Go Black Caviar Go!

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

By Rudi Filapek-Vandyck, Editor FNArena

A few observations from the week past:

– So many stories following the passing of Margaret Thatcher, highlighting opposing angles, experiences, views and legacies. And they are all valid.

Something to think about, surely.

(I experienced Thatcher as a young boy when growing up in Belgium. I too was punk and loved Johnny Rotten's Pistols and Joy Division. I only grasped the true meaning of what was happening in those days decades later).

– RBA is facing $715m losses on its foreign-exchange holdings

– Nikkei 225 index is up 50% since start of October, but only up 17% in AUD terms

– Friday's "outperformance" by the Dow Jones Industrials was due to two (2) stocks. Why investors and commentators should ignore the most iconic of all equity indices: http://goo.gl/RZUka

– The earnings growth profile for Woolworth's ((WOW)) now looks superior vis-a-vis estimates for BHP Billiton ((BHP)) and Rio Tinto ((RIO))

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Probably the best way to describe the manner in which Aussie thoroughbred racehorse Black Caviar wrote history over the weekend is by making a comparison with that other wonder of athleticism; Usain Bolt. So when people asked me over the weekend: did you see the race at Randwick? Did she win? My standard reply was: in the same style as Usain Bolt wins the 200 meters. All others are competing for silver and bronze.

And so it was that Black Caviar became the first horse in over one hundred years to stay unbeaten for 25 successive races.

I am once again venturing into dangerous territory this week as I am about to draw a parallel between horse racing, gambling and the share market. I am sure that regular readers of my market analyses know I am not a gambler and never would I recommend investors use the share market as a gambling opportunity. But I do see a clear message in Black Caviar's impressive run of 25 victories, so there's a story waiting to be told.

According to the betting information displayed on my TV screen during the Group One TJ Smith Stakes at Royal Randwick, everybody's favourite was running at $1.10 while other horses had been assigned odds of $60 and higher in case Black Caviar was to stumble. Alas, for those who placed a bet against a new milestone in the history of horse racing, Black Caviar never looked like she was not in control.

Bottom line: sometimes it's simply best to go for the hot favourite, even if the rewards are not that great.

I can see a clear, direct parallel with what's been happening in the share market. I think investors have been making the exact same consideration when putting their funds to work in Australian equities. Those eight local favourites ^(*) may not offer the same blue sky potential as some of the miners and biotech hopefuls, but the favourites are on a solid winning streak and unlikely to stumble anytime soon.

Anyone who bet against Black Caviar lost and so did everyone who went for cheap looking mining stocks over the past two years.

I suspect most punters on the day would not have bet against Black Caviar, but with her. This means they would have bet on a trifecta whereby Black Caviar was nominated to win the race, with two other horses on positions two and three. This way, the rewards can still be higher.

You probably already know where I am going with this, aren't you? As a long term investor, make sure you start by having Black Caviar on position number one. Then start thinking about whom you are going to nominate for places two and three.

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My market research over the past five years has focused on what types of stocks are best suitable for long term investment portfolios. The conclusions put forward in my eBooklet "Make Risk Your Friend. Finding All-Weather Performers" ^(*), published in January this year, are that three types of stocks tend to perform well over longer dated time horizons:

– Reliable, solid dividend payers (such as Woolworths and Telstra ((TLS))
– All-Weather Stocks (such as Invocare ((IVC)) and Amcor ((AMC))
– Stocks in an operational sweet spot (such as M2 Telecom ((MTU)) and Carsales.com ((CRZ))

The problem is that, with only few exceptions, most stocks that fit in with each of these three categories have, on the back of their outperformance in recent years, firmly landed on the investor's radar. In horse racing lingo this translates into: everybody has now figured out that Black Caviar is unique, special and pretty much unbeatable by its peers. As a result, bookmakers will never again raise their odds significantly beyond a paltry $1.10.

This is how the share market and horse racing bookies work alongside the same base principle: once the world has figured out what works best, the rewards automatically shrink.

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While I hope that my research has created a solid framework that supports investors and advisors in their own market research and investment strategies, many more angles, frameworks and strategies are possible and these might equally deserve investors' attention. Within this context my attention was recently drawn to a market update by Pengana Capital, one of the success stories among professional funds managers in Australia. Point number one from Pengana's market update: do not take on board too much risk.

Point number two: Pengana's own investment framework is centred around identifying "companies with resilient business models that have the balance of power over their suppliers and customers". This framework, reports the funds manager, has proved a "fertile area of positive returns, particularly in the current difficult environment".

Stocks in Australia that feature high on Pengana's list include:

-Tatts Group ((TTS))
– NIB Holdings ((NHF))
– News Corp ((NWS))
– Telstra ((TLS))
– and Caltex ((CTX))

Point number three: the recent weakness in share prices may provide opportunities to redeploy cash at attractive prices, says Pengana. Make sure you stay disciplined and take all of the above into account if you are looking to do the same.

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If you think that most of the high quality stocks with a proven, reliable and sustainable growth path now look expensive on a short to medium term outlook then you are absolutely correct, says also Macquarie market strategist Tanya Branwhite. Last week Branwhite published an alternative approach to find value in today's share market: mid-cycle earnings forecasts.

If earnings growth for Australian listed companies has now bottomed, as Branwhite certainly believes it has, then one way to determine value is to assess which companies look safe enough to reasonably achieve growth in profits and cash flows between today and the year to June 2015 and then calculate those values back to today's share prices to see whether there's still value to be had.

On this basis, Branwhite believes the following stocks are offering value that can potentially translate in annual returns in excess of 10% in the years ahead:

– News Corp
– JB Hi-Fi ((JBH))
– Downer EDI ((DOW))
– Toll Holdings ((TOL))
– Seek ((SEK))
– Boral ((BLD))
– Lend Lease ((LLC))
– Computershare ((CPU))
– WorleyParsons ((WOR))
– Oil Search ((OSH))
– Woodside Petroleum ((WPL))
– Beach Petroleum ((BPT))
– Orica ((ORI))
– Origin ((ORG))
– Rio Tinto ((RIO))
– Woolworths
– Sydney Airport ((SYD))
– Transurban ((TCL))
– Ainsworth Game Technology ((AGI))
– Bendigo and Adelaide Bank ((BEN))

According to the same research framework, the following stocks are at risk of generating significant negative returns in the years ahead:

– Insurance Australia Group ((IAG))
– Atlas Iron ((AGO))
– OZ Minerals ((OZL))
– Caltex
– Tatts Group

Note the latter two featured highly in Pengana's market update, but in a positive sense. Also, Branwhite's research assumes that stocks will trend back to their long term valuation metrics by mid-2015 which is not necessarily correct. Those who have read my recent Weekly Insights will remember I believe mining companies are poised to trade at a discount to their Net Present Value (NPV). That discount may well turn out larger than what we've seen over the years past, depending on what happens exactly with growth across the globe and with prices for industrial commodities.

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Stockbroker Moelis has decided to upgrade furniture retailer Nick Scali ((NCK)) to Buy after a meeting with management confirmed the new Sofas2Go brand is delivering on its promise. With projected EPS growth numbers of 29%, 17% and 13% for FY13-FY15, Moelis reasons today's share price looks good value.

Bottom line: in order to achieve higher returns, investment portfolios will have to combine known champions with some of the lesser gods, but investors better not go overboard and stay vigilant and conservative. I am certain both Pengana and Branwhite are standing behind me on that statement.

(This story was originally written on Monday, 15 April 2013. It was published on the day in the form of an email to paying subscribers).

^(*) The ASX200 in Australia has effectively been carried higher by eight stocks since mid last year: Woolworths, Wesfarmers ((WES)), CSL ((CSL)), Telstra and the Big Four Banks.

^(*) "Make Risk Your friend. Finding All-Weather Performers" is to date exclusively available to paying subscribers (6 and 12 months) at FNArena.

Below are some of the feedback/responses received since its release in January this year:

Great work, perhaps your best yet 🙂

From Richard, St Ives, NSW, who describes himself as a "very happy long-term FN Arena subscriber"

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Rudi has found the wood for the trees.

Supported by detailed research and historical facts, the eBooklet derails the thesis that private investors need to take on greater company risk to outperform the market. The research piece is written without jargon and goes to heart of every investor’s challenge: how to make money consistently and without undue risk.

The eBooklet details actual cases through the GFC and prior and identifies Australian companies for 2013 and beyond. The analysis is both quantitative and qualitative.

Whether you are a professional investor and adviser like myself or manage your own share portfolio, I thoroughly recommend investors not only read Rudi's research, but keep going back to it.

David Manchee, Belvedere Share Managers

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Rudi’s e-book “Make Risk Your Friend” is exactly the kind of book investors need to read. It provides commonsense, user-friendly ideas of portfolio construction, risk-taking and risk management as well as doing what most commentators studiously avoiding doing – giving individual stock suggestions! Rudi’s approach is simple and easy-to-follow. His broad experience shows up in his writings.

It is true that the best investments don’t have to be high-risk by nature of their business, capital structure or balance sheet. They don’t need high-profile shareholders or great marketing teams. They need a strong business case, a favourable industry climate, and most importantly experienced and responsible management who are aligned to the interests of shareholders.

Rudi selects a number of these as well as providing a framework to allow investors to find future performers outside a high quality list of ”All Weather Performers” he has nominated.

It’s a great book, and I congratulate Rudi on its publication.

Jeremy Hook, TMS Capital

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I much enjoyed reading Rudi's eBooklet and it will help many investors as it just makes sense.

I like the fact that for a stock to qualify as an All-Weather Performer, that the business needs to have pricing power, sticky client base and recurring streams of revenue.

It’s a must read for anyone that has a SMSF or looking to start investing in the market for the long term.

Michael Kodari, Kosec – Kodari Securities

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If you are a paying subscriber and haven't as yet received your copy, send an email to info@fnarena.com

If you are interested in signing up for a paid subscription (so you can claim your own copy) visit for more information:

https://www.fnarena.com/FNArena_Promotion_2013_March.html

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(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)

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Rudi On Tour in 2013

– I will present and contribute during the 2013 National Conference of the Australian Technical Analysts Association (ATAA) at the Novotel in Sydney's Brighton Beach, June 21-23

– I will present to members of AIA NSW North Shore at the Chatswood Club on Wednesday 11 September, 7.30-9pm

Rudi on the Radio

This Sunday, April 21st, I will be interviewed about my eBooklet, "Make Risk Your Friend. Finding All-Weather Performers".

'Ringside', Sundays 10-11am, Radio Northern Beaches, 87.7fm & 90.3fm / www.rnb.org.au/stream

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