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Late for the Party?

by Chris Wright

Chris Wright, the editor of Smart Money in the Australia interviewed Professor John Price for an article he was writing on looking for value in the current Australian market. Below is a transcript of the article. (20 September 2003, Pages 41, 42, 43)

Want to join the share surge but afraid there's nothing left worth buying? Here's where the experts see value.

Does this sound like you? You've invested in shares before, but for the past year or so you've been out of the market, fed up with being battered by losses and unpredictable market swings. Over the past six months, you've seen share prices climb and climb, and you're finally convinced that things are on the mend and prepared to invest again. But now you're worried you've missed the boat and that the latest big rally could come to an end the moment you buy back in. Fund flow data from research houses such as Assirt and InTech suggests that many people did pull money out of equities at the start of this year, and are only just beginning to put it back in again now a sad state of affairs since those people have missed out on a 20 per cent rally, but there it is.

If you're in this camp, then there are two questions you ought to ask before wading back in. One is: is the rally at an end and the market now overvalued again, ready to fall once more? And second: which specific stocks still look like good investments today?

To find out, we asked a group of investment specialists a mixture of fund managers, consultants and researchers and distilled their thoughts.

CATHERINE ALLFREY, Colonial First State

An equities portfolio manager for the largest funds manager in Australia, Allfrey thinks there is more to come from the market rally. ``There are two reasons. We have just had the best reporting season since 1999 in terms of earnings upgrades. The other is the global economy: Japan with record GDP, continuing strong growth from China and now the US recovery as well."

Domestically, Allfrey thinks the jobless numbers were also good news and notes retail companies expect a good Christmas.

In terms of specific stocks, Allfrey highlights three that have lagged the market rally but still offer good growth prospects: James Hardie, Westfield and Woolworths.

In addition, she says analysts always underestimate the upside in earnings coming out of a cycle low. Applying this logic to media, she highlights Publishing & Broadcasting Ltd. ``It had much better than expected results, plus the market upgraded its earnings, plus I think there's more to come."

Allfrey also highlights Macquarie Bank, given the operating leverage it ought to gain from increasing mergers and acquisitions and initial public offering activity. ``We could see strong double-digit growth for Macquarie in the next couple of years."

Finally she highlights two smaller caps: Flight Centre and Transfield Services . Although most aviation-connected businesses (Qantas excepted) have bounced well after the severe acute respiratory syndrome and the war in Iraq, Flight Centre has lagged, and its 30 per cent increase in shops last financial year hasn't yet come through in terms of earnings. It will benefit from people returning to travel. And Transfield? ``Because 90 per cent of their revenue is already contracted for 2004, and they're still winning more work."

ERIC METANOMSKI, MMC Asset Management

``It's way overcooked," says Metanomski, principal of Adelaide-based fund manager MMC, of the rising market. ``The maniacs are back; the day traders are back; there's a bunch of crap in the markets that goes up every day regardless, and we're back to a situation where the less you know about stocks the better off you are, because if you knew more about them you wouldn't invest in them in the first place.

``The same alarm bells that should have been ringing a year and a half ago are ringing again."

Metanomski, as the astute reader might infer from his opening remarks, is somewhat cynical about valuations in the Australian stockmarket. And he should know: his MMC Value Growth Fund has boasted some of the best returns in the market in recent years, returning 22.2 per cent annualised over the 10 years to June 30, by a strict value methodology that mirrors a lot of the principles often associated with Warren Buffett .

His value system is struggling because he can't find much that's reasonably priced. ``I'm finding it unbelievably hard to find good value," he says, on his mobile phone while tramping Sydney's streets looking for investment opportunities. ``Some of the people I'm seeing are good companies, you bet your boots they are. But the prices are starting to discount for the next two or three years and there's too many variables that can intervene for that to make sense. Any prudent investor has got to be very careful about looking too far forward."

Within his own portfolio, Metanomski says he has many core holdings he believes are great long-term prospects but doubts they have much share price growth in them in the short term because they've already grown.

Any exceptions? He names just two: Record Realty and Nufarm . ``And we've been looking at a lot of the third-tier telcos, but the more we dig the more nervous we get."

PAUL XIRADIS, Ausbil Dexia

Xiradis, an Ausbil Dexia director, manages $1.2 billion in Australian equities. ``We're certainly of the view that there is still momentum in the markets," Xiradis says. Ausbil has a 3350 to 3400 target for the stock exchange in June 2004 and, since it closed at 3099 in June 2003, that suggests a 10 per cent rise in the markets. ``Investors could get a return in the order of 14 to 15 per cent for the year," he says.

Xiradis is wary about recommending specific stocks, though he does say that Toll Holdings has got a good deal in its proposed Tranz Rail acquisition, if it goes through. In terms of sectors, he believes banks are protected by their strong yields and that following a period of underperformance could do well in the lead up to their results. ``There's a bit of value to be had in the run-up," he says. He notes, though, that some banks have overhanging issues NAB's intentions towards AMP, ANZ's in New Zealand, and Commonwealth's soon-to-be announced broader strategic plans which suggests Westpac and St George Bank stand out for being in a good sector without the encumbrance of uncertain news.

``The insurance sector still looks good despite a strong run," says Xiradis, who also likes healthcare following a strong bounceback in earnings. Mayne will look interesting if it sells off its underperforming hospital asset.

Xiradis thinks resources look strong, too. ``We are entering a period where growth should improve, driven by the really aggressive stance that has been taken in getting the US economy to grow." If the US economy improves, and with it manufacturing and employment, resources demand should follow.

TOM COTTAM , van Eyk Research

As the head of investment research, Cottam runs the model portfolios for van Eyk, which have become the basis of several independently managed accounts that will soon form the basis of a listed investment company.

``We hate trying to make predictions of where the market will go, but I actually believe there is scope for the rally to continue," he says. ``It wouldn't surprise me if there was a correction at some point in the not-too-distant future, but in terms of valuation there is still more to come from the rally."

Longer term, Cottam thinks the rate of return will be in single-digit terms, punctuated with sharp rallies and corrections.

How big a correction? ``If bonds went up in terms of yield, depending on the extent of that, you could conceivably see a very big correction," he says. ``We're not expecting bond yields to go up dramatically, so any possible correction might be limited, but the risk is always there." Names in the various van Eyk model portfolios include Simsmetal, QBE, Mayne, Leighton Holdings , Toll Holdings , Lion Nathan and unusually Fairfax. ``That's a slightly contentious one because there aren't many people finding it favourable these days.

``If you wanted a sector, we could generally say that the retailing group looks attractive," Cottam says. ``Coles and Woolies, and one could include with it Metcash and, for those who want income, David Jones."

Among banks he prefers Westpac and thinks ANZ looks OK, but not Commonwealth. He likes SunCorp Metway, and thinks Orica and Lend Lease look interesting. Finally, among small caps, he highlights Portman Mining, particularly following its recent permission to mine a new area of Australia. ``It probably comes in as one of the more attractive resource stocks at the moment."

PROFESSOR JOHN PRICE, Conscious Investor

Professor Price developed a software package for investors mirroring the investment strategies of Warren Buffett. He believes in long-term investment the long, long term. He draws the analogy of buying a stock with getting married: a stock is something you might well stay hitched to for the rest of your life (or at least 20 years).

That being the case, he doesn't worry too much about today's valuations, instead looking at some of the basic competitive advantages of specific companies. He looks for ``economic moats", which protect the business. These include brand names like Coca-Cola and Gilette or, in an Australian context, Westfield Holdings . When Westfield opens a shopping centre, nobody else dares open one for miles around.

Few people would argue that Westfield Holdings looks cheap on present multiples a price-earnings ratio of well over 20 but Price's conviction of the management's strength over-rides that. He believes it's the sort of company you would want to hold in the long, long term.

Price, and his investment computer program Conscious Investor , also looks for consistent and high earnings per share, return on equity and return on capital. He also only wants to invest in businesses he understands and he wants you to like the products of the companies you invest in. That's not just because you, as a consumer, are in a perfect position to evaluate the quality of products you buy. ``It also makes you more sensitive to changes," he says. ``If you notice the quality of a product deteriorating and you own shares in the company that makes it, you know something's wrong, and that in time it will probably be reflected in the share price."

He says you should only invest in companies you support. You might make a quick buck out of timing the gyrations of AMP's share price, but unless you are fully convinced of the abilities of its management, it wouldn't make the cut under a Price methodology. ``And investment should be fun," he says. ``How much fun can it be if you're always worrying about what might go wrong next?"

Companies Price has applauded as investment opportunities include household names like ANZ, Harvey Norman, Flight Centre, Toll Holdings, Cochlear (despite a p/e that hovers around the 30 times mark!) and Perpetual Trustees . Smaller names like bull-bar manufacturer ARB also make the grade.

ANTON TAGLIAFERRO, Investors Mutual

The investment director for this strongly performing boutique and Assirt's fund manager of the year for 2003 says: ``Sentiment towards equity markets has certainly improved significantly in the last few months and the rally may go on for a bit longer. But we see many reasons to be cautious."

Tagliaferro says much of the recent gains in markets here and abroad has been driven by liquidity pumped into the markets by low interest rates and loose fiscal policy, particularly in the US, which he says has created some imbalances in economies that will have to be addressed down the track. Recent policies have improved confidence and created a consumer spending boom, but the benefits are not flowing through to Australian (or US for that matter) manufacturing industries, and are therefore not creating new jobs, particularly since companies have to become more competitive to survive.

``Excess liquidity is also leading to the creation of asset price bubbles," Tagliaferro says. House prices are at record levels all over the western world and some stock market bubbles are in evidence, too. ``In fact the best performing stocks in the last six months have been some of the least profitable and often most speculative types of companies" he says. ``In Australia we are seeing the return of rampant speculation in areas such as biotech stocks." He uses the example of Ventracor : yet to be profitable, capitalised at almost $500 million, and with no sustainable earnings stream yet.

Tagliaferro, like Metanomski, has noticed the return of the day trader, here and on Nasdaq. ``The proper foundations do not yet appear to be in place for a sustained bull market. In fact the current rally appears more liquidity driven than fundamentally driven."

Nevertheless, Tagliaferro says IML is keen to buy companies that can generate reliable earnings and cash flow in almost any conditions. In this camp are Transurban , AGL, Lion Nathan and the banks shares that ``have actually fallen in the current rally as many large investors trip over themselves buying into higher risk areas of equity markets such as the Nasdaq, the resources sector or other speculative areas."

PETER CONSTABLE, AM Constable

The principal of the firm, consistently among the Top 3 retail managed funds in recent years, says: ``The market has got a little bit ahead of itself." He believes the market was cheap in February and March, has climbed on the back of solid profits, then reached fair value and overshot. A lot of cash on the sidelines has been forced into the market, Constable says, creating an environment in which ``people are chasing shares again, the upshot of which is several billion dollars worth of floats coming our way."

``I don't think the market wants to pay what it's paying, but sometimes when you want to put cash to work you've got to pay what the supply and demand characteristics are in the market."

There are a handful of stocks, though, where Constable continues to see value. One is Health Communication Network . ``We think it's still reasonable value. It's doubled in the last six months, but it is on a strong earnings recovery, and we are still buying at these levels." Another is Chiquita Brands South Pacific , and a third Record Investments , provided it's held over the long term ``we think that's got 20 to 25 per cent in it over the next 12 months". He also likes iiNet , the West Australian ISP company that is raising $30 million to go towards the costs of an acquisition in NZ.

The biggest name that catches Constable's eye is Burn Philps, despite a recent disappointing result. ``That presents a bit of a buying opportunity. It's fallen 25 per cent since its highs of a few weeks ago and we think it's outstanding long-term value."

Of upcoming floats, he's most interested in Cashcard .

EMILIO GONZALEZ, Perpetual Investments.

Gonzalez, who heads investment for one of the largest managers, believes the six month rally has been justified. ``You have to bear in mind we were at a period around the March quarter this year where every bit of news was negative," he says. ``We had a lot of pressure in terms of outlook for the economy, SARS, war the sentiment was poor and the potential for fundamentals looked poor."

The last six months, he says, have involved a turnaround not only in sentiment but in outlook: ``a double swing in the market's favour".

Gonzalez won't recommend individual stocks. But is he able to find value today? ``Yes, but it's harder. The companies with strong cashflow, with good dividend policy, focused on shareholder returns, have been recognised by the market and have done well, making it harder to find an element of value."

``The last six months have been something of a free ride... now you have to be more selective."

SIX MONTHS IN THE MARKETS
The six months since war started in Iraq coincided with the strongest bull run
in Australian equities for years. Here's what the market has done since then.
 
Then
Now
% Change
All Ords
2778
3202
15%
S&P/ASX 200
2800
3199
14%
Dom mkt cap
$630bn
$730bn
16%
Trades in a month
1.1m
1.5m
16%
Avg daily trades
55,000
70,000
55%
Avg trade size 37,000 34,000
37,000
34,000
-8%
Monthly turnover
$41bn
$50bn
22%
Retail participation
47%
59%
Monthly options contracts
1.42m
1.45m
2%
Proportion of calls/puts*
95%
158%
*A barometer of confidence that means many more people have been
betting on the market rising than falling.

Source: ASX

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