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).

In this week's Weekly Insights:

-More Data, More Brokers
-US Recession More likely
-(Not) About The Banks

By Rudi Filapek-Vandyck, Editor

More Data, More Brokers

FNArena continues building the best service possible.

On Friday, we added yet another window of company-specific data, thanks to FactSet.

Potentially, the first eye-catcher in Stock Analysis is now how much debt each company is carrying.

Behind the 'More Data' button in Stock Analysis are now four windows of data and charts.

In addition, Credit Suisse is being removed as an FNArena database broker. Instead, the Australian Broker Call Report will now update daily on research from Bell Potter and Shaw and Partners.

This not only means more research, but also more companies that previously were not covered through The Australian Broker Call Report.

If you are not a subscriber, or you are no longer a subscriber, and would like to have another look at our service, contact us via email.

US Recession More likely

Nothing is set in stone when the subject is financial markets, but a financial crisis for regional banks in the US will, all else being equal, put further strain on the availability of credit and thus hamper economic growth.

All talk about a 'no landing' scenario should now definitely been relegated to the sin bin. There will most likely be a 'landing' for the US economy in the twelve months ahead.

As to exactly how 'soft' or 'hard' that landing might be is still dependent on multiple factors and yet to be established outcomes.

Common logic suggests markets will opt for a reduced risk approach, at least until more clarity emerges about the consequences for US businesses and economic growth.

Then again, common logic is not always that common, and the prospect of a boring sideways channel would not excite many who make a living out of daily volatility.

(Not) About The Banks

Today's story is about Australian banks, except it isn't. Not really.

Hopefully this is not too confusing already, but Dear Reader, you will have to read until the end to understand what this story really is about.

As said, I'd like to start off with Australian banks.

For more than a decade now, CommBank ((CBA)) has been priced at a sizeable premium versus other banks in Australia.

The embedded gap in valuation attracts both criticism and amazement; to many Commbank shares sit right at the bottom of industry rankings; other banks on cheaper valuations look so much more attractive.

This is the case today as it has been at any point post the GFC.

The obvious contradiction here is that CommBank shares have not underperformed throughout those years. To the contrary, CommBank shares today are the one sector exception in that the shares have managed to rise above their peak from back then.

The only one in the sector locally.

Fifteen years after the GFC, all other bank shares in Australia are still trading (well) below the levels recorded in 2007.

Popular explanations for CBA's valuation premium, there are many, but the most quoted and most credible on my observation, is that CommBank is simply Australia's superior bank - better than all the rest.

Testing The Thesis

To genuinely test the thesis, we must have an impartial, non-subjective, unbiased method for measuring the corporate quality for CommBank and the others. Is there a difference at all, and can we measure it?

Investors own the banks for regular and reliable income. Also, whereas profits and related financial metrics are heavily subjected to accountancy decisions made, dividends are paid out of cash, a much more straightforward and equalising measurement.

If CBA is truly the superior among peers, this must show up in the banks' common history of paying out dividends to shareholders.

Let's investigate.

The table below (with thanks to FactSet) shows the dividend payments per financial year for each of the Major Four in Australia. Whenever a dividend was cut from the year prior, the payment is shown in pink. If a dividend was left unchanged, the highlight is in yellow.

Overall, Australian banks' positive view among local investors stands out from the table: in most years dividends increase, for all four banks involved.




Let's zoom in on what happens when industry conditions get tougher, like, for instance, back in 2007 when ANZ Bank ((ANZ)) stopped lifting its dividend while others still were, followed by reduced dividends from all in 2009 as a result of the Global Financial Crisis.

Two observations stand out already:

-Back in 2009, dividend reductions from CBA and Westpac ((WBC)) were much smaller than those from ANZ Bank and National Australia Bank ((NAB))

-In the subsequent post-GFC recovery, CBA was the only one who raised the following dividend payment above the 2008 payout

-All others took multiple years to achieve the same outcome:

-Both ANZ Bank and Westpac required an extra year
-It took NAB five more years to raise its dividend in 2014 above the payout prior to the GFC-fallout in 2008

Let's move on to the next time when Australian banks were seriously challenged:

-In 2016 both NAB and Westpac started freezing their dividends
-ANZ Bank, however, cut its dividend and then kept it unchanged for the next three years

-CommBank kept lifting the annual payout, admittedly in small increments, but the difference is there

By 2018 CBA too is no longer increasing its annual dividend. The following year both NAB and Westpac are cutting. By 2020 the global pandemic is among us and all four are yet again reducing their dividend.

Simple observations:

-Heavy reductions from ANZ, NAB and Westpac sharply contrast with a milder reduction at CBA

-This time around the impact on the subsequent recovery is long-lasting for all four banks. Dividends have been rising since the 2020 cut, but as yet no dividend has matched the payout from 2019.

-Looking at current consensus forecasts does open up the same old discrepancy with CBA's dividend to come close to matching the 2019 payout in the current financial year, with FY24 destined for a new all-time high in nominal terms.

-The same projections are in place for ANZ Bank, but this bank started cutting in 2016. If we measure from its dividend peak in 2015, it looks like ANZ Bank is likely to require another 1-2 years before that old dividend record can be exceeded.

-Projections for NAB and Westpac suggest their shareholders may have to wait until FY26, at least, before payouts have recovered to previous levels.

I assume we can all agree the history of dividend payments by the Big Four Banks in Australia shows that:

-Dividends from ANZ, NAB and Westpac are much more vulnerable during times of stress and duress
-The threat of a dividend reduction from CBA is significantly smaller
-Combined with a quicker recovery, this makes the long-term trajectory in dividends from CBA more robust and steeper in its uptrend

I think we can all agree, CommBank is the superior operator inside the Australian banking sector, and it shows up through the one measure Australian investors value most; income from annual dividends.

How To Value Superiority?

In the second part of our investigation, we look at how CBA shares have performed relative to others in the sector.

The table below shows the annual relative performance through three colours:

-Pink: CBA shares underperformed at least 2 of the other three banks
-Yellow: CBA shares were the second best performing that year
-Green: CBA shares outperformed all others



What the overview clearly shows is that, overall, investors' appreciation for CommBank's superior report card looks very different pre-GFC as it does post 2008.

In the past 14 years, CBA has either outperformed all others or proven second-best in 11 of those years. Thus far in 2023, CBA and ANZ Bank are outperforming NAB and Westpac, hence that underlying trend remains well and truly in place.

Looking at the pre-GFC years, however, shows no such pattern with CBA shares only outperforming in three of the eight years between 2001-2008.

A possible explanation that springs to mind is that, pre GFC, CBA being the "better" bank was mostly a topic of public debate and interpretation. Investors were clearly more focused on relative valuations back then. The bank that commanded the higher valuation in one year would be punished for it later on.

Equally interesting to note is that in the years leading up to the GFC, dividends from ANZ Bank and Westpac were increasing at a faster rate than those from CBA and, back then, with the sector laggard plagued by multiple scandals and problems, NAB.

With the advantage of hindsight, we can today also conclude those years were the final window in the golden era for banks globally that lasted for most of the prior two decades.

With that golden era well and truly behind us, and banks encountering GFC, pandemic and credit crises, the trend-trajectory in CBA dividends stands head and shoulders above the rest in Australia. Consider, for example, Westpac is forecast to pay out the same 138c in the current financial year as it did back in 2010! (NAB is still paying out less).

Is this a case of true Quality only proving its mettle when tougher times arrive? Or maybe it simply takes time before paying out less to shareholders and reinvesting more in the business accumulates into a true and tangible difference? Whatever the explanation, one thing that certainly doesn't lie is the difference in share price performances between CBA and its three major peers post GFC.

As per the overview below, in the first decade of the nougthies, CBA was simply one of the pack. One year better, in other years a laggard. But all investment returns calculated post 2010 leave no room for interpretation. Both ANZ and Westpac have effectively seen no capital gain since 2010. NAB achieved small progress, but that's on the back of the horror decade that preceded.



A Sign O' The Times?

So... the most expensive stock in the sector provides the highest return and the cheaper alternatives are cheaper for a reason. No doubt, most investors are well and truly shocked-to-the-core by now.

Unless, of course, the past is behind us and tomorrow awaits a fundamentally different world?

One popular narrative doing the rounds is that excess liquidity and extremely low bond yields have throughout the decade past fueled an over-emphasis on Quality and Growth, with those assets being priced at unsustainable, high valuations that leave no further room for a positive return in the years ahead.

But is it really that simple? Has the market not already corrected from the general reset in interest rates and bond yields? Also: why exactly would CBA more than other banks benefit from central banks providing liquidity?

A more plausible explanation might be that, overall, the global context has changed and part of that broad change includes investors now valuing extras such as reliability, sustainability, predictability and consistency on top of yield and profits. If CBA shares trade at a sizeable premium versus other banks, and they have been doing this for more than a decade, is this still an aberration or a new reality?

Not one single analyst who's looked at valuing CommBank shares in isolation in years gone by has ever concluded the shares did not look 'expensive'. Yet, this has not prevented those shares from posting a new all-time record high as recent as earlier this year.

These observations raise a few obvious questions:

-Maybe CBA's valuation should be best considered in relative terms, i.e. including a premium versus the sector generally
-Shrinkage and/or widening of that relative premium might be the better indicator of whether CBA shares truly are 'expensive' or 'cheap'
-If history repeats itself, times will become tougher for banks. Can CBA once again shine as the safer and stronger of the local banks?

While we don't as yet know the answer to that last question, it is most likely investors will grant CommBank the benefit of its historical track record, until proven otherwise.

As investors, we always need to keep our eyes and mind open for any changes that might disrupt the status quo, but it is equally important to consider whether CommBank is indicative of a much wider phenomenon that, in a similar vein, makes other Quality stalwarts look a lot more 'expensive' than they in reality are.

P.S. It is my view CBA's superiority has been achieved on the back of more targeted, sizeable investments made throughout the years, whereas others have been happy to put more in shareholders' pockets.

CBA's payout ratio has been consistently below its peers'. This may not seem like a major item on a short-term view, but accumulated over many years, it does make a substantial difference.

Quod Erat Demonstrandum.

(This story was written on Monday, 27th March, 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).

FNArena Subscription

A paid subscription to FNArena comes with numerous bonus publications and data on more than 1200 ASX-listed companies. Subscriptions cost $480 for 12 months and $265 for 6 months and can be tax deductible (ask your accountant about it).

https://www.fnarena.com/index.php/sign-up/

In this week's Weekly Insights:

-Banks Need Confidence (Lots Of It)
-All-Weather Stocks - Back In Fashion
-All-Weathers: Post-February
-Research To Download

By Rudi Filapek-Vandyck, Editor

Banks Need Confidence (Lots Of It)

What investors are witnessing this month is not a re-run of the Lehman Bros collapse in late 2008, but it isn't "nothing to see here" either.

Central banks and regulators around the world have been in a frenzy to prevent confidence to fully abandon local and international banks. While their swift actions might prevent worst case scenarios, confidence remains all-important for all banks; from the strongest down to the smallest lenders.

It is anyone's guess precisely how markets will respond to further daily news flow. As things stand on Monday, we have two separate bank problems that need to be dealt with. The easiest to solve is Credit Suisse, the weakest link inside the global financial system for a long while and it seems this particular vulnerability will soon be quarantined.

Over in the USA, however, we have now witnessed Silicon Valley Bank (SVB), Silvergate Capital, Signature Bank and First Republic Bank making headlines and there's more news waiting to come out, for sure. How much exactly remains unknown, also because we don't as yet know how effective regulatory actions will be.

No two situations are exactly the same, but this year's banking crisis in the US appears to have plenty of similarities with the Savings & Loans (S&L) crisis that occurred in the 1980s and early 1990s.

That crisis followed aggressive tightening from the Fed, looser regulatory restrictions and oversight, and lenders not marking to market which prevented the outside world to get a clearer (and more accurate) insight into the balance between assets and liabilities.

Ultimately, the S&L crisis went on and on, preceding a nasty recession in the US and elsewhere (the recession Australia had to have, according to Keating).

Not saying history is about to repeat, but the public debate whether the US will suffer an economic recession this year has instantaneously become a lot less combative. Banks' focus has now shifted to preserving, if not repairing, balance sheets, and counter-party risks.

History shows when this happens, economic recession is usually not far off. Bank credit is almost literally the oxygen that feeds today's economies.

There will be rallies after falls, but I would not recommend trying to be a hero in the days, weeks, or even months ahead. When the facts change, savvy and experienced investors know it's time to adapt.

For those who'd like to find out about today's similarities for themselves, I'd recommend putting S&L crisis in your internet search engine, and start reading.

It won't cheer you up.

All-Weather Stocks - Back In Fashion

This year's deterioration in economic prospects, now complimented with a banking crisis in the US and the inevitable demise of Credit Suisse, has strengthened expert calls for robust, defensive, reliable, High Quality equity exposures.

Many of the calls made include a large overlap with my personal research into All-Weather Performers listed on the ASX (see further below).

Outside of my personal selections, references often include Cleanaway Waste Management ((CWY)), Ramsay Health Care ((RHC)), Sonic Healthcare ((SHL)), and Washington H Soul Pattinson ((SOL)).

The general idea is that indiscriminate selling will at some point recognise not all companies are of similar core characteristics and those with more robust and dependable earnings will ultimately outperform.

Traditional labeling by the investment community refers to defensives versus growth companies, and many of the High Quality companies listed on the ASX are usually included when the market focus shifts to defensives, but differences still matter.

A recent research paper released by Wilsons suggests investors have a choice between 'defensive' and 'defensive growth' - the difference in return between these two categories can be significant over time.

To illustrate their thesis, analysts at Wilsons compared the performance of CSL ((CSL)) and Woolworths ((WOW)) shares over the past ten years. Woolworths functions as your typical defensive exposure, while CSL is the counter-example of a defensive growth company.

Back in early 2013, CSL shares were trading on a PE multiple of circa 21x and a forward-looking implied dividend yield of 1.9% only. Woolworths looked a lot more attractive, trading on a PE of 13.3x and offering a yield of 5.3%.

Fast forward to one week ago (March 14) and $100,000 invested in CSL shares back then would have generated $525,473 while total return from Woolworths only reaches to $142,078.

The first calculation amounts to an annual capital return of 18% over the decade while investors in Woolworths had to satisfy themselves with an annual return of 3.6%, 5.4% in total if we include dividends.

Wilsons still thinks CSL shares are more attractive than Woolworths today. Its projections for CSL are for EPS CAGR of 24% between FY23-FY25. For Woolworths the comparative pace of forecast growth is 7%.

The underlying message from this research is that growth matters, growth ultimately creates the difference in return between shares. The lowest valuation is not by definition the better choice (even though this may not be apparent in the short term).

The same principle applies to the highest dividend yield. My namesake at First Sentier Investors, head of equity income, Rudi Minbatiwala explained recently how investors looking for income in early 2013 had ignored the high yield on offer from Telstra ((TLS))  and instead had opted for what appeared a pitiful yield at the time from shares in REA Group ((REA)).

When making up the final balance after ten years of owning either Telstra, an oft cited income stock, or fast-growing REA Group, investors might be surprised total income received from REA exceeds total dividends paid out by Telstra. And that's without the obvious difference in capital appreciation (Telstra shares went backwards over the past decade).

On Wilsons' labeling, circa 25% of the ASX300 can be categorised as 'defensive' - not everybody is on board with traditional labeling, but selections usually include Amcor ((AMC)), APA Group ((APA)), Brambles ((BXB)), Coles Group ((COL)), Endeavour Group ((EDV)), Medibank Private ((MPL)), The Lottery Corp ((TLC)), and Transurban ((TCL)), among others.

It's probably worth highlighting smaller cap companies can also be labelled 'defensive', but a smaller size and less diversified shareholder register tends to go hand in hand with greater volatility when things get truly hairy in markets. A smaller sized business tends to be more vulnerable to negative developments which also reduces the solidity of earnings.

When choosing which defensives should be included in the portfolio, Wilsons' preference is with defensive growth. Its portfolio currently includes CSL, ResMed ((RMD)), Insurance Australia Group ((IAG)) and Cleanaway Waste Management as your typical 'growth defensives' while its top defensive choice is The Lottery Corp, with Telstra also included.

Two other opportunities highlighted are Ramsay Health Care and Treasury Wine Estates ((TWE)).

One potential deterrent for investors to consider investing in the companies mentioned is that Quality and Defensives, in particular during uncertain times, are seldom trading on truly attractive-looking, low PE multiples. But, as explained by James Abela, portfolio manager for the Fidelity Future Leaders Strategies, the 'trick', so to speak, is for investors to distinguish between Quality and Momentum stocks.

Both enjoy above-average valuations, but not for the same reasons. Momentum stocks are companies that temporarily enjoy the triple-peak in earnings, valuation multiples and market sentiment. The latter usually involves a large participation from the so-called 'hot' money crowd. They'll leave instantly when momentum wanes.

Recent examples would include the BNPL sector and technology stocks such as Appen ((APX)), as well as online retailers; think Redbubble ((RBL)) and Kogan ((KGN)), for example.

This is not to say Quality stalwarts cannot get into trouble, or lose their way.

Woolworths once lost its way when hubris gripped top management and the board (2014-16) and Brambles is only now seemingly ready to awaken from its slumber that has lasted half a decade-plus. Contrary to opinions voiced elsewhere, I also believe the longer-term outlook for Ramsay Health Care is a lot more clouded, which raises serious question marks about this company's inclusion in the local Quality basket.

Regardless, the value of owning Quality companies over long periods of time has over the decade past increasingly been acknowledged by investment experts, including many of your typical 'value' investors who traditionally would shun these stocks as they were 'too expensive' or at least 'not cheap enough' by default.

The obvious statement to add here is that a cheaper share price should only add to the attraction, and to prospective longer-term returns, from owning Quality companies.

My research into All-Weather Performers attempts to identify which companies are truly sustainable growers of High Quality, spread over a number of separate lists. On my own observation, the overlap with selections made and published elsewhere is usually noticeably large. I consider this an added validation of the research itself.

Paying subscribers have unlimited access to a dedicated section on All-Weather Stocks: https://www.fnarena.com/index.php/analysis-data/all-weather-stocks/

For obvious reasons, selections don't change much (you're either 'in' or not, and that doesn't change upon the first headwind), but I have been making small changes since February.

All-Weathers: Post-February

The first observation to make is that Australia's Quality companies usually perform well during results seasons. This doesn't mean they cannot miss forecasts or suffer from share price weakness, as macro and general sentiment play a role as well, but overall, your typical Quality company is a great place to be when reported financials are measured against medium- to longer-term expectations.

The first company to highlight post-February financials is CSL with the interim report indicating the negative impact from covid and lockdowns on plasma collection is now truly in the past. Underlying, this company is yet again ready for solid, double-digit percentage growth in EPS, which is also reflected in today's consensus forecasts.

To some, the primary observation is that CSL shares have effectively trended sideways since 2020, but if I picture a conversation between Mr Market and CSL, it revolves around that old cliche: "it's not you, it's me". Investor focus in Australia has been all about covid-beneficiaries, bond yield victims, inflation protection and China leverage. None of these themes du jour include the largest healthcare company on the ASX.

This too shall pass, eventually. It might still take a while before enough investors feel confident about the acquisition of Vifor, but I still remember the scepsis surrounding the purchase of Novartis' global influenza vaccine business in 2014. It proved overly conservative and unnecessary. CSL has had Vifor on its wishlist for more than a decade. Already, analysts have been positively surprised, and excited, about the add-ons Vifor brings to the CSL future product pipeline.

This is not to say there are no risks. There's a small Dutch-based company, Argenx, that is on everyone's radar. And CSL management itself is not super-confident where exactly profit margins will be in 18 months' time, as higher operational costs might stick around for longer.

But if history is any guide, sceptics will again be left barking in the wind, while shareholders enjoy the rewards from their loyalty. As Warren Buffett tends to say: invest in companies, not in the share price. Longer term, share prices do follow underlying fundamentals.

We might as well stay with the Wilsons comparison... Indeed, Woolworths is more 'defensive' than 'growth', and its typically elevated valuation multiple became a big burden to bear last year. But make no mistake: Woolworths is the superior operator in its sector, similar to CommBank ((CBA)) among local banks, and this superiority will prove its value, one way or another, throughout the ups and downs ahead.

I have become a big fan of picking market leaders in sectors as I have come to appreciate their sustainable, long-duration competitive advantages vis-a-vis smaller competitors. Other obvious examples are REA Group versus Domain Holdings Australia ((DHG)), Sonic Healthcare versus Healius ((HLS)), and Aristocrat Leisure ((ALL)) versus Ainsworth Game Technology ((AGI)).

Woolworths runs the superior franchise in Australia and as a typically defensive, its valuation is probably high because of the multiple uncertainties out there. Then again, current consensus forecasts confirm the market leader's superiority versus Coles and Metcash ((MTS)).

Supermarkets and big box department stores have their challenges ahead, including pressure on household budgets and rising costs, but Australia is still an island and many of the products are non-discretionary. The possibility of a weaker share price later in the year will be very much dependent on what is going on elsewhere, including for the Australian economy generally.

One Quality market leader that is using post-covid uncertainties to strengthen its future growth platform is Carsales ((CAR)). Usually most attention goes towards REA Group, also because real estate remains a long-term no-brainer in Australia, and Seek ((SEK)), with the latter a prime example of the long term value of making strategic investments, but this time Carsales' strategy of buying out its partners in offshore portals is catching investors' attention.

First the US, then Brazil. Carsales is effectively broadening its growth and appeal beyond the Australian market in which it remains the undisputed number one. Expanding offshore is not a guarantee of success, even REA Group can attest to that statement, but Carsales knows the businesses it is buying. And locally it has discovered the advantages of exerting pricing power, as well as strengthening relationships when covid hit dealerships hard.

If there's one Quality, sustainably growing market leader that has seen value investors appearing on its register in recent years, it has been Carsales. Maybe this is because, on a simple comparison with REA Group and Seek, PE ratios of 28x and 25x don't look too bad for a platform operator that promises 10%-plus growth (pretty much) annually with a dividend yield of circa 3%?

One company that 100% doesn't receive enough attention in Australia is Ebos Group ((EBO)). This NZ-listed company joined the ASX in late 2013 and has proven a consistent and reliable performer since, which is also reflected in its share price over the period. Ebos Group might be the one ASX-name whose shares are trading at an all-time high while most investors locally might still respond with: huh, who?

Some might be familiar with chemist brands including Terry White Chemmart, Symbion and Pharmacy Choice+, but Ebos does a lot more, calling itself the largest and most diversified Australian marketer, wholesaler and distributor of healthcare, medical and pharmaceutical products. It shares with Woolworths the recognition of the potential of moving into animal care products.

Ebos wasn't always included in my selections, but it had been on my radar for multiple years, until I decided to add it as a Potential All-Weather Performer.

The February results season offered plenty of misses and disappointments, but from the perspective of All-Weathers, the biggest disappointment was delivered by Domino's Pizza ((DMP)). I could read between the lines of multiple research reports post the interim result that analysts had been quite shocked by how dreadful things had become operationally in such a short time.

Will this be the (negative) turning point in what has been an extremely volatile, but also exceptionally successful international trajectory for this company over the past decade?

I dare not to make any firm statement at this point, other than that history has taught me it's usually best to remain prudent, and not on the register, of companies whose fortunes turn in such a quick and decisive manner. Others that have preceded Domino's in past seasons, think a2 Milk ((A2M)), Appen ((APX)) and Blackmores ((BKL)), are hardly encouraging examples to look back upon.

Other companies on my curated selections that caught my attention in February include Audinate Group ((AD8)), Endeavour Group, Goodman Group ((GMG)), NextDC ((NXT)), ResMed, Seek, Steadfast Group ((SDF)), Wesfarmers ((WES)), and WiseTech Global ((WTC)).

With exception of NextDC, all those companies have been registered in FNArena's Monitor as a 'beat'.

I remain confident Pro Medicus ((PME)) is one of the highest Quality growth companies on the ASX. Getting on board is simply a case of picking one's entry level, while ignoring the multiples and the dogs on the sideline barking in the wind.

A special mentioning goes out to HomeCo Daily Needs REIT ((HDN)) which, as a REIT, doesn't fit the mould to be included in my selection of Dividend Champions, but its interim result left little to criticise and the All-Weather Model Portfolio owns it as part of its allocation to dividend/income stocks, alongside Telstra and a dedicated ETF.

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

Research To Download

Edison Research on:

-Actinogen Medical ((ACW)): https://www.fnarena.com/index.php/download-article/?n=DC84362D-92D5-AABE-7ADBFA4EC1F54072

-Incannex Healthcare ((IHL)): https://www.fnarena.com/index.php/download-article/?n=DC8BA139-D9FB-5F9F-E43145705FCECD86

-Recce Pharmaceuticals ((RCE)): https://www.fnarena.com/index.php/download-article/?n=DC791250-C9DD-4639-F1622ABD1B800B03

Research as a Service (RaaS) on:

-Australis Oil & Gas ((ATS)): https://www.fnarena.com/index.php/download-article/?n=DCA02B7F-D6DF-118D-CCB6DCD42574A524

-Comms Group ((CCG)): https://www.fnarena.com/index.php/download-article/?n=DCA84136-DF31-2B16-39A161D0FC9C137B

-Empire Energy Group ((EEG)): https://www.fnarena.com/index.php/download-article/?n=DCB462F7-BEA6-76FA-356481EAE235D838

-Harvest Technology Group ((HTG)): https://www.fnarena.com/index.php/download-article/?n=DCBC6A0C-FC5C-CAB3-3CD881F96CFBF368

-Pointerra ((3DP)): https://www.fnarena.com/index.php/download-article/?n=DC979EB6-FC68-83C0-4BEE92E909DDC116

-Ricegrowers ((SGLLV)): https://www.fnarena.com/index.php/download-article/?n=DCC93F71-051F-C87A-87693676DD73FD0F

-X2M Connect ((X2M)): https://www.fnarena.com/index.php/download-article/?n=DCCF2C83-AF32-A3A0-338286699F9E5FE9

(This story was written on Monday, 20th March, 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).

FNArena Subscription

A paid subscription to FNArena comes with numerous bonus publications and data on more than 1200 ASX-listed companies. Subscriptions cost $480 for 12 months and $265 for 6 months and can be tax deductible (ask your accountant about it).

https://www.fnarena.com/index.php/sign-up/

It has become the 'unofficial' tradition in recent years: an interview with Livewire Markets ahead of yet another corporate reporting season in Australia. Below is a sub-edited transcript from last week's interview, released this week by Livewire (also available on YouTube).

James Marlay: Since early October the ASX200 has rallied a stunning 17% to the highest point in February. Straight off the bat: is this still a bear market or a rally with more positive long term implications?

Rudi Filapek-Vandyck: It'll depend on one's definition. We all tend to get more excited when share prices rally and we get more optimistic about the future. But I would caution that after a return of that magnitude which, let's call it out, has surprised most people in and around the market, such a strong rally is going to colour the February reporting season.

It will have a massive impact. Needless to say, company reports will be judged differently from when markets were still -17% lower. It's good for investors to keep this in mind. The benchmark for company results to exceed has now been reset. The bias has shifted. At the depths of last year, companies would be given a lot more leeway. Right now, I think companies will have to prove why share prices should still go higher.

Early indications are in most cases companies that release financial results see their share prices weaken, in some cases quite significantly so. While it's still early days, I think this trend may well dominate this season.

James: We'll touch on that trend in a bit more detail later on. I want us to revisit some commentary that we covered in our last interview (August last year). Back then it was your view that commodities were not recession-proof. I bring it up as we can all see today that the commodities component of the market has been very strong and a big driver of the market's recovery. Have you been surprised by the strength in commodities and what's the impact of China re-opening for Australian commodities?

Rudi: Similar to what has happened with equities in general, I think commodities have rallied ahead of fundamentals, and the China re-opening is part of it. The other thing which I think is very important to note is that the process of raising interest rates, higher bond yields and then the impact on the economy has been much slower than history would suggest.

Markets are not patient. They are not going to sit around and wait for things to happen. So the obvious observation is that the direct correlation between an economic slowdown, economic recession and commodity prices weakening is usually a pretty solid correlation. The problem thus far is, of course, we haven't seen any recessions just yet; we have hardly seen economies slow down.

This is an important part of the picture that is weighing over this reporting season. Some of the corporate results will look absolutely fantastic. But the question remains: what comes next?

For commodities, yes, they've all rallied and the fact that the slowdown is arriving in a much slower manner than one would expect has given investors a lot of leeway to put a lot more risk in markets, but there are still question marks out there. If we look at bond markets; bond markets essentially are forecasting a significant slowing in economic activity.

Whether this will result in a recession or not, we will have to wait and see, but markets don't wait around. Having said so, it may well be given the re-opening in China that even if we still see massive slowdowns in places like Europe and the US, the prices of commodities might remain well supported. I do think the commodities space will splinter. Not every commodity will hold its own.

Another observation is that I did make the forecast last year that oil would not hold above US$100/bbl, and that has proven correct. This hasn't translated into a similar pullback for share prices of producers. This is not that unusual. It happens on occasion.

Needless to say, at some point this gap has to be corrected. Either one goes down or the other goes up.

If those two explanations are not sufficient, I can always fall back on the old joke about economists. What's an economist? That's someone who makes erudite forecasts and then later on explains in that same erudite manner why those forecasts have been inaccurate.

It's very difficult to make forecasts in a market that is all but normal, definitely not textbook. As investors, we always have to be mindful that things change along the way. Will we avoid recessions? I don't know. But I would not be cocky about it because share prices have rallied.

James: Let's dig a little deeper into what I think is a good read on how you're feeling about markets. Twelve months ago, you were holding 30% in cash. When we last spoke in August, that had reduced to around 20%. What's your cash position now and what's the reasoning behind it?

Rudi: I have done remarkably little. I checked this morning, the cash level (in the All-Weather Model Portfolio) is slightly below 18%. From memory, the last thing that happened was buying extra shares in NextDC ((NXT)) when the share price looked ridiculously low. The Portfolio has done nothing else. The reason for that is that I remain skeptical about the fundamentals underneath this rally. The other reason is I expect this reporting season to be brutal at times, and this means you can jump on opportunities.

James: You mentioned you hold a healthy level of skepticism. What are some of the reasons? What are the big things that support your position?

Rudi: Because it's such a slow, ongoing process. Maybe the best comparison to make is with an example from real life. If one asks the billionaire and the homeless guy how did you end up where you did? They usually give the same answer: it happens very slowly and gradual for a long time, and then all of a sudden it accelerates.

My suspicion is we are in a similar process. We're all getting very optimistic because consumer spending is holding up and company results are not falling off a cliff. But central banks continue to tighten and the full impact from last year's rate hikes still has to come through. I think time will come when we might see things deteriorate rather rapidly.

I have a suspicion this is also the view of central bankers, which is why the Federal Reserve is injecting liquidity in the system, and China's doing the same.

As I said earlier, yes, share prices can rally and investors are taking a big leap in that fundamentals will catch up, but there are some big question marks that still need to be answered. To my surprise, which I suspect has also surprised many locally, the increase in the RBA cash rate has not yet been fully passed on by the banks to mortgage holders. Let's see what the impact will be when that happens.

James: Nearly every sector is in the green this year. Last year was effectively all about materials and energy. Small caps have also been resilient. What's your interpretation of these moves? Do you think the market is now looking through the great hiking cycle you are referring to?

Rudi: I think the big rally can partially be explained by market positioning. Many an investor last year was positioned for much worse times ahead. Forecasts were for a very tough first quarter, with improvement likely further out. This rally has now put everything on its head. Some people might draw a direct correlation with central banks and liquidity.

The market is supposed to be forward looking, but it's not perfect in what it does. Human nature, how we are built and operate, is that we become optimistic when share prices go up, but share prices arguably were quite beaten down. So from the moment share prices start moving upwards, money starts flowing in.

The current situation requires that fundamentals catch up with prices. Either that, or share prices have to come down. We will see both in February, and that process can be brutal.

James: We've had a few early reports and as you alluded to, the trend has generally been for negative market responses despite what looked from your analysis and your reading relatively okay results. Can you explain what you've observed and how you think that plays out through the rest of the season? Maybe you can give a couple of examples?

Rudi: I think there's a big difference between the laggards and those companies that have performed well, either in the past weeks or throughout last year. That second group, I think, is now being treated more harshly by investors. You saw that with results from the likes of Nick Scali ((NCK)), ResMed ((RMD)), maybe even Amcor ((AMC)).

There have been a few exceptions, such as Janus Henderson ((JHG)) and Suncorp Group ((SUN)). Suncorp hasn't genuinely participated in last year's market and it is now getting the benefit of the doubt. While others are basically being punished for the little things that may not be perfect. Sometimes this comes down to cost inflation, which is very difficult to forecast from outside the business. Not even management teams themselves can often put a finger on what is likely to happen.

This is not something that just applies to financials or industrials, or healthcare, it applies across the board. In January we saw production reports coming out and many mining companies showed difficulty with containing costs. We've seen few mining companies update early in February. One is an iron ore miner (Champion Iron ((CIA))) and the other is IGO ((IGO)). In both cases share prices weakened. In both cases cost inflation was one of the key ingredients.

This signals it's very difficult to know in advance how investors will respond to financial results.

James: Let's talk some names. Which are the companies you are expecting to deliver strong results, which we don't know whether that's a good or bad given how the market is responding. But tell me some of the names that you're interested in, and follow closely?

Rudi: I think it's important to emphasise the dynamics for this season will be different from what normally applies. What happens usually is that if you're surprising to the upside, you get rewarded. Your share price outperforms sometimes for up to four months. And the opposite holds true as well: you disappoint and that can linger for months.

I think this time around dynamics will be different because we have that Sword of Damocles hanging in front of the market that things might still look good right now, but what about the second half? What about the third quarter?

Having said so, because of the work I do at FNArena, I see a lot of research passing by and that allows me to pick up when sentiment clearly improves towards a given company. Over the past few weeks sentiment has noticeably improved for CSL ((CSL)), also a laggard from last year as the share price hasn't done much. This is why the CSL share price is no longer around $270.

Another stock for which sentiment has improved is Telstra ((TLS)). Last time Telstra actually increased its dividend and very few were anticipating that. It appears from research since then that, overall, dynamics for the telecom sector on the ground have only further improved. Indications are this might further improve in the second half and beyond.

Why is this important? Because if we are preparing for tougher times ahead, then companies like Telstra will become more attractive, because they move in the opposite direction operationally.

Next, the company I already mentioned, Suncorp, is widely regarded as the undervalued insurance company. This doesn't explain everything, but it does explain why this insurer can release a wishy-washy result and the share price goes up. I would be surprised if that share price does not keep on going up in the next few weeks, or months.

Another interesting thing to point out about last year's laggards, and this is a comparison that very few investors make, is that we all get excited about copper and lithium as they are, apparently, in a long term beneficial trend. So we're more than just excited about this prospect and prepared to own those companies for the longer term.

It's not too far out of the ballpark to make a similar comparison to many of the high quality, sustainable growers in Australia who each have a super-cycle that helps and supports them. That has helped those companies over the past decade and it will continue to help them in the years ahead.

Many people still have to get their head around this. Today's opportunity in the share market is not necessarily with PE ratios on three, or eight, or thirteen. The opportunity can be with a stock that is trading on a PE of 30 and beyond. Now we are talking about REA Group ((REA)), Seek ((SEK)), Carsales ((CAR)), even Pro Medicus ((PME)), TechnologyOne ((TNE)), CSL and ResMed, Breville Group ((BRG)) even, and Goodman Group ((GMG)).

Some investors have this misconceived idea these companies have not yet de-rated, but they have. We had a massive de-rating of multiples last year, but it hasn't hit every segment of the market in the same way. There's an illusion that a stock like CSL, which essentially moved sideways, hasn't de-rated, but it has. Last year was a big bear market which only didn't show up at the index level in Australia.

I'll be definitely watching these stocks, in particular as they have participated in this year's strong rally. I wouldn't necessary jump on board at current levels, but if weakness kicks in at some point, I am certain I am not the only one who's looking to get on board.

James: Final question: what does it take for you to reduce your cash to, say, 10%, or lower? Is it down to share price movements or an external factor that increases your confidence that we've moved through the worst of the impacts from the tightening cycle?

Rudi: It will probably be a combination of the two. Confidence should not necessarily come from how markets behave. But it's difficult because the market doesn't always cooperate, it doesn't always present the opportunities when people would like to see them.

Assuming equities don't continue rallying, the market has two choices; either move sideways for a while, or revisit the low. In the second scenario, hopefully we'll all be more keen to allocate more money than in the first. But we can only make assumptions and the market will ultimately decide where the opportunities come from, and how to allocate one's money. We have to be flexible.

James: Thanks for coming in today. Always good to catch up.

(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.)  

P.S. I - All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories. Go to My Alerts (top bar of the website) and tick the box in front of 'Rudi's View'. You will receive an email alert every time a new Rudi's View story has been published on the website. 

P.S. II - If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

In this week's Weekly Insights:

-Final Weekly Insights For 2022
-Regrets, 2022 Delivered A Few
-Conviction Calls

By Rudi Filapek-Vandyck, Editor

Final Weekly Insights For 2022

Weekly Insights is taking a break until January next year, when we start preparing for the February reporting season.

I hope you all enjoyed reading my weekly writings as much as I enjoyed preparing and sharing them.

Merry Festive Season to you all!

Regrets, 2022 Delivered A Few

You just know 2022 has been an eventful, but certainly unusual year when you look back over your shoulder and conclude moving into Overweight cash early has been the best decision made in the year.

As the Federal Reserve in the US, and many central banks around the globe, abruptly reversed course and embarked on probably the steepest tightening path ever witnessed, it seemed appropriate to lift the portfolio percentage in cash to 30%-40%, where it has been until last month.

Cash makes up less than 20% in November, but serious considerations will be made whether it should be higher ahead of what promises to be another volatile reporting season in January-February (US and locally).

A decision to convert part of the portfolio into cash always meets with emotive resistance and fierce rejections among investors. Is it possible to "time" the market (including when to get back in)? Shouldn't investors simply take a long term view and resist the urge to respond negatively during times of extreme volatility?

Certainly, there is a class of investors who holds a strong belief that share markets always recover and post gains in the long run. Those investors have been busy buying more stock upon volatility and weakness this year. Judging from some of the data available, there has been a lot of such buying at lower prices this year.

Contrary to what many might expect, including experienced veteran market commentators, bear markets are never quite the same. 2022 certainly has not been one-on-one comparable with late 2018, 2015-16 or that dreadful 2007-09.

This year, the FNArena/Vested Equities All-Weather Model Portfolio found itself quickly on the wrong side of share market momentum. As an investor in long-duration, high quality and growth companies, owning shares in Goodman Group ((GMG)), Hub24 ((HUB)), REA Group ((REA)), Xero ((XRO)) and the likes was never the ideal starting point in early January.

While the pressure from rising bond yields was relentless and inescapable, we take comfort from the fact the portfolio sold shares and substantially lifted the allocation to cash.

But there's another observation that equally deserves to be highlighted: in my research I try to distinguish the higher quality companies from the rest. Not that high or low quality makes a lot of difference during the run-away bull market that preceded this year, but when times got tough, it most definitely did.

Whereas many a prior high-flyer got smashed to pulp in the first half of 2022, personal favourites such as Pro Medicus ((PME)), TechnologyOne ((TNE)) and WiseTech Global ((WTC)) stoically stood their ground, and not simply in a relative sense (though they did fall a lot less than most High PE peers); as we approach the end of the calendar year these stocks are sitting on a net positive return.

Yes, you read that correctly. 2022 has not all been about fossil fuels and large cap financials. One of the regrets for the year is the All-Weather Portfolio went cautious and conservative early, and this included selling out of Pro Medicus, Xero, Breville Group ((BRG)), Charter Hall ((CHC)), Seek ((SEK)) and Hub24.

We did not get back in. With perfect hindsight, there are no silver bullets when it comes to protecting one's capital. In light of next year's plausible ramifications from the international 2022 tightening frenzy, there are reasons to remain cautious on immediate prospects for Xero, Breville and Seek, maybe for Charter Hall too, but this year's regrets definitely include Pro Medicus, WiseTech Global and Hub24 no longer being part of the All-Weather Portfolio.

We will bide our time. Today's eerily calm is unlikely to be representative of what next year will look like for the share market. Opportunities will present themselves, exact timing unknown.

Moving a large percentage of the portfolio into cash is not a panacea for all conditions and circumstances, but my personal contribution to the public debate is that local fund managers saw their return slump to -20% or more, sometimes a lot more, and the All-Weather Portfolio has kept losses this year in the single digits.

Raising the level of cash was specifically aimed at exactly such outcome. Or as I like to respond when receiving questions about it: it's never an attempt to "time" the market; it's aimed at reducing risk. There's a difference between the two.

****

Resources and other heavily levered cyclical companies remain off the menu for the All-Weather Portfolio and that's certainly no help in a year when shares in coal producers quadruple and earnings momentum, including massive dividend payouts, resides with closed shop fossil fuel producers (Ukraine-inspired or otherwise).

Bear market rallies, including the one that is currently still taking place off the October lows, have been fierce and powerful, and they too benefit the lower quality, small cap laggards most.

Somehow I feel we shouldn't be overly disappointed with the small portfolio retreat that will likely mark this year on December 31. Most portfolio constituents and companies on my radar have largely compensated for earlier losses in the opening months, in particular over the two months past.

CSL ((CSL)), for example, is trading in positive territory year-to-date, ex a small dividend, as is Amcor ((AMC)) though the latter made all gains early in the year. Overall, your traditional defensives largely missed out on sustainable market momentum in 2022, including supermarket owners Coles ((COL)), Metcash ((MTS)) and Woolworths ((WOW)).

The largest surprise, however, has been the significant outperformance of energy producers, which is not solely because of LNG exposure and not simply a local phenomenon either. Investors should always be mindful of the fact that share prices in producers do not by default blindly follow the price of the commodity, but this year's de-coupling of share prices when the price of oil succumbed to fears of global demand shrinkage is still remarkable.



There's no shortage in energy bulls in today's market, but history shows that gap between the price of oil and share prices in Santos ((STO)), Woodside Energy ((WDS)), et al will close, exact timing unknown, and there are, roughly, two scenarios:

-either the price of oil picks up again and share prices for the sector globally have been proven prescient, confidently focusing on underlying fundamentals rather than short-term volatility in futures markets;

-or share prices will fall to match the price of oil to the downside.

My favourite observation about bear markets is that of domino stones; ultimately the last ones standing will also fall. Note, for example, how shares in high flying coal producers quickly lost -25% and more in just a matter of weeks recently. The latest sector to be hit are currently the producers of lithium.

Of course, such short-term sell-offs tell us nothing about the longer-term up-trends, but it is probably wise to keep an eye on what is happening in those smaller markets for what might follow next for your typical fossil fuel energy producer.

****

Among the beneficial decisions taken this year is the addition of the Vanguard Australian Property Securities Index ETF ((VAP)) to the Model Portfolio on the belief that, yes, inflation might stick around for longer and central bankers are not yet done with tightening, but bond yields might have seen their peak already.

This ETF was added on an implied yield above 5%. According to the Vanguard website, the yield has now shrunk to 4.6% (implying there has been a rally in the price).

Bonds no longer rallying has equally allowed the share price in the HealthCo Healthcare and Wellness REIT ((HCW)) to appreciate from a very beaten-down looking level in weeks past, though volatility remains high on a daily basis, and it has been a disappointing allocation overall.

We haven't lost faith and if next year brings us uncertainty over corporate profits and lower bond yields, we will welcome the prospective 5% in payout, hopefully with some price appreciation on top.

Telstra ((TLS)) remains another yield stock in the portfolio, to date generating a small capital erosion for a prospective 4.3%. Telstra's attraction remains the sale of infrastructure assets, while underlying the shares should benefit from the same bond market dynamics.

The portfolio also stuck with retailer Super Retail ((SUL)) whose come-back is currently in full swing. At just under $11, Super Retail's prospective payout should yield 5.5% in the year ahead, though a lot will depend on whether margins and cash flow can be maintained.

The latter might turn into a crucial question next year, as also suggested yet again by shares in over-sized women's wear retailer City Chic Collective ((CCX)) whose latest profit warning has caused the share price to tank by -50%-plus in two days, after the shares had already lost circa -75% since the all-time peak last year.

****

The All-Weather Model Portfolio has had no City Chic experiences this year, which can be interpreted as a vindication of the quality company choices, as well as the decision to reduce risk.

Xero, for example, is still carrying the risk of significant further deterioration in the post-Brexit UK economy, while the geographic exposure to troubled economies stretches further for Breville Group. This is why both are no longer in the portfolio.

Inside the All-Weather Portfolio, companies such as Amcor, CSL, Goodman Group, TechnologyOne, Carsales ((CAR)), etc have mostly stuck with positive guidance for the year ahead. Disappointments have thus largely been macro-related, including negative impact from FX and bond yields.

With one notable exception...

Iress ((IRE)) used to be part of the higher quality ASX listings, which had gone through a tougher period dominated by margin pressures.

The dangers of investing in higher quality companies is that quality generally requires maintenance and constant investment. CSL, as a prime example locally, invests more than $1bn every single year to secure its product pipeline and guarantee future growth.

Iress, it seems, is today but a shadow of its former quality self. I wouldn't be surprised if in years to come, investors rank it in the same basket as the likes of AMP, Lendlease, Myer and Westfield. Maybe they already do and I have simply been too slow in catching up (?).

Compensating for the solidity elsewhere in the Portfolio, Iress has been forced to issue two profit downgrades in the year past. Time to remove this company from my research radar.

The Portfolio sold out of NextDC ((NXT)) early in the year, and returned at much lower price level, only to see the shares take another leg lower. It turned out, investors are worried about a potential capital raising assuming company management is still looking to expand into Asia.

We're comfortable with the market position and longer-term growth dynamics that support the investment thesis in NextDC.

****

All in all, the key question that pops up as share markets seem hell-bent on finishing 2022 on a positive note remains: if one became cautious and defensive too early, does that mean the decision itself was wrong, or was it just that the timing was off?

By now, early in the year I would have expected corporate profits had wilted and central bankers would be closer to pause or pivot, but none is the case as we prepare for 2023 (though there's lots of speculation about the latter).

The market has simply split and polarised in 2022. While we can all make confident predictions about what might be in store for next year, I think it's important to keep an open mind.

Shorter-term, investors best not forget about the challenges that are hitting corporate margins and profits. Share price action this year has been mostly directed by bond markets and other macro-considerations, including speculation about central banks' stamina.

While the latter will remain with us for longer, investors might be forced to pay attention to corporate challenges in the not-too distant future.

When this happens, I think we'd want to be on the right side.

More Weekly Insights reading:

-Preparing For Bear Market Phase II:

https://www.fnarena.com/index.php/2022/11/24/rudis-view-preparing-for-bear-phase-ii/

-Re-Opening Opportunities In Healthcare:

https://www.fnarena.com/index.php/2022/11/17/rudis-view-re-opening-opportunities-in-healthcare/

-More Choice For Income Hunters:

https://www.fnarena.com/index.php/2022/11/10/rudis-view-more-choice-for-income-hunters/

-Technology's Moment Of Truth:

https://www.fnarena.com/index.php/2022/11/03/rudis-view-technologys-moment-of-truth/

Conviction Calls

Shares in Breville Group have come under pressure this month and the reason seems to be related to market updates by peer companies in the US.

Sector analysts at Wilsons and Jarden weighed-in on growing concerns last week.

Wilsons suggested with weakness popping up in Q3 market updades for the likes of Williams Sonoma and Best Buy, this might be an indication the US consumer is simply following into the footsteps of consumers in Europe.

Not colouring the overall picture any rosier, DeLonghi has signalled both increased discounting and strong growth in manual coffee machines, which might be an indication the Italian competitor is grabbing market share from Breville.

Jarden focused on the fact a number of US retailers is sitting on too much inventory; this raises the risk of general price discounting to reduce stock. As part of inventories are supplier funded, Jarden has scaled back its expectations for margins.

All in all, Jarden has moved to Underweight on the stock (downgrade from Neutral) also because of momentum concerns across the EMEA countries, with a reduced price target of $19.20.

Wilsons is still sitting on Market Weight with a price target of $22.10.

****

When it comes to seeking exposure to the local lithium story, Macquarie's preferences are with Mineral Resources ((MIN)) and IGO ((IGO)).

****

Goldman Sachs' A&NZ Conviction List consists of 13, all Buy-rated, ASX-listed companies:

-Charter Hall Social Infrastructure REIT ((CQE))
-Elders ((ELD))
-Fisher & Paykel Healthcare ((FPH))
-HealthCo Healthcare & Wellness REIT
-Iluka Resources ((ILU))
-Lifestyle Communities ((LIC))
-NextDC
-Omni Bridgeway ((OBL))
-Qantas Airways ((QAN))
-REA Group ((REA))
-Webjet ((WEB))
-Westpac ((WBC))
-Woolworths Group

****

How low 2023? According to the latest investment outlook by Credit Suisse, global economic growth next year will slump to 1.6% only. And no major central bank is expected to cut its cash rate.

Credit Suisse believes investors should consider adding fixed income assets to their portfolios.

Other predictions made: the eurozone and the UK will see recessions, while China will experience a growth recession. All regions will start a weak, tentative recovery by mid-year, on the assumption the US manages to avoid a recession.

On freshly updated projections, GDP growth next year in the US is expected to average no more than 0.8%, but to stay positive nevertheless.

Economic growth in Australia is projected to decelerate to 1.6%, in line with international growth, from 4% this year. Local inflation is expected to peak at 8% and to have fallen to 3.5% by year-end next year.

Credit Suisse expects a muted performance for equity markets in the first half next year.

****

The latest update on 2023 by Goldman Sachs essentially reflects the same blue print outlook as projected by Credit Suisse.

The numbers look slightly different, but Goldman Sachs also sees the US economy narrowly avoiding negative growth (i.e. recession) while the recovery in China is expected to be "bumpy" and underwhelming.

The Federal Reserve is expected to hike by a further 125bp to 5-5.25%. Inflation will come down. No repeat of the 1970s is anticipated. No rate cuts are expected in 2023.

Recessions in Europe and the UK are expected to remain relatively mild.

(This story was written on Monday, 28 November, 2022. It was published on the day in the form of an email to paying subscribers, and again on Thursday 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: info@fnarena.com or via the direct messaging system on the website).

****

BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS

Paid subscribers to FNArena (6 and 12 mnths) receive several bonus publications, at no extra cost, including:

– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
– Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow.
– Who's Afraid Of The Big Bad Bear? eBook and Book (print) available through Amazon and other channels. Your chance to relive 2016, and become a wiser investor along the way.

Subscriptions cost $480 (incl GST) for twelve months or $265 for six and can be purchased here (a subscription to FNArena might be tax deductible):

https://www.fnarena.com/index.php/sign-up/