Short-Term And Long-Term Not Aligning

This story features WESTPAC BANKING CORPORATION, and other companies. For more info SHARE ANALYSIS: WBC

By Rudi Filapek-Vandyck, Editor FNArena

Every now and then all participants in the share market, and all expert commentators, are reminded not everyone is in it with the same goals and time horizons.

Forget about Michael Lewis and High Frequency Trading Robots, this is about market characteristics that are as old and as stubborn as the market's existence itself. For every investor who buys today with the aim of accumulating wealth and profits over an extended number of years there's at least someone else who dares to take a punt and hopes to make a profit, not matter what size, before the day's session has ended.  And there are many market participants who operate in between these two opposites.

At present the share market offers two obvious and easy to distinguish examples of this. In both cases direct interests of short-term traders and longer-term investors are diametrically opposed.

First up are the banks. At face value, the story of the banks in Australia hasn't changed. There's still the prospect that sharpened requirements and changes in sector regulations might put a lid on future growth potential, while on the operational side things have proved more than many feared. Low bad debt numbers and improvement in funding and cost cutting -all inside the framework of a relatively tight and cosy oligopoly in Australia- have provided shareholders with robust growth in years past, even if some of the dividend payout ratios (Westpac) now look uncomfortably high.

Australian banks (minus CBA) are about to report on their interim performances and sector analysts' previews are simply anticipating more of the same, albeit with one key difference: double digit growth is being replaced with single digit growth, dividends included. No matter what measurement tool is being used, banks' share prices are not cheap, but that won't stop these share prices from rising higher in the short term, allowing the likes of Westpac ((WBC)) and ANZ Bank ((ANZ)) to reach new all-time record highs in the process.

With the exception of laggard National Australia Bank ((NAB)), all banks are now trading above consensus price targets, including both regionals and Macquarie Group ((MQG)). Traditionally, banks trading above targets has often been an indication of too much investor optimism being priced into the share market, so this is probably as good as any other time to be a little more cautious. One thing's for sure, trading banks ahead of dividend payout has been a profitable strategy in most years and this year the bandwagon already is in full swing.

On Monday, one trader tweeted on Twitter: "Riding some nice positions again in this dividend cycle – ANZ and WBC currently showing nice gains".

No doubt, there's a whole cohort of traders and momentum players enjoying exactly the same gains in the same stocks. Investors with a longer term focus, however, might want to take note of the table below, taken from the most recent sector preview published by analysts at Goldman Sachs. Look at the projected total shareholder return (TSR) on the right. With the exception of Bendigo and Adelaide Bank ((BEN)) all projections for the twelve months ahead are negative. Projections for all of Westpac, Commbank ((CBA)) and ANZ are double-digit negative AFTER dividends.

Of course, banks share prices can remain elevated for much longer than anyone is able to predict -they already have- but it doesn't take away the underlying consideration that joining the current momentum herd is probably not the right strategy if you, as an investor, are looking at a different strategy, with different rules and different objectives.

Sector analysts at UBS released their preview on Monday and the underlying story is one of sector strength with UBS predicting the sector is about to reveal the highest top line (revenue) growth in the post-GFC era. Alas, the current rally is also pushing valuations to near all-time highs. UBS puts the sector PE at 14.6x for this year (note: this average includes sector laggard NAB) and the number doesn't fall by much when projected into FY15 (thanks to single digit growth ahead only); 14.2x. For the sector aficionados: it's 9.4x Pre-Provision Profits and 2.8x Tangible Book.

It is on this basis that UBS concludes: "we would not be surprised to see the banks once again sell off through reporting season".

Not everybody's in it with the same strategy and objectives and this becomes even more apparent when looking at this month's sell off in high valuation stocks as traders and funds managers here try to copycat the Nasdaq sell-off which is impacting the likes of Twitter, Amazon and various overheated biotech hopefuls. While there should be little surprise that a stock like Xero ((XRO)) has subsequently lost more than one third of its previous mind-blowing rally -there are no profits so "momentum" is pretty much all there is to the stock- herd-following market participants have also elected to sell shares in REA Group ((REA)), Flight Centre ((FLT)), G8 Education ((GEM)), Domino's Pizza ((DMP)), CSL ((CSL)), Ramsay Healthcare ((RHC)) and others.

While doing so these sellers have completely ignored the fact most of the high PE stocks in Australia only look "expensive" on a short-term horizon because growth is there, in attractive numbers, and operational risk profiles, in many cases, look a whole lot better than for most other stocks in the share market. While it is probably true that none of these stocks will see a quick return to previous elevated Price Earnings multiples, delivering on today's growth promises should be enough to carry share prices back to where they have been. As I have tried to explain in previous writings: it is these growth promises that distinguished "All-Weather" stocks from the rest in the share market in the first place. Investors should keep in mind that while short term momentum might have changed, and PE multiples have contracted, some of these stocks are actually enjoying improving growth forecasts.

Usually, better growth forecasts translate in rising share prices, albeit not necessarily immediately. Quant analysts at Macquarie observe high momentum (elevated PE) stocks that are enjoying significant positive momentum in profit projections include Computershare ((CPU)), REA, DuluxGroup ((DLX)), CBA, Henderson Group ((HGG)), James Hardie ((JHX)), Seek ((SEK)) and Ramsay Healthcare. (Everyone should note FNArena publishes a weekly overview of changes in ratings, valuations and profit momentum on Monday morning – see website).

Equally important, I believe, is that many a member of the local High PE club has seen securities analysts release additional in-depth research in recent weeks, further confirming the growth outlook on a 2-3 year horizon continues to look solid, robust and attractive. Stocks that come to mind include G8 Education, Flight Centre, REA Group, Carsales.com ((CRZ)), Domino's Pizza, Navitas ((NVT)) and Retail Food Group ((RFG)).

I note some of these stocks have already started to claw back some of the losses that have occurred this month.

Viewed from a broader, macro point of view, investors might also take a moment to pause and reflect upon the following introduction to a recent UBS quant strategy report: "We have entered a world of sub-par growth combined with high levels of gearing and elevated risk, which we believe is likely to last for the next ten years. In this environment, Quality is likely to outperform".

I would add the observation that the percentage of companies and sectors that is facing structural challenges because of new technologies, changing demographics and further globalisation has likely never been as high as today. Thus investors will continue to focus on the higher quality, more secure and reliable growth stories available, short term price movements notwithstanding.

It is better to know your own game than it is trying to play someone else's.

(This story was written on Monday, 28 April 2014. It was originally published in the form of an email to paying subscribers).

(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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THE AUD AND THE AUSTRALIAN SHARE MARKET

This eBooklet published in July 2013 forms part of FNArena's bonus package for a paid subscription (excluding one month subscriptions).

My previous eBooklet (see below) is also still included.

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MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS

Things might look a lot different today than they have between 2008-2012, but that doesn't mean there are no lessons and conclusions to be drawn for the years ahead. "Making Risk Your Friend. Finding All-Weather Performers", was published in January last year and identifies three categories of stocks that should be part of every long term portfolio; sustainable yield, All-Weather Performers and Sweetspot Stocks.

This eBooklet is included in FNArena's free bonus package for a paid subscription (excluding one month subscription).

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

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RUDI ON TOUR

I have accepted an invitation from the Australian Shareholders' Association (ASA) to present to members (and others) in Wollongong on June 10. Title of my presentation: The Share Market: Always The Same, Always Different.

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