REPEAT Rudi’s View: Here’s The Secret: Buy Cheaply

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

(This story was originally published on Wednesday, 6th October, 2010. It has now been re-published to make it available to non-paying members at FNArena and readers elsewhere).

By Rudi Filapek-Vandyck, Editor FNArena

One of the better things we have done over the past two years is develop a service that shows investors which stocks are cheap and which ones are expensive. It's not necessarily a life-saving tool for short-term traders in the Australian share market (even though feedback suggests they use it too), but for those looking to invest with a longer timeframe, it can provide enormous value.

We introduced this new service in the second quarter of 2009 and we called it the R-Factor. The service is updated daily and 24/7 available to paying subscribers on the FNArena website.

I recently spoke to some of our “institutional” clients and they told me they first had to get their head around the service, but now they absolutely love the R-Factor.

And this, I thought, is exactly what is the problem with the service we developed; one has to first grasp what it really means and how it works. It's an initial barrier which I am certain has discouraged many of our readers and subscribers from using it on a regular basis.

This is a shame. The R-Factor is not only, I believe, a unique service in the Australian market (and potentially far beyond), from a personal perspective I can tell you without the slightest hesitation the R-Factor has changed my life.

As a market analyst and commentator (all from a finance journo perspective, of course) one is limited by one's access to data, to insights and to tools. The R-Factor, from its development and subsequent launch, has instantly changed the way I look at the Australian share market. I don't think I can ever go back to viewing the market without it.

Let's forget about the details for a moment, there's a PDF document on top of the R-Factor page which says “Read Me First”, but what this service does is combine consensus forecasts for earnings per share and dividends, both two years ahead, with Price-Earnings ratios and then compares the full top 200 in Australia against each other.

We called it the R-Factor because it doesn't tell you whether the market itself is expensive or cheap, that's an eternal debate among strategists anyway, but the R-Factor does reveal which stocks are priced cheaper than others (and which ones are more expensive) on a relative basis. That's where the “R” comes from.

I know I am talking my own book, but I think it's an absolute brilliant service. One look tells me instantly OneSteel ((OST)) is currently much more cheaply priced (on those above mentioned metrics) than Commonwealth Bank of Australia ((CBA)), but then Boral ((BLD)) is even less cheap, but still beating Foster's ((FGL)) by a considerable margin.

And there are plenty of smaller names in the ASX200 to follow up with: OM Holdings ((OMH)) is much cheaper than Kagara Zinc ((KZL)), but the latter is still much cheaper than GWA International ((GWT)), which is still far ahead of Mermaid Marine ((MRM)).

Why is it so important to know whether a certain stock is relatively cheaply priced or not? Because the more you think about this, the more logical it becomes. As a trader one might jump on an expensive stock with the aim of offloading it at an even more expensive price, but as a longer term investor you better start off by buying cheaply – otherwise you risk throwing away your first year of return.

(Just ask Investor's Mutual Anton Tagliaferro and other like-minded long term, value investors).

Problem number one is one cannot put everything that could possibly matter into one single tool. So while the R-Factor reveals which stocks are relatively cheap and which ones are relatively expensive, it doesn't tell you why this is the case (other than showing the data upon which this is based).

So the very first thing investors using the R-Factor should do is ask the question: why is this stock so cheap?

It may not be immediately apparent, but there's always a reason. There's no such thing as a free lunch in the share market. Other investors might not have the same tool at their disposal, but they will have a reason why not to jump on a particular stock, even though the price is cheap.

Problem number two is that we are conditioned to read tables in strict order: number one is better than number two, which is better than number three, and so forth. This does not apply to the R-Factor. A more appropriate comparison, I believe, is with a weekly top 100 of best selling songs on the radio.

Because a certain song makes it to the top spot, this doesn't mean you have to like it and buy it too. Maybe you're thinking quite the opposite, wondering who is buying that particular song because it doesn't match your taste at all.

That's exactly what the R-Factor does too. It shows you which stocks are cheap, but if you don't like the top ones, because of, for example, the associated risks, you can simply ignore them. Always remember: a stock that looks cheap today can still become much cheaper tomorrow (and vice versa).

No surprise thus, during the development of the R-Factor the likes of Babcock and Brown and ABC Learning Centres would show up as cheap stocks. Both ultimately disappeared from the stock market, so there was one very good reason why those stocks became cheap.

What investors have to assess for themselves is the level of risk involved; again, something we cannot put in this tool. A rule of thumb is that if industrial stocks are priced at prospective dividend yields in excess of 7% the risks are probably elevated (there are exceptions, of course).

Last but certainly not least, the R-Factor weighs stocks on a trade-off between earnings growth and valuation plus dividend yields, but not all stocks pay out dividends and some stocks trade on other drivers, like take-over potential or re-valuation of reserves.

No surprise thus, stocks such as Eastern Star Gas ((ESG)) and Karoon Gas ((KAR)) are consistently at the bottom of the table. What I find so brilliant about the R-Factor is that while we might know these things, this tool actually visualises it.

(Note: investors can exclude the dividend factor and when one does, a complete different table shows up).

Here are a few, easy to draw conclusions (from someone who has a bit of experience):

– Rio Tinto ((RIO)) and BHP Billiton ((BHP)) are pretty much equally valued now; BHP looks a bit cheaper but that's because it pays out a higher dividend
– QBE Insurance ((QBE)) is the cheapest among financials (banks and insurers), but for those who believe next year should see the turnaround (certainly signaled by consensus forecasts) there's a dividend yield (only partially franked) higher than 7% up for grabs
– Qantas ((QAN)) shares have performed splendidly of late, but they still look cheap as chips (note this is a trading stock, not one to own for the longer term)
– National Australia Bank ((NAB)) is the cheapest of the Big Four – also indicated by the prospective dividend yield of 6.7% two years out
– Telstra ((TLS)) has become a lot less cheap these past weeks, even though the share price has underperformed. Investors should always keep in mind that lowered forecasts make a stock less cheap too (it's not necessarily always a rising share price)
– Even though Fortescue ((FMG)) pays no dividends (small payout potential in FY12) the shares are still cheaper than BHP's and Rio's
– Defensive stocks, including Woolworths ((WOW)), Invocare ((IVC)) and Coca-Cola Amatil ((CCL)) are relatively expensive
– Hastie Group ((HST)) is now the cheapest stock in the ASX200

The latter has caught my attention this week, predominantly because I thought, on the basis of stockbrokers' reception of the company's FY10 report in August, that Hastie had left the trough of the cycle behind it and was now looking forward towards a much improved environment.

Of course, if this were the case Hastie would not show up on top of the R-Factor table.

I thus spent some time to find out the “why” behind Hastie's cheap share price. There are a few straightforward explanations:

– the company is partly a victim of the much stronger Aussie dollar, with operations in the UK and in the Middle East
– the company is exposed to non-residential property cycles both in Australia and in the UK and especially the latter would make investors a bit more cautious
– above all, however, the FY10 release in August also showed an ongoing deterioration in receivables; apparently customers in the Middle East are not too quick in paying their invoices

I have a suspicion that until the market sees an improvement in the Middle East payments received, Hastie shares won't trade up to full potential for a while yet. This despite all stockbrokers covering the stock rating it positively with price targets well above the current share price, and with double-digit growth projections for each of the next three years.

As announced earlier, all of the above, and much more, is part of presentations I will provide in the coming weeks in Perth, the Gold Coast, Brisbane and Melbourne. On Monday, a select group of investors gave up their public holiday to attend my first presentation in Sydney. I have a suspicion each of them went home with a lot of extra knowledge and insights.

If you are looking for a similar experience: see the promotion below. You are all welcome.

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 Portfolio and Alerts in the Cockpit 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.

Rudi On Tour 2010 – Some dates have changed.

YOU ARE ALL INVITED!

Your editor will be roaming the country in the coming weeks to conduct presentations to investors about his latest views on financial markets and about how to better use the info, data and tools on the FNArena website.

These presentations offer the unique opportunity to catch up with your editor in person and to ask questions directly.

Investors should note not all of these events are free, and they are all organised by one of FNArena's commercial associates.

The first series of presentations will occur on invitation from MINC Trading, with your editor contributing personally to opening day sessions of multiple day seminars on the Gold Coast, in Brisbane, in Sydney, Melbourne, and Perth.

Your editor will also provide the closing presentation on the “BULLS VS BEARS” one-day seminar organised by the Australian Investors Association (AIA) on Friday, 12 November at the Tattersalls Club, 181 Elizabeth Street, Sydney. (Other speakers include Steve Keen, Robert Vagg and Shane Oliver).

Finally, your editor will fill 100 minutes presenting and answering questions about the theme “The Market Always Knows Best, Or Does It?” to members of the Australian Technical Analysis Association (ATAA) on Monday, 15 November, also in Sydney.

While the AIA and ATAA presentations are for members, access to both events is possible after paying fees to the organisers.

The schedule for the four day seminars organised by MINC Trading is as follows:

Day One – Taking the fear out of the Stock Market
Day Two – Introduction to Options as a Trading and Investment Tool
Day Three – Trading Strategies to Profit from an Uncertain or Trending Market
Day Four – Long Term, Low Risk Income Generation Strategies

The current roster is as follows:

Sydney – 4-7 Oct
Perth – 11-14 Oct
Gold Coast – 16-17 Oct
Brisbane – 18-21 Oct
Melbourne – 6 Nov

Important: your editor will only present during the first day's session. All sessions start at 7pm. Fees to attend are $40 for one day, $100 for all four days.

To express your interest: send an email to info@fnarena.com

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