Rudi On Thursday

This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP

(This story was first published on Wednesday, 21 October 2009. It has now been re-published to make it available to non-paying members at FNArena and readers elsewhere).

As a day-to-day consumer there can be no doubt: I deserve the label “value-minded”. For example, on my recent trip to Perth I walked past a shoe shop that had a special discount on offer for already heavily discounted shoes. Did I need a new pair? Not necessarily, and certainly not necessarily right now. But hey, what are the chances I can buy a nice looking pair, robustly built, with a solid feel, at a doubly discounted price, at any other time in the future?

And so it was that I returned from Perth with a new pair of shoes. They fit nicely, walk great and look good. Above all, they were good value. Just like the pair I was wearing when I travelled from Sydney to Perth. That pair was purchased at a discount as well. As was my all-time favourite pair of boots, purchased years ago during a visit to Melbourne.

The trick is, I found out long time ago, to wait for opportunities to come along and to avoid being put in a position of pressure. I never planned to buy those boots in Melbourne, and neither did I think about it in Perth, until I walked past the shop and saw what was on offer. When the day comes that you need to buy a pair and you only have half an hour to do so, that’s when you likely will pay top dollar and wonder where have all the discounts gone? A few years ago I ended up at a rugby tournament with my youngest son, in Canberra. Two hours before the first game we discovered we left his boots at home. That’s one of those pressure shopping experiences one should try to avoid, at all times.

As an investor one should abide by the same basic principles.

Avoid putting yourself under any pressure. You will raise your risk profile, and thus the chances of making mistakes. It’ll only cost you money, even if it appears to be going okay at first. Everyone long enough in the market knows the day will come that you will regret having taken this decision, or another one, for all the wrong reasons.

That’s one side of the story.

The other one is that, as a consumer, we all know when a bargain is on offer. As an investor, it is more likely that we have no clue whatsoever. “The share price moved up” is probably the main reason behind our decision to step in. This is, I believe, partly because we are all constantly misinformed. Instead of reporting “BHP’s share price went down by 8 cents to $39.83 today”, I believe media and commentators should tell us “BHP’s implied Price-Earnings Ratio improved today, as both the share price and the Australian dollar fell slightly”.

Spot the difference?

Of course, journalists and publishers will argue they have no readily available information to switch to this type of reporting, and they certainly don’t want to pay fatcats such as ThomsonReuters and Bloomberg for it, or FNArena for that matter. But I think at some point in the future, no matter how unlikely it may seem today, this type of in-depth information will be more readily available to share market investors. By then, hopefully, the overall knowledge and insight among media staff and investors about how to deal with this type of information will have significantly improved as well.

When I arrived in Australia, now more than nine years ago, there was virtually no up-to-date reporting on broker research. Not in the Australian Financial Review. Not on radio, or television (there were no finance channels in those days, though that wouldn’t have made one single bit of a difference). Not even by news wires such as Reuters, Bloomberg, AAPT or Dow Jones. And look where we are today: brokers cannot put out an important report without investors hearing about it the very same day. If it’s not through FNArena, it will be through the above mentioned news services, on FinanceTV, or maybe even via one of the online newspaper websites.

Maybe, in a few years from today, we will all learn that the Australian share market is now trading at more than 16 times this year’s average earnings per share (in addition to: the market lost a few points and closed at 4838 today), while the average dividend yield has fallen towards 3.5%. The first ratio is above the market’s historical average, the second one is below the historical average.

Both types of value-information suggest the share market is rather expensive.

Of course, investors will still need the analyst and the commentator that is smart enough to tell them that as long as economic data continue pointing to the direction of economic recovery, investors with a longer time frame will likely take guidance from FY11 instead of FY10, but certain things will never change, no matter how sophisticated we all become as a whole.

In case anyone wonders: the implied PE ratio on the basis of FY11 consensus expectations is a little less than 13, which is still below the long time average of 14.5-15 for the Australian share market. The implied projected dividend yield on FY11 estimates is 5%, which is above the long term average of circa 4%.

That seems to suggest there’s still value around in the share market, even though, of course, the value gap is no longer as big as it was only a few months ago.

This is why “value-oriented” fund managers will still tell us: the trend remains up. The market won’t continue rising month after month after month, like it has done since March this year, but on a medium to longer term horizon, which would have to be at least one year or so, the Australian share market should be higher than where it is today.

Unless the economic recovery takes a big stumble between now and then. There are never watertight guarantees in life. If my shoes from Perth fall off my feet next week, I will feel angry and embarrassed, but there’s little I can do about it. Right now they seem fine and I think I bought an absolute bargain.

The bottom line is, however, I would not have bought these shoes if they weren’t available at a discount.

Professional value investors, with many years of experience in the market, will tell you this is exactly the attitude long term investors should have when deciding which assets to buy for their portfolios. Still got cash on the sidelines? Don’t let it burn into your psyche. Simply tell yourself this is the tool you need for when an opportunity comes along.

If I hadn’t had the money, I couldn’t have bought those shoes in Perth, no matter how deep the discount on offer.

I agree, BHP Billiton ((BHP)) is a great company. But those investors who bought above $40 last year (or the year before) are still sitting on a paper loss. Great company, but not so great value at the time of purchase makes for a less than great return. Unless you sold somewhere in the high-thirties and bought back in below $30 – but that’s a completely different investment approach (even though still centred around “value”).

A true value investor, however, is someone who completely ignores the share market momentum of the day. These are the investors who buy into stocks that don’t go up at all. At least not now. But they know from experience that if they do their homework well, buying stocks at deep value will bring great fortunes, over time. It’s always difficult to predict when a company like CSL ((CSL)), or Amcor ((AMC)) or Origin Energy ((ORG)) will re-find investors’ focus ,but when it happens, rewards for those who bought at yesterday’s prices will naturally flow.

The problem is, however, one cannot time these things. Right now investors don’t see value in CSL, they don’t feel any urge to stock up on Amcor and they don’t have any patience when it comes to Origin. That’s good, say these value investors, because these are all good companies, led by good management and they are completely missing out on the share market rally. Because no-one is interested, these value-seekers can buy these shares at today’s neglected prices. When the day arrives that the wheels of fortune turn, they know they’ll be happy chappies.

Mind you, the turning of market focus can take a while, and investors have to hold on to their conviction even though the market will do its best to make them look foolish in the meantime.

Investors also have to have a good insight into what their risk profile is. Stocks such as Macquarie Infrastructure ((MIG)), Boart Longyear ((BLY)) and Telstra ((TLS)) look very cheap, but they come with above average risks. That’s why they are cheap in the first place.

Earlier today, I witnessed an interview with Kieran Kelly from Sirius Funds Management, one of the value investors in the Australian share market. Kelly admitted his funds have not been buying any shares for the past six weeks. He doesn’t see much value at present share prices.

Kelly also acknowledged someone among his staff told him recently: You have been waiting for a pullback since April, but we’re still waiting.

So he was wrong, as were so many others. But think about it this way: he didn’t lose any money because of it. His funds simply didn’t make any profits. It’s the opposite that hurts, and will continue doing so for a long time ever after.

If the Australian share market does go to 5000, and beyond, which remains a real possibility in the months ahead, maybe investors shouldn’t ask whether 5100 could be on the cards, but whether the stocks they own still represent value. Maybe that’s a question they should start asking right now?

With these thoughts I leave you all this week,

Till next week,

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by the Ab Fab Team at FNArena)

P.S. I – It has been pointed out by others as well, but financial markets trading guru Dennis Gartman is genuinely worried about the lack of volume behind this ever-lasting share market rally. Abiding by the old rule that volume should follow the trend, and vice versa, the US share market should either see trading volumes pick up, or the trend should ultimately fall in line with volumes, which would be negative.

P.S. II – Gartman’s worries are being echoed by the TechWizard’s view this week. The Wizard reports he’s becoming a little uncomfortable too. He suspects investors are becoming complacent once again, and that always opens the door for an unexpected surprise. The VIX, also known as “fear index”, is close to low levels suggesting complacency is once again creeping into the market, says the Wizard. As he would like to see an end-of-year rally take place, he obviously hopes he’s wrong in his assessment of the VIX.

P.S. III – As long as the economic recovery remains on track… unless you have been asleep over the past year or so, you know by now the GFC has opened up a Great Divide amongst the world’s economies and Australia has become the poster child of the Asian recovery, while Europe, Japan and the US still have to keep their fingers crossed. The chart below shows the remarkable recovery of the Westpac-Melbourne Institute Leading Index for Australia over the past months. Of course, the flip side is that the RBA is now on a tightening path, which won’t be a problem at first, but as interest rates creep closer to the neutral level, this will change.

P.S. IV – All paying members at FNArena are being reminded they can set an email alert for my editorials. Go to Portfolio and Alerts in the Cockpit and tick the box in front of Rudi On Thursday. You will receive an email alert every time a new editorial has been published on the website.

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