Rudi’s View: Growth Is Not A Dirty Word

This story features WISETECH GLOBAL LIMITED, and other companies. For more info SHARE ANALYSIS: WTC

In this week’s Weekly Insights:

-Growth Is Not A Dirty Word
-FNArena On Tour

By Rudi Filapek-Vandyck, Editor

It was by no means a universal outcome, with some of the smaller cap companies delivering unexpected negative surprises, but the Technology sector crowned itself as the best performing segment on the ASX throughout the August reporting season.

It wasn’t just about WiseTech Global ((WTC)), whose share price has been handsomely rewarded this year (40% up post August result), but equally about Car Group ((CAR)), Hub24 ((HUB)), Pro Medicus ((PME)), REA Group ((REA)), ResMed ((RMD)) and smaller cap companies such as Bravura Solutions ((BVS)), Breville Group ((BRG)), Codan ((CDA)), DUG Technology ((DUG)), Electro Optic Systems ((EOS)), Life360 ((360)) and Temple & Webster ((TPW)).

Not all of these names are part of the local Technology Index, but respective core businesses very much revolve around new innovations and keeping up with the latest developments in technological advances and breakthroughs. In extension, we might even include some of the direct beneficiaries of Gen.Ai, Goodman Group ((GMG)) & Co, which are not technology companies in se, but their growth momentum and attraction is very much related to the latest megatrend, which is technology-driven.

For most of these companies, in particular the large caps, August has not been a one-off. Anyone opening up a 10-year historical price chart, or longer, can easily see how strong, consistent and prolonged the rewards for loyal shareholders have been.

Taking into account how both banks and resources tend to go ‘missing’ for long periods of time, there’s but a fair argument to be made achieving positive returns from the local bourse has become a lot easier through Technology in the post-GFC era, which still continues.

As I have observed on multiple occasions over the years past: the local Technology sector offers Nasdaq-alike returns, or better. Yet, your average Australian investor might be forgiven for completely missing that point.

From mainstream media to local newsletters and tip sheets, most reports and commentary revolves around banks and other financials, and about mining companies and energy producers, China, coal, lithium, housing, dividends and franking.

Only occasionally there’s time and space left for your typical high-achieving local Technology champion.

Why is this so?

At the recent Livewire Live 2024 conference, Dushko Bajic, head of Australian equities growth at First Sentier Investors, suggested Australian media, and by extension Australian investors, are mis-guided by their perception of what makes an attractive investment.

Most commentary around local Technology companies focuses on the elevated Price-Earnings (PE) ratios these stocks trade on, and that’s usually where the attention stops.

Indeed, if a high PE automatically translates into dismal investment returns ahead then the companies mentioned have collectively done an excellent job in proving otherwise.

Bajic also made the point the Australian share market harbours some of the best Technology companies in the world. His number one favourite? WiseTech Global, still.

Others with dedicated interest have throughout the years past expressed similar views, including myself. This does not change the fact your average Australian investor is constantly directed towards ‘cheap’ looking small cap cyclicals and dividend-paying financials, away from the better performing, ‘expensive’ looking segment.

To help those who’d like to overcome their natural inhibition against investing in higher-valued, champion performers, let’s address some of the issues seldom discussed or explained.

Our starting point is by acknowledging Technology stocks on the ASX do trade on PE multiples that are well above the market average, not to mention banks and resources that usually trade on below-average multiples, making stocks like Pro Medicus or WiseTech Global look extremely expensive.

Equally important, when comparisons are made with international peers, usually in the USA, multiples on the ASX tend to be noticeably higher as well. The usual complaint made is something along the lines of: I can buy Microsoft or Apple while trading on much lower multiples, why would I bother with WiseTech shares or Pro Medicus on such high multiples?

An expert like Bajic would defend the local choices by stating they are among the highest quality performers globally, often grabbing market share and exerting dominance in sectors and sub-sectors that offer faster growth with less threats from regulatory intervention, while allowing for higher margins behind a solid operational moat.

A recent study by analysts at Canaccord Genuity backs up that view, concluding the better equipped Technology performers on the ASX offer world-leading financial metrics, placing them among the best of the best, globally.

It is equally true the ASX offers less choice for institutional investors who’d like to stock up on exposure to high-quality growth performers, and this probably means these investors have to accept that seeking out quality growth locally comes with a higher price tag.

The latter is often highlighted by your typical value investor as a stern no-no, but it’s important to also highlight the first factor, as well as the fact none of the above has prevented the local sector from delivering above average returns over extended periods of time.

Just like CommBank’s ((CBA)) premium valuation has not prevented Australia’s largest bank from delivering superior returns vis a vis the rest of the local sector over the past 15 years.

Within this context, Bajic referred to WiseTech Global shares that IPO’d on the ASX at $3.35 in April 2016 and have traded on an average PE of 75x since. Sounds expensive? The share price today is $133 for a total market cap of $43.68bn, making WiseTech a Top20 member locally by company size.

For those who like to see numbers: the total return over 8.5 years is 3,870.15% or 47.22% CAGR per annum.

Others have equally provided outsized returns, be they Hub24, Pro Medicus, REA Group, TechnologyOne ((TNE)), Car Group or Xero ((XRO)), and over longer periods of time as they listed much earlier.

One observation to add is the number of IPOs has pretty much dried up in recent years while numerous promising names have left the ASX, including Altium, Elmo Software and Nearmap while others such as ReadyTech Holdings ((RDY)) and Bigtincan Holdings ((BTH)) might soon succumb to take-over interest.

The good news is expectations are building for a pick-up in fresh IPOs which should add new ideas to the bourse for investors. Canaccord analysts report the relative higher valuations on the ASX make it extra-attractive for technology companies to list locally.

Which brings us to the most tricky part of this story: if not by PE ratio, how does one ‘value’ these high-performing, high-quality, sustainable growth companies?

I often refer to consensus price targets myself, but many of these companies have repeatedly, if not persistently, traded above targets set by analysts, which yet again feeds into the perception these stocks are always too expensive, keeping investors at bay.

As such companies’ valuation typically benefits from lower bond yields, I’d wager some additional premium is built-in because of bond markets pricing-in aggressive cutting from the Federal Reserve & Co (though continued robust growth is what ultimately makes the share price trend upwards).

The study by Canaccord Genuity concludes the best valuation methodology remains the so-called Rule of 40, whereby revenue growth and EBITDA margin combined sum up to 40 or more. Companies that outperform are typically those that can accelerate either top line growth, or expand their margin, or both.

Looking back at FY24 results in August, Canaccord Genuity has highlighted Bravura Solutions, Catapult Group International ((CAT)), Domain Group Australia ((DHG)), Superloop ((SLC)), Objective Corp ((OCL)), Praemium ((PPS)), Megaport ((MP1)), Nuix ((NXL)), Smart Parking ((SPZ)), hipages ((HPG)) and SiteMinder ((SDR)).

The obvious observation to make is most of these companies are still loss-making or making a come-back from not-so-great times. This means their current momentum might not last and prove temporary only.

Also, as witnessed in August, smaller cap growth companies are more at risk for succumbing to the unexpected hiccup than the larger cap peers mentioned.

Think Audinate Group ((AD8)), for example, or Hansen Technologies ((HSN)).

Also taking into account a company’s return on invested capital (ROIC) refocuses the attention towards the better capital allocators. Canaccord’s study highlights some with the highest ROIC: Netwealth Group ((NWL)), Pro Medicus, Jumbo Interactive ((JIN)), RPMGlobal Holdings ((RUL)), TechnologyOne, and REA Group.

For those who’d like to still get on board some of Australia’s prime success stories, but do not want to overpay for the privilege, the strategy that suits best might be to draw up a short list of desired exposures, and wait for that calamity that eventually will impact on the share price.

Another strategy might be to start nibbling but keep enough powder dry to purchase more exposure over time. If share prices rally higher, you may not have the full allocation, but you are benefiting already. If the share price falls, you’re averaging in with a longer-term focus.

The FNArena-Vested Equities All-Weather Model Portfolio has used similar tactics to initiate and renew exposure to companies including WiseTech Global, ResMed, REA Group, Hub24 and NextDC ((NXT)).

Paying subscribers have 24/7 access to my curated lists of All-Weather Performers and Quality Growers: https://fnarena.com/index.php/analysis-data/all-weather-stocks/

See also last week’s edition: https://fnarena.com/index.php/2024/09/18/rudis-view-plenty-of-traps-in-equity-valuations/

FNArena On Tour

Dani and myself will perform as a surprise double act on the Gold Coast next week on invitation of local members of the Australian Shareholders Association (ASA).

The event is scheduled for 1:30pm on Wednesday 2nd October at the Mermaid Beach Hotel by Nightcap Plus (one hour plus tea/coffee break plus more). We’ll share our personal insights and market observations with plenty of Q&A opportunity afterwards.

Next week’s Weekly Insights will be written from a hotel room nearby.

Model Portfolios, Best Buys & Conviction Calls

This section appears from now on every Thursday morning in a separate update on the website. See Rudi’s Views for the archive going back to 2006 (not a typo).

FNArena Subscription

A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (21 since 2006); examples below.

(This story was written on Monday, 23rd September, 2024. 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).

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