Sweet Spot Stocks: All Market Beating Performances (No Exception)

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By Rudi Filapek-Vandyck and Andrew Nelson

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Three types of Australian listed stocks have proved an absolute boon for loyal shareholders and investors in the post-2008 era: reliable dividend payers such as Telstra ((TLS)) and the Big Four Banks, All-Weather Performers such as Woolworths ((WOW)), Amcor ((AMC)) and CSL ((CSL)) and stocks experiencing an operational sweet spot, generating strong profits and shareholder returns along the way.

All three categories have one key characteristic in common: they are able to generate satisfactory returns even when risk appetite retreats or economic momentum wanes. In mid-March this year FNArena opened this new series with an inaugural update on All-Weather Performers, see story "All-Weather Stocks: MND And BKL In The Red". The following week we took a look into stocks we think are experiencing an operational sweet spot. Note that we intend to make this an interactive exercise: readers are encouraged to nominate stocks they believe should be added to our updates. Send your nominations to info@fnarena.com and we will follow up and consider.

At the basis of all this lays research by FNArena Editor Rudi Filapek-Vandyck since late 2007 which earlier this year led to the publication of "Make Risk Your Friend. Finding All-Weather Performers", an eBooklet which to date is exclusively available to paying FNArena subscribers (if you haven't received your copy as yet, send an email to info@fnarena.com).

The eBooklet argues that successful investing is closely correlated to minimising and managing risk. Hopefully the framework we are creating with these regular updates will assist subscribers in executing successful, long term investment strategies.

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Probably the most straightforward observation is that both the list of All-Weather Performers (see update last week) and Sweet Spot stocks continue to outperform the broader share market. Most stocks on the Sweet Spot list beat just about anything else on the ASX handsomely.

There is a second observation that is easy to make too: some of the former outperformers have posted some losses in recent weeks, suggesting excessive momentum still leads to profit taking, eventually.

To place some of these losses in context: Ainsworth Gaming ((AGI)) shares have lost nearly 6% since mid-March but they had gained more than 32% in the 2.5 months prior. Similarly, shares in Carsales.com ((CRZ)) have now lost more than 3.5% since mid-March, but they had appreciated by more than 26% since January 1st before that.

Alternatively, some of the stocks on our Sweet Spot list that had lagged their peers in earlier updates, have added some market-beating gains since. Shares in iiNet ((IIN)) have gained no less than 20% over the past four weeks, but then they had prior gained only less than 5.5% since the start of the year. ResMed ((RMD)) too had only gained 5.8% by mid-March, but the shares have added 3.8% since amidst a seriously struggling broader share market.

Bottom line: all stocks on the Sweet Spot list (no exceptions) have outperformed the broader market since January 1st, even though some have lost territory in recent weeks. The latter seems related to the market beating performances that were put in place prior.

It is within this context that we note shares in debt collector Collection House ((CLH)) are down 10.5% between the 18th of March and the 16th of April. Including this drop, the shares are still up nearly 49% year to date.

The earlier mentioned Ainsworth Gaming maintains a positive sentiment read in the FNArena Database. The one broker not at Buy is JPMorgan. The broker explains its Hold recommendation as a valuation call while maintaining a much lower target than peers. The positive stance is easily supported by year to date performance, with shares up 24.5% since the beginning of January.

The Reject Shop came off 4.9% over the last month but shares are still up 7.5% this year and, it has to be said, without the approval of brokers. The FNArena Database shows one Sell and two Holds, which adds up to a negative sentiment read. Macquarie, who downgraded to Hold at the end of February after results were released, blamed a share price that was too high. On the other hand, UBS said the multiple is not expensive. Both brokers seem to like the stock, citing significant longer-term value.

Flexigroup ((FXL)) also had a tougher month, with shares down 4.2%, pulling back the performance so far this year to a positive 5.8%. Brokers unanimously rate the stock a Buy, citing a solid track record of outperformance over the past few years and a solid platform for future earnings growth over the mid-term. Credit Suisse points out the company's underlying organic growth runs at 17-20% per annum. With a 3.7% yield on offer and a fairly reasonable looking FY14 PE of 13.6x, you can see where the broker sentiment comes from.

Shares in Carsales.com are also down (by 3.5%) over the past month. Year to date the performance remains better than 21%. CIMB dropped its call to Sell back in February, citing an expensive looking multiple that will be harder and harder to substantiate given the stockbroker's view growth will start to flatten from next year. Display advertising, which has provided much of the cream over the past few years, will also have to mature at some point. Macquarie and UBS, both at Hold, like the stock, but find it too expensive. Both Credit Suisse and BA-Merrill Lynch still feel confident enough to keep a Buy rating in place, as both find the present premium in the share price more than justified.

Wesfarmers ((WES)) shares are also down (by 3.4%) from the middle of last month, but still up more than 10% since the beginning of the year. Investors in search for sustainable, reliable yield have pretty much ignored analysts' traditional valuation assessments in recent months. As things stand right now, stockbroker sentiment is negative on two Sells, four Holds and one Buy and the problem seems to be a very tight looking valuation and the sheer difficulty in predicting performance. This year’s yield (forward looking) is running at 4.3% and FY13-14 consensus EPS growth expectations are at 7.3% and 9.8%. The FY14 PE ratio is running at 18.7x on current forecasts which remains the main reason as to why stockbrokers prefer Sell and Hold ratings. The company will update investors today on its operational performance during the March quarter.

Technology One ((TNE)) shares are down 2.3% over the month, but up some 13.3% on the year so far. Sentiment for this stock in the database is perfect, brokers citing an attractive valuation, a strong pipeline and solid cash generation. BA-Merrill Lynch went so far as to predict investors may even see some form of capital management in the year ahead. Macquarie is also a fan of the balance sheet. FY13-14 earnings growth is pegged at 9% and 12.4% on yields of 4.1% and 4.3%. The FY14 PE of 18x may sound a bit steep, but is seen as warranted given the growth prospects and longer-term upside.

Including Amcom Telecom ((AMM)), whose shares lost 0.5% after gaining 20% prior, eight stocks on the Sweet Spot list gave back some gains over the past four weeks, but there were five others who gained strongly (in an inverse relationship to previous performances).

As mentioned earlier, shares in iiNet are now up nearly 27% for the year, of which 20% was added in the past four weeks. The last we heard from brokers was mid-March, when JP Morgan and Credit Suisse, both at Hold, said the latest determination for wholesale ADSL services was an improvement on the interim one. The stock offers 48% earnings growth this year and is projected to follow up with 14.4% growth next year. The FY13 yield is running at 3.1% and the PE sits at 16.6x. Sentiment for the stock is negative.

The earlier mentioned ResMed is up nearly 10% year to date and up 3.8% over the past month. Citi, at Buy, noted a few weeks back that the market reaction has been very overdone since Round 2 Competitive Bidding results were released at the end of January. Citi sees upside from the company's home sleep test offering, which provides more than enough offset for the Competitive Bidding upset. Projected FY13-14 EPS growth is running at 31% and 11%, although the yield is just 1.6% and the current year PE ratio is 20.1x.

Shares in Super Retail Group ((SUL)) are up 22.6% year to date. They added 1.6% over the last month. On consensus estimates, the stock offers 34% EPS growth this year and 14.6% next. The yield is at 3.2% and a current year PE ratio at 19.7x. Despite the lofty looking PE, stockbroker sentiment for Super Retail remains positive.

Webjet ((WEB)) shares are up nearly 17% so far this year, with the share price lifting 1% over the month. There are three Holds in the database and one Buy from UBS via an upgrade in early March. The broker really liked the look of the recent Zuji acquisition as well as the 1H13 results. UBS ultimately believes Zuji will be a key growth driver going forward. UBS also pointed out the stock was trading in-line with the ASX Industrials, but should be trading at a 10%-15% premium given higher growth potential plus the upside from Zuji. The broker admits the stock is in-line with online peers, but thinks it should be at a premium given better EPS growth prospects. FY13-14 EPS growth is pegged at 10% and 30%. The FY13 yield is 2.8% and the FY13 PER runs at 24.7x. Sentiment remains positive.

The exception in today's update comes from online real estate classifieds portals operator REA Group ((REA)). The shares were already up by more than 50% in mid-March and they have added 5.7% since for a total gain so far this calendar year of 58%. JP Morgan noted last week that some serious price increases look more than possible given the company’s end markets. The stock shows more Hold calls than Buys, with valuation seemingly the biggest concern. FY13-14 growth is expected to come out at 23% and 25%. A dividend yield of just 1.4% and the FY13 PE ratio of 35.1x explain why Hold ratings outnumber the Buys.

The ASX200 lost more than 1% since mid-March, but Wednesday's rally put the index narrowly back in positive territory for April (up less than 1%). Year to date the index is up circa 6.5%. In comparison, the list of Sweet Spot stocks has gained more than 21% on average over the same period (any dividends not included).

For more details about share price performances for all the stocks mentioned in this story, see attachment (sorry, paying subscribers only). Note the attached PDF overview contains three (3) pages.

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DO YOU HAVE YOUR COPY YET?

Earlier this year, FNArena published the e-Booklet "Making Risk Your Friend. Finding All-Weather Performers". This e-Booklet (58 pages) is offered as a free bonus to paid subscribers (excl one month subs). If you haven't received your copy as yet, send an email to info@fnarena.com

(Do note that 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.)

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