Ask FNArena: High Multiples About To Collapse?

This story features PRO MEDICUS LIMITED, and other companies. For more info SHARE ANALYSIS: PME

Earlier this month we asked investors to send in their questions. Today, we answer another question received.

Question: Are outperformers including Pro Medicus ((PME)) and WiseTech Global ((WTC)) at risk of collapsing? Some ‘experts’ have been warning these share prices could fall by as much as -50% due to elevated multiples?

By Rudi Filapek-Vandyck, Editor

Years and years of market observations on top of my own research and analysis have taught me one very important lesson: there’s no one size fits all when it comes to investing and putting a valuation on companies and their equities.

The second important lesson I’d like to add is that rules and principles change over time, and most people don’t like change.

From the moment I started to research the highest quality and better performing stocks on the ASX, I ran into the everyday dilemma investors face: according to the commonly quoted general rules we should all be looking for lowly valued stocks and ignore the ones on high multiples, because buying “cheaply” is the ideal starting point for long-term returns.

Except this isn’t the case.

What actually happens in share markets is more reliable, better quality businesses are rewarded with a premium valuation and they still outperform their lower priced peers who might enjoy their moment every now and then, but overall offer a much shakier track record because they don’t have a moat, are much more dependent on the economic cycle, or rather pay out a meaty dividend instead of investing in future growth avenues.

You don’t have to take my words for it, but I invite you to compare the long-term track records of the likes of TechnologyOne ((TNE)), Hub24 ((HUB)), Aristocrat Leisure ((ALL)), Xero ((XRO)), REA Group ((REA)), Car Group ((CAR)), et cetera with companies that are trading on much cheaper valuations such as Aurizon Holdings ((AZJ)), Helius ((HLS)), Lendlease ((LLC)), Ramsay Healthcare ((RHC)), and many, many others.

Do those ‘cheaper’ alternatives catch a favourable wind every now and then? They most certainly do. But they’re not fit for a marathon, which, in my view, is what investing is all about.

The key hurdle for any investor who considers venturing into the higher quality segment of the Australian share market is almost without exception the higher valuations on display; either vis a vis peers in the same sector, or in comparison to peers offshore, or simply because of a sizable premium versus the rest of the market.

Unless you simply decide to close your eyes and follow market momentum during the good times, you’re never going to overcome this hurdle, except when you accept that markets have profoundly changed post GFC, including on how to value businesses that grow irrespective of the economic cycle, with capital-light requirements, recurring revenues, extremely high margins and cornucopias overflowing with cash.

To your average dyed-in-the-wool value investor it is nothing short of heresy to suggest a company trading on PEs as high as 100x can be a much better investment than their preferred hostage to the cycle trading on a single-digit multiple, but that’s exactly the experience from the past decade and a half.

One of the success stories from that period, WiseTech Global, listed on 11 April 2016 and has seen its share price multiply by more than 30x times tor a total return of 3275%. Very important detail: the average PE multiple this stock has traded on is circa 75x.

Note: not seven, not five, but SEVENTY-FIVE! Current multiples are 108x on FY25 consensus forecasts and 75x on FY26 forecasts.

This is also the key reason as to why so many have been calling out ‘the greatest bubble of all time’ and the ‘everything bubble’. I think those alarmist calls are misguided and wrong. For starters, modern day businesses are a far cry from their predecessors from the old economy past; they are a far superior breed, as also expressed through various key financial metrics.

Hanging on to old-fashioned valuation methods is most likely not the best way to deal with the changing environment, especially when a megatrend like Gen.Ai comes along. We could all study the teachings from Aswath Damodaran, here’s a link ( https://pages.stern.nyu.edu/~adamodar/ ), but I find the analysts covered as part of the service FNArena provides equally represent most valuable input.

At the very least, their assessments and valuation inputs have been much more practical and useful than those bubble-critics on the sidelines who liked to challenge investor’s sanity for owning shares when the WiseTech Global share price was around $90 (it has been above $140 since) or when TechnologyOne shares were trading around $12 (above $30 today).

Having said all of the above, as investors we also must acknowledge this year’s outperformers including Goodman Group ((GMG)), Pro Medicus, TechnologyOne, and others have enjoyed an exceptionally favourable environment in which not only the US market supported continuous investor interest, but frequent positive operational surprises have provided ongoing fuel for additional share price rallies.

At some point, one must assume, things will become less straightforward and those share prices might yet again become more volatile. One observation to add is that higher PE multiples certainly attract more volatility, as has happened to all the companies mentioned at some stage in the past.

How to deal with this ‘risk’ is largely a personal choice. If you’re confident in the longer-term uptrend that is supporting the outlook for the companies you own, you may elect to simply let volatility run its process. Yes, at times it can be stomach-churning, and those bubble-critics on the sideline will make you feel extra-bad about it, but such is life in the share market, no?

For what it’s worth, the FNArena-Vested Equities All-Weather Model Portfolio, which owns most of the names mentioned, tends to keep exposure to single stocks between 2.5%-7.5%. Small adjustments are made to prevent that misfortune in one or two holdings torpedoes the overall performance of the Portfolio.

One of the most valuable lessons I learned from the decade past is that it’s seldom a great idea to sell out completely of these great businesses, unless valuations have gone genuinely wacky, or the outlook has dramatically deteriorated. Even then, how many times has everyone among us thought Pro Medicus is now really flying too close to the sun, only to be proven wrong, yet again?

Morgan Stanley has just initiated coverage with a market-beating price target of $300. Not that that is a 100% watertight guarantee, far from, but I tend to give it more credence than those forecasting a fall of -50% imminently.

By all means, take some profits every now and then, if that makes you sleep better at night and stay comfortable and relaxed with what you own. But also keep in mind that share price weakness, on occasion, is simply par for the course. If we’d demand 100% sunshine every day or else, we’d never leave home for a holiday.

I have a long-standing view that every expert who is interviewed on TV should wear a badge stating ‘value-investor’, or ‘daytrader’, or ‘Quality-Growth’, et cetera.

That way investors would have a much easier task with assessing the views and opinions expressed. Most value investors have a specific talent. Forecasting the direction of markets or appreciating the valuation of growth stocks are not included.

Make sure you listen to the voices that make you a better investor, or at least those that are genuinely trying to. There’s so much noise flying around and only so much our human brain and emotions can deal with. And don’t be afraid of change. Life is change.

Keep learning and educating yourself.

See also: https://fnarena.com/index.php/2024/12/16/ask-fnarena-csl-charter-hall-dexus/

(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.)  

P.S. I – All paying members at FNArena are being reminded they can set an email alert for my Rudi’s View stories. Go to My Alerts (top bar of the website) and tick the box in front of ‘Rudi’s View’. You will receive an email alert every time a new Rudi’s View story has been published on the website. 

P.S. II – If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

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