethora in small and micro cap companies offering exposure to online shopping, electric vehicles, cyber security, data centres, et cetera, but the above can serve as a reminder that large-cap exposures to ongoing, long-lasting Megatrends can offer above-average returns with a much more benign risk profile (even with above-average valuations).

Other companies worth mentioning in this regard include Carsales, Cochlear ((COH)), Goodman Group ((GMG)), ResMed and Seek ((SEK)). Though having a long runway for growth ahead need not necessarily be linked to an identifiable Megatrend, as proved by companies including Breville Group ((BRG)), Hub24 ((HUB)), IDP Education ((IEL)), Pro Medicus ((PME)) and WiseTech Global ((WTC)).

If we truly adopt a broad spectrum on this, we might even shine a light on Macquarie Group ((MQG)) and Wesfarmers ((WES)).

Investors like the idea of snapping up a bargain or playing tomorrow's Megatrends through commodities, but history shows true outperformance can be achieved through less risky, larger cap industrials trading on above average valuations.

And that is a lesson yet to be learned by many an investor, big and small, both institutional and retail.

****

Graphics included in today's edition don't look great due to the limitations that come with the email format. Wednesday's story on the website should offer better optics.

Most companies included in my curated lists on the website have a so-called extended runway of growth, either through a Megatrend or otherwise, which is, of course, why they carry the label of All-Weather Performers, or one of the sub-labels applied.

Paying subscribers have 24/7 access to all lists via the dedicated section on the website: https://www.fnarena.com/index.php/analysis-data/all-weather-stocks/

Research To Download

Research as a Service (RaaS) on:

-Armour Energy ((AJQ)): https://www.fnarena.com/index.php/download-article/?n=E6A6B99C-CB5A-CF4C-CA8D89FF11383C6F

-Pointerra ((3DP)): https://www.fnarena.com/index.php/download-article/?n=E69B53F0-FFA1-4F21-6BFA557C35D4214A

-Quantm ((QIP)): https://www.fnarena.com/index.php/download-article/?n=E6ABAD9C-D276-62FE-62B38A1BF632C8A3

Edison Research on:

-Alkane Resources ((ALK)): https://www.fnarena.com/index.php/download-article/?n=E6D9DA79-9794-FC6F-569F0D9A60ABA5C8

-EML Payments ((EML)): https://www.fnarena.com/index.php/download-article/?n=E6E59D9F-06BD-4079-310B881FA01F7DA8

-Vection Technologies ((VR1)): https://www.fnarena.com/index.php/download-article/?n=E6EE4517-A0BA-C488-78420CD522C98D84

FNArena Talks

In an earlier edition, I forgot to highlight that presentation slides used for any of my presentations are always made available to paying subscribers via the SPECIAL REPORTS section on the FNArena website (drop down menu starting from Analysis & Data).

A recording of my recent presentation to members of the Australian Investors Association (AIA) is available via the FNArena Talks section on the website:

https://www.fnarena.com/index.php/analysis-data/fnarena-talks/

In addition, my latest interview by Peter Switzer is available via YouTube:

https://www.youtube.com/watch?v=2I853N3Bu38

(My appearance is after circa 14 minutes)

FNArena Subscription

A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (20 since 2006); examples below.

(This story was written on Monday, 24th April, 2023. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).

(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: contact us via the direct messaging system on the website).