Low Risk Growth Still Reigns Supreme

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In this week's Weekly Insights:

– Low Risk Growth Still Reigns Supreme
– QE Works, Or Does It?
– Questions Raised About Vocation And G8 Education
– Buy-Backs Perform, But Stakeholder Yield Is Superior
– Rudi On TV: The Week Ahead
– Rudi On Tour

Low Risk Growth Still Reigns Supreme

By Rudi Filapek-Vandyck, Editor FNArena

The house of Goldman Sachs, which in the past has given us popular acronyms such as BRICs, recently labeled it the return of the "defensive bull market".

Granted, we only have to look at the local share market's performance throughout the turmoil and the volatility in October and conclude there's a whole lotta truth to how Goldman Sachs describes the current environment for Australian equities.

A proprietary basket of defensive stocks rose 5.5% in October, outperforming the ASX200 which "only" added 4.4% versus 2.3% for the S&P500 and a 1.1% gain for MSCI Global. Adding insult to injury, those maligned banks in Australia added 7.7% over the month, clearly outperforming not just about everything else, but just about everybody's expectations too.

Wait. It gets worse.

Small caps as a group ended slightly in the negative (minus 0.5%), resources lost 1.8%, energy lost 3.5%. Best performing sectors were (in order of performance): gaming, banks, REITs, healthcare and telcos.

If ever there was a need to come up with an accurate label for what is going on in the Australian share market, and what has been going on for most of the 5.5 years since the bottom in early March 2009, "defensive bull market" might just do the trick. Like BRICs did for a while, and PIIGS.

Goldman Sachs strategists don't believe the outperformers from the past will necessarily stay in the lead next year and the year thereafter when the US Federal Reserve and global bond rates are expected to change course.

Two types of outperformers have been identified:

– defensive high yielding dividend payers
– structural growth stories that by now have become high PE stocks

Goldman Sachs believes the second group is most at risk from losing their market premium, and to a larger degree, as these stocks are more susceptible to rising long term bond yields, say the strategists. Longer dated bond yields are expected to move before the Fed does.

The first group, attractive because of solid, sustainable dividends, is expected to de-rate from the moment central banks start acting on cash rates.

As such, the strategists have been spending their time and focus on selecting today's outperformers whose reign will come to an end. Their methodology consists of finding stocks that have appreciated by more than 80% since mid-2011 of which at least 25% is due to PE expansion. Stocks selected for de-rating include TPG Telecom ((TPM)), AusNet Services ((AST)), Ardent Leisure ((AAD)), M2 Telecom ((MTU)), Amcor ((AMC)), Ramsay Healthcare ((RHC)), Telstra ((TLS)), iiNet ((IIN)), APA Group ((APA)) and CommBank ((CBA)).

Defensive outperformers for which Goldman Sachs retains a positive view include Spark Infra ((SKI)), ANZ Bank ((ANZ)), Goodman Group ((GMG)) and Sydney Airport ((SYD)). High PE stocks that continue to enjoy GS support include Seek ((SEK)), CSL ((CSL)), Aristocrat Leisure ((ALL)) and ResMed ((RMD)).

Those among you who have kept track of my personal analyses of the post-GFC era will have spotted the similarities with my own concept of reliable dividend payers and All-Weather Performers, as well as individual company names. While I do not necessarily agree with Goldman Sachs' selections as per above, I am full well aware that many of the names I selected since late 2012 have grown from solid performers into high multiple stocks, and further into highly popular, high PE stocks, often further into very high PE stocks.

Scarcity can become a real burden in a small market place as is the ASX where most companies promote a block of land with maybe something economically viable underneath the surface. Certainly stocks like Domino's Pizza ((DMP)), REA Group ((REA)) and Invocare ((IVC)) have lost a big chunk of their intrinsic defensive quality simply because PE multiples have soared to such highs.

Over at Macquarie, market strategist Tanya Branwhite's analysis has remained very similar to mine post 2008. Contrary to strategists at Goldman Sachs, Branwhite does not seem to be worried about valuation premia since she remains of the view that genuine growth is to remain a scarce commodity in the Australian share market, while returns overall are likely to be lower than in the past. "Stocks best placed to deliver sustained, above average growth with some yield, should deliver the highest relative returns."

So which stocks are we talking about? Macquarie's analysis has identified the following candidates that are seen as having the best chance to deliver what is required in terms of above average, sustained growth plus dividends for shareholders:

-Woodside Petroleum ((WPL))
– Magellan Financial ((MFG))
– Oil Search ((OSH))
– TPG Telecom
– Santos ((STO))
– Charter Hall ((CHC))
– REA Group
– Dexus Property ((DXS))
– Transurban ((TCL))
– Platinum Asset Management ((PTM))
– Carsales.com ((CRZ))
– Sirtex Medical ((SRX))
– Flexigroup ((FXL))
– IOOF ((IFL))
– Slater & Gordon ((SGH))
– Bank of Queensland ((BOQ))
– Growthpoint Properties ((GOZ))
– BT Investment Management ((BTT))
– Stockland ((SGP))
– Seek
– McMillan Shakespeare ((MMS))
– Commbank
– Domino's Pizza
– Qube Logistics ((QUB))
– Ansell ((ANN))
– G8 Education ((GEM))
– Westpac ((WBC))
– Spark Infra
– Ainsworth Gaming ((AGI))
– Ardent Leisure
– ANZ Bank
– Aristocrat Leisure
– Challenger Financial ((CGF))
– Harvey Norman ((HVN))
– APA Group
– Bendigo and Adelaide Bank ((BEN))

As everyone can tell from the selection above, Branwhite might start her analyses from a similar macro-framework, she does not constrain herself through a concept such as All-Weather Stocks.

Investors might also pay attention to the lowest ranked selection of stocks according to Macquarie's research. These are stocks that have the least chance to generate above average, sustained growth on top of a rewarding dividend for shareholders:

News Corp ((NWS)), Computershare ((CPU)), WorleyParsons ((WOR)), Caltex ((CTX)), Treasury Wines ((TWE)), Origin Energy ((ORG)), Downer EDI ((DOW)), Incitec Pivot ((IPL)), Rio Tinto ((RIO)), Fairfax Media ((FXJ)), Boral ((BLD)), Tatts ((TTS)), UGL ((UGL)), Metcash ((MTS)), APN News & Media ((APN)), Woolworths ((WOW)), Village Roadshow ((VRL)), Leighton Holdings ((LEI)), Toll Holdings ((TOL)), Seven West Media ((SWM)), Seven Group ((SVW)), Transpacific ((TPI)), ALS Ltd ((ALQ)), Coca-Cola Amatil ((CCL)), JB Hi-Fi ((JBH)), Wesfarmers ((WES)), Qantas ((QAN)), Monadelphous ((MND)), Myer ((MYR)), Sims Metal Group ((SGM)), Arrium ((ARI)), Goodman Fielder ((GFF)), Graincorp ((GNC)), Fletcher Building ((FBU)), and QBE Insurance ((QBE)).

Even if you don't want to take notice of any of the macro-frameworks that feature in market analyses by the likes of Macquarie, Goldman Sachs and myself, my gut feel tells me investors probably would do themselves one big favour by paying extra attention to Macquarie's bottom list. Some of these names do surprise and while no piece of research can ever be 100% prescient and accurate, I suggest that if your portfolio has too much exposure to those names, it should make you think really, really hard.

Macquarie's research was, on Monday at least, vindicated by the release of disappointing growth numbers by market darling Woolworths, resulting in a sell-off for the shares on that day.

I am currently planning a general update on All-Weather Performers, which will occur two-fold. The eBooklet published in early 2013 shall be updated before year-end plus I shall write a general update before then which becomes part of the eBooklet update.

In the meantime, we have updated share prices until October 31st (see further below).

QE Works, Or Does It?

Not that long ago, Alan Greenspan was lauded as the best central banker the world had ever seen. Until the world woke up to the fact that Greenspan had ignored possibly the largest and most disastrous financial fraud – ever!

Needless to say, opinions and views inside the world of finance and investing don't often stretch much further than the duration of the next rally in financial assets. The Federal Reserve has now ceased buying US government bonds. The end of Quantitative Easing went relatively smoothly, thus far. Has it worked? Well, equity markets are up. So it worked!

Can the economic recovery in the US, and the absence of it in Japan and in Europe, be simply explained by QE? Some bright voices beg to differ.

Here's an intelligent expose by Anatole Kaletsky, of GaveKal fame, as to why QE is NOT the ingredient of success in today's world of central bank's dominance:

http://blogs.reuters.com/anatole-kaletsky/2014/10/31/the-takeaway-from-six-years-of-economic-troubles-keynes-was-right/

(I am not going to reveal what is. Read the story)

Questions Raised About Vocation And G8 Education

There are a few lessons to be drawn from the train wreck that is unfolding at the ASX-listed entity known as Vocation ((VET)).

The company itself was a merger of three young vocational educational institutions with the aim of achieving an ASX listing which, ultimately, was the goal because it turned founders into millionaires.

When governments issue legislation and effectively create an attractive opportunity for skillful entrepreneurs to rapidly enrich themselves on the back of reliable government subsidies, those entrepreneurs will do exactly that. The vocational education sector has boomed in years past and now its first victims have arrived in the form of shareholders that have seen shares in Vocation plummet from above $3 to 85c on Monday.

Judging by background stories published in newspapers this past week alone, this is going to turn into a nasty affair. One should have little doubt litigation processes are being prepared right now.

For investors, the harsh lesson, yet again, is it is far too easy (and too simplistic) to rely on share price performance and use it as some kind of evidence that all is OK. Well, it wasn't and there are quite a number of funds managers who are left licking their wounds post carnage.

Within this context I feel it as my duty to report that parts of the financial community are turning away from aggressive childcare centres acquisitor, G8 Education ((GEM)), with stories abound about sector insiders questioning targets set by management as well as the sustainability of the business model.

I know of at least one funds manager who sold out.

None of this proves, or even suggests, that G8 will follow the same route as Vocation. Admittedly, there always has been some negativity in the market in connection to G8, but that was predominantly because of ABC Learning's legacy. This negativity now seems to have changed colour as it has become more company specific, supported by negative industry feedback.

For investors, the risk is this general negativity might start impacting on the share price, even with the company still seemingly operating in a blue sky environment. FNArena's consensus forecasts show projected EPS growth of 69% this financial year and 54% in FY16.

Most stockbrokers who cover the stock remain supportive with FNArena's consensus price target some 20% above the current share price. Analysts at Citi, however, recently separated from the pack and downgraded to Sell, declaring the path of least resistance is not owning any stock in the company. Citi too questions how much synergies can actually be achieved from combining an ever higher number of childcare centres, while paying out 90% of profits in dividends and enjoying an elevated PE multiple (to name but a few of Citi's considerations).

Most of all, G8 Education is about to be included in the ASX100 and this might well become a negative, rather than a positive, in Citi analysts' view, with small caps funds selling stock and large cap funds managers unwilling to fill the void given the elevated valuation and the small index weight only.

Citi's latest research update equally mentions negative feedback coming from industry insiders, such as: "Industry feedback suggests that G8 Education may be pushing the centres hard to boost short-term profits, but may be hurting the longer term viability of centres".

Buy Backs Perform, But Stakeholder Yield Is Superior

This Weekly Insights email has been carrying a section about share buy backs for a while and thanks to regular contributions from readers, we hopefully provide a useful guide for investors.

As pointed out, research conducted both locally as well as overseas, suggests stocks from companies buying in their own shares more often than not outperform peers who don't. However, a recent quant research report from Macquarie suggests investors shouldn't narrow their focus to buy-backs only.

Macquarie analysts developed the concept of "Stakeholder Yield" which covers companies ability to reward stakeholders outside the business from the cash generated inside the business. This concept covers share buy-backs, of course, but also higher dividends and paying down debt. Macquarie had been working off this concept in Asia and in Japan, and recently decided to apply the principle in the Australian share market.

It still turns out investors seem to reward buy backs the most, but Macquarie's quant department has observed a strong performance for Stakeholder Yield in general in the market, while also observing the concept helps investors avoiding so-called manufactured yield. The latter relates to a false impression for delivering additional rewards as the cash comes from debt and not from operational performance.

To come up with a list of favourites, the quant analysts have developed a score system and combined this with stock ratings from the fundamental analysis division. As such the Top 11 consists of the following names:

– Seven West Media ((SWM))
– Dexus Property ((DXS))
– Village Roadshow ((VRL))
– GPT ((GPT))
– Bradken ((BKN))
– JB Hi-Fi ((JBH))
– Amcor ((AMC))
– Downer EDI ((EDI))
– IOOF ((IFL))
– Singapore Telecom ((SGT))
– CommBank ((CBA))

Below is the chart (historical analysis) that supports the concept. Note how paying down debt is the least rewarded when done in isolation, but when combined with buying back shares and paying reliable, steadily growing cash dividends (either or both), the combination turns more powerful than any of the factors solo.

Another observation to make is that buying back shares has narrowly beaten paying out dividends, according to average annual returns as compiled by Macquarie (see calculations at bottom of chart).

Meanwhile, here's our regular update on share buy-backs:

Ansell ((ANN))
Aveo Group ((AOG))
Cape Lambert Resources ((CFE))
China Magnesium Corp ((CMC))
CSL ((CSL))
Dexus Property ((DXS))
Donaco International ((DNA))
Fiducian Portfolio Services ((FPS))
Helloworld ((HLO))
Hills ((HIL))
Karoon Gas ((KAR))
Logicamms ((LCM))
Telstra ((TLS))

Companies believed to potentially announce buy backs in the not too distant future:

Aurizon ((AZJ))
BHP Billiton ((BHP))
Rio Tinto ((RIO))

We continue to welcome your participation/contributions. Send them to info@fnarena.com

Rudi On TV: The Week Ahead

On request from readers and subscribers, here are my scheduled TV appearances for the seven days ahead:

– Wednesday – Sky Business, Market Moves – 5.30-6pm
– Thursday – Sky Business, Lunch Money – noon-12.45pm

Rudi On Tour

I have accepted an invitation to present to the Sydney chapter of the ATAA, in Sydney, on November 17th.

(This story was written on Monday, 03 November 2014. It was published on the day in the form of an email to paying subscribers at FNArena).

(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

For paying subscribers only: we have an excel sheet overview with share price as at the end of October available. Just send an email to the address above if you are interested.

Click to view our Glossary of Financial Terms