Rudi's View | Nov 22 2023
This story features INTEGRAL DIAGNOSTICS LIMITED, and other companies. For more info SHARE ANALYSIS: IDX
-Quality In Stocks; What Is It Good For?
-Conviction Calls & Best Ideas
By Rudi Filapek-Vandyck, Editor
Quality In Stocks; What Is It Good For?
Institutional investors and grey-haired market commentators often refer to it; Quality. But what is it exactly and does it really matter in a low volume share market that hasn't made any sustainable progress in 2.5 years?
The simplest definition is to seek out those companies that have superior qualities over the majority that can be measured through financial metrics such as gross margins (and the stability thereof), high return on equity and on capital invested, as well as managerial characteristics such as market-leading products and services, delivering on promises and execution on strategy and plans.
Some experts might take this one step further and also include something as intangible as 'corporate culture'.
Let's face it, a quality company led by quality management is not expected to issue a serious downgrade to forward guidance less than three months after reporting the business is back on track and the only way forward is through higher margins, revenues and profits, like what just happened with Integral Diagnostics ((IDX)).
Financial markets at times can be 'blessed' with a short memory, but those investors who own the shares on the basis of management's previous optimism have plenty of reasons to feel disgruntled and disappointed today.
Quality businesses also don't carry too much debt as that might impact on their operational stability and profitability. Having a strong moat helps with keeping margins stable and high.
Those who manage to continue to generate shareholder value over long periods of time know profitable investments, regularly executed, are but an essential part of the secret sauce that distinguishes the superior few from the low quality peers.
Quality companies are seldom the fastest growing in the share market, and neither will they ever be the cheapest priced, but they are usually adept in dealing with misfortune and challenges, always coming out on top given enough time.
And that, right there, at the end of the previous sentence is the biggest dilemma for today's investor: Quality does not by default distinguish itself through daily share price moves.
In the here and now, Westpac ((WBC)) shares can beat expectations and forecasts, and so can ANZ Bank ((ANZ)) and National Australia Bank ((NAB)), but their performances look pretty bleak when compared against CommBank's ((CBA)) over the past 10-20 years.
Owning Quality then becomes a matter of identifying the strong track record, trusting management at the helm, keeping the faith in their ability and qualities, and having a long-term horizon.
There's no uniform concept of what exactly is Quality, not in the share market, but it remains remarkable that whenever someone tries to identify the select few on the ASX, there's a lot of overlap with other selections and attempts.
Selections that come to mind include those released by Bell Potter, Morgan Stanley and Wilsons; selections that usually find their way into Weekly Insights when renewed or updated.
I've often remarked on the many similarities with my curated lists of All-Weather Performers in Australia (see the website and further below).
"The Best Of The Best"
One investor recently published his Quality Top20 for Australia; the best of the best available through the ASX:
-REA Group ((REA))
-Pro Medicus ((PME))
-Car Group ((CAR))
-JB Hi-Fi ((JBH))
-Pexa Group ((PXA))
-Lottery Corp ((TLC))
-Ebos Group ((EBO))
-Dicker Data ((DDR))
-ARB Corp ((ARB))
-BHP Group ((BHP))
My main disagreement with that selection centres on Pexa Group, which seems to be lauded by all and sundry for its local near-monopoly in digital housing transaction settlements, but a costly and slow-going expansion into the attractive-looking UK market has eroded much of the company's halo since de-merging from the troubled Link Group ((LNK)).
Having a near-monopoly position in one market is definitely not good enough reason to be labelled High Quality. If it were, the number of companies carrying the label would be a whole lot higher.
For me personally, being part of the select few on the ASX means a company has the track record to earn inclusion, and for Pexa that is definitely not the case today.
I always think in terms of risk-adjusted returns when I shift focus to Quality and All-Weather stocks; the fact these companies have a proven track record of deliveries and success means the risk for heavy disappointment is considerably reduced.
A similar argument can be made against Lottery Corp, which was spun-off by Tabcorp ((TAH)) only in mid-2022.
The first observation to be made is a number of the selected companies are trading at or near an all-time record high, which by definition means they've achieved great rewards for loyal shareholders.
A second observation is that respective superiorities shine through when compared with similar companies over a longer period of time.
Domain Group ((DHG)) is only able to keep pace with REA Group during the boom times and while the local software services sector is welcoming a reborn Data#3 ((DTL)), it is but fair to say no company has ever come close to match the phenomenal trajectory of TechnologyOne shares on the exchange, including mini-look-alike Objective Corp ((OCL)).
Aristocrat Leisure is also outperforming the international competition, which is an achievement the company shares with Altium, Car Group, Computershare, CSL, Cochlear, ResMed, and Pro Medicus.
It takes time and lots of luck and effort to become the global number one, but it takes many times over more effort, tenacity and successful execution to remain on top of the global competition.
This is why established global market leaders should be appreciated for what they are; special.
Unfortunately, as we've also witnessed with CSL and ResMed this year, Higher Quality companies are not 100% immune against the occasional disappointment or set-back. They are simply less likely to be seriously impacted by it, and mostly quicker in successfully dealing with it and recover.
Investors might want to keep this in mind now international shopping platforms Amazon and Temu are starting to make further inroads into Australian household shopping habits. A recent study has found both shopping apps are now the sixth and the first most downloaded shopping apps in Australia.
Combine this with the fact that middle and lower income Australians are under pressure to seek more value for their discretionary and non-discretionary dollars and we may well witness more pain and disappointment from those who are most vulnerable to changing spending habits in the months, if not years ahead.
Consumer Spending Is Changing: Winners vs Losers
Analysts of consumer-related stocks at Jarden have been warning for a while now the gap between winners and losers in the sector is about to widen. They've already spotted the first signals during AGM season indicating the winners may not remain completely unscathed, but the gap with the more vulnerable is likely to only widen further.
The first comparison that comes to my mind is between supermarket operators Woolworths Group ((WOW)) and Coles Group ((COL)). Too many investors still think of them as 'equals' for whom the pendulum swings favourably in alternate periods. What they are missing is that Woolworths is now the CommBank in this sector.
As it turns out, Jarden's analysis agrees with me with the latest sector update identifying Super Retail ((SUL)) and Woolworths as having the "best opportunity to re-rate via successful execution". Jarden equally appreciates Wesfarmers spending $100m on customer data, with $80m more to be spent in FY24.
It is this type of forward-looking investments that ultimately create the division between winners and losers in any sector.
And now for the ultimate question: are there any companies that should be included in the above list instead of Pexa and Lottery Corp, and maybe even a few others?
There's always a level of subjectivity of course, and any Top10 or Top20 selection will always have its numerical limitation, but names that spring to my mind are Goodman Group ((GMG)), Macquarie Group ((MQG)) and Wisetech Global ((WTC)), alongside some of the names that had already been highlighted above.
Paying subscribers have 24/7 access to a dedicated section on the website to All-Weather Performers on the ASX, and other curated lists:
Conviction Calls & Best Ideas
Martin Crabb, CIO at Shaw and Partners:
"If we look at the last two and a half years, the market has effectively gone nowhere, but there have been opportunities to trade and add value.
"In fact the 2.5 year return to the end of October was -1.57% in price terms (versus an average of 15.7% since 1990) and 9.7% including dividends versus an average of 28.1%."
Citi banking sector analysts in Australia:
"We think the unexpected resilience of share prices was driven by strong capital returns, supported by surprisingly benign asset quality.
"Looking forward, we expect price performance will be increasingly pressured by declining core earnings. Higher deposit and funding costs, as well as elevated cost growth are emerging as the key hazards.
"We believe the current set of PEs are not reflective of the growth and risk profile and, thus we no longer have any Buy recommendations amongst the Major Banks."
The guardians of Wilsons' Model Portfolio have been rather negative on Australia's supermarket operators, arguing while valuations were relatively elevated, there was not enough growth on the horizon for the industry overall, while tailwinds from price inflation were reducing and operational costs are difficult to tame.
Last week they simply reiterated that view, in particular singling out Woolworths Group shares as too expensively priced in a strategy update titled Zero Appetite for the Supermarkets. No room for double-guessing the message there.
The conclusion says it all: "…given the sector’s uncompelling long-term growth outlook, we are structurally cautious the supermarkets."
Now inflation is being replaced with disinflation, Collins Foods ((CKF)) has become the favourite stock to invest in the theme.
"The final mile is often the most difficult. While we hope that adage does not result in significant economic hardship in regard to the US monetary policy, we also recognize that hope is not a strategy. Investors may need to prepare for a difficult final ascent.
"Franklin Templeton says investors risk underestimating the resolve of the Fed to engineer below-trend economic growth and rising unemployment to achieve its inflation target.
"A harsher-than-expected recession is likely.
"Rate cuts will probably occur later and more gradually than is currently priced into the market."
"There's too many sellers, too many buyers, making too many problems. And not much "dove" to go around.
"Can't you see this is a land of confusion?
"Lower central bank policy rates, smaller balance sheets, more sovereign bond supply, and a global economy near recession mean lower rates, stronger USD."
"Despite calls for structurally higher inflation, the US headline consumer price index (CPI) appears to be falling as fast as it went up.
"This should provide support for both fixed interest and equity markets over the coming year.
"The past 12 months have shown that the trend improvement in inflation will not be a straight line."
"Overall, the decline in inflation is supportive for our relatively constructive fixed interest and global equity market view, and provides support to Australian equities (and bonds) despite our own stickier inflation situation and higher-for-longer cash rate expectations."
Also, from another strategy update:
"Overall, we see a mixed outlook for the local share-market, with disinflationary global trends likely providing some upside pressure, while a higher-for-longer domestic cash rate will create headwinds for the local market.
"Within our neutral view on the Australian equity market (global equities still marginally preferred), investors should focus on active portfolio management, with the local market’s heavyweight banking sector particularly likely to struggle to grow in 2024."
Real estate sector analysts at Citi:
"Historical regression analysis suggests REITs outperformance starts 0-4 months prior to the first RBA rate cut."
Stock beneficiaries identified include:
-Residential stocks Stockland ((SGP)) and Mirvac Group ((MGR))
-Defensive retail real estate stocks BWP Trust ((BWP)), Charter Hall Retail REIT ((CQR)) and Vicinity Centres ((VCX)) benefitting from lower interest rates on both the consumer and the real estate loans.
-Industrial including one of our top picks Goodman Group with best in class financial and operational position.
-Higher Beta value stocks such as GPT Group ((GPT)) and Charter Hall ((CHC)) where valuations may be supportive of performance.
"In our view the largest commodity and equity positioning market debate is in the lithium sector.
"The 70%+ correction in prices and up to 60%+ in equities has been severe, but we don’t see enough evidence to call a market bottom.
"As always markets can over-shoot and capitalize a short-term problem. Our preference in mining is to be generally exposed to free cash generation in iron ore and now emerging in gold."
"Equities are still the best place to be for the long term, but the playbook that worked for the last 10 years won’t work for the next 10. In a more uncertain environment, valuations will become even more important.
"A sensible investing approach to generating excess returns in the new regime is to balance growth and value style factor tilts, to invest in durable growth themes, to balance recession and macro risk, and to find companies with a positive catalyst for change.
"In an uncertain world, areas of investment opportunity include artificial intelligence, such as the semiconductor ecosystem and AI infrastructure, health care innovation, such as obesity drugs and bioprocessing, and residential and commercial construction.
"Artificial intelligence is a big deal, in both the boardroom and in the public’s imagination. We can all feel it – AI is going to proliferate in nearly every facet of our daily life. This unique technology has the potential to be the biggest productivity enhancer for the global economy since electricity, and we’re positioning our strategy to navigate this rapidly changing environment responsibly.
"The global market environment is now in a state of purgatory, with continued uncertainty about both inflation and recession risks as the Fed considers its next move. Stock/bond correlations are constantly shifting. Investors need to hedge their bets accordingly, taking advantage of attractive yields while choosing their stock, bond, and real asset allocations wisely."
Last week I was interviewed by Peter Switzer about share markets and a bevvy of individual companies.
That video of approximately 37 minutes is now available via Youtube: buff.ly/3usNHUG
A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (20 since 2006); examples below.
(This story was written on Monday, 20th November, 2023. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).
(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.
In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: contact us via the direct messaging system on the website).
For more info SHARE ANALYSIS: AGI - AINSWORTH GAME TECHNOLOGY LIMITED
For more info SHARE ANALYSIS: ALL - ARISTOCRAT LEISURE LIMITED
For more info SHARE ANALYSIS: ALU - ALTIUM
For more info SHARE ANALYSIS: ANZ - ANZ GROUP HOLDINGS LIMITED
For more info SHARE ANALYSIS: ARB - ARB CORPORATION LIMITED
For more info SHARE ANALYSIS: AX1 - ACCENT GROUP LIMITED
For more info SHARE ANALYSIS: BAP - BAPCOR LIMITED
For more info SHARE ANALYSIS: BHP - BHP GROUP LIMITED
For more info SHARE ANALYSIS: BWP - BWP TRUST
For more info SHARE ANALYSIS: CAR - CAR GROUP LIMITED
For more info SHARE ANALYSIS: CBA - COMMONWEALTH BANK OF AUSTRALIA
For more info SHARE ANALYSIS: CHC - CHARTER HALL GROUP
For more info SHARE ANALYSIS: CKF - COLLINS FOODS LIMITED
For more info SHARE ANALYSIS: COH - COCHLEAR LIMITED
For more info SHARE ANALYSIS: COL - COLES GROUP LIMITED
For more info SHARE ANALYSIS: CPU - COMPUTERSHARE LIMITED
For more info SHARE ANALYSIS: CQR - CHARTER HALL RETAIL REIT
For more info SHARE ANALYSIS: CSL - CSL LIMITED
For more info SHARE ANALYSIS: DDR - DICKER DATA LIMITED
For more info SHARE ANALYSIS: DHG - DOMAIN HOLDINGS AUSTRALIA LIMITED
For more info SHARE ANALYSIS: DTL - DATA#3 LIMITED.
For more info SHARE ANALYSIS: EBO - EBOS GROUP LIMITED
For more info SHARE ANALYSIS: EDV - ENDEAVOUR GROUP LIMITED
For more info SHARE ANALYSIS: GMG - GOODMAN GROUP
For more info SHARE ANALYSIS: GPT - GPT GROUP
For more info SHARE ANALYSIS: GUD - G.U.D. HOLDINGS LIMITED
For more info SHARE ANALYSIS: HLS - HEALIUS LIMITED
For more info SHARE ANALYSIS: IDX - INTEGRAL DIAGNOSTICS LIMITED
For more info SHARE ANALYSIS: JBH - JB HI-FI LIMITED
For more info SHARE ANALYSIS: LNK - LINK ADMINISTRATION HOLDINGS LIMITED
For more info SHARE ANALYSIS: MGR - MIRVAC GROUP
For more info SHARE ANALYSIS: MQG - MACQUARIE GROUP LIMITED
For more info SHARE ANALYSIS: NAB - NATIONAL AUSTRALIA BANK LIMITED
For more info SHARE ANALYSIS: OCL - OBJECTIVE CORPORATION LIMITED
For more info SHARE ANALYSIS: PME - PRO MEDICUS LIMITED
For more info SHARE ANALYSIS: PXA - PEXA GROUP LIMITED
For more info SHARE ANALYSIS: REA - REA GROUP LIMITED
For more info SHARE ANALYSIS: RMD - RESMED INC
For more info SHARE ANALYSIS: SEK - SEEK LIMITED
For more info SHARE ANALYSIS: SGP - STOCKLAND
For more info SHARE ANALYSIS: SHL - SONIC HEALTHCARE LIMITED
For more info SHARE ANALYSIS: SUL - SUPER RETAIL GROUP LIMITED
For more info SHARE ANALYSIS: TAH - TABCORP HOLDINGS LIMITED
For more info SHARE ANALYSIS: TLC - LOTTERY CORPORATION LIMITED
For more info SHARE ANALYSIS: TNE - TECHNOLOGY ONE LIMITED
For more info SHARE ANALYSIS: VCX - VICINITY CENTRES
For more info SHARE ANALYSIS: WBC - WESTPAC BANKING CORPORATION
For more info SHARE ANALYSIS: WES - WESFARMERS LIMITED
For more info SHARE ANALYSIS: WOW - WOOLWORTHS GROUP LIMITED
For more info SHARE ANALYSIS: WTC - WISETECH GLOBAL LIMITED
For more info SHARE ANALYSIS: XRO - XERO LIMITED