Rudi’s View: Time For Appreciating Quality

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

The company is included in ASX100, ASX200, ASX300, ALL-ORDS and ALL-TECH

By Rudi Filapek-Vandyck, Editor

Time For Appreciating Quality

My biggest surprise, when overlooking the local share market this week, is undoubtedly the fact that, on most measurements, the damage done thus far to investment portfolios in Australia remains relatively limited.

It can easily be argued the risks out there, predominantly stemming from the US President’s favourite word (tariffs), are much greater than what has been priced in thus far.

Then again, not everyone is convinced the US administration’s intention is to keep tariffs in place indefinitely, rather than using them as a temporary negotiating tactic. Not yet anyway.

The more experienced traders will acknowledge it’s plain impossible to properly price in all the risks without having clear oversight of the finer details and their potential implications.

In other words: we better not read too much into share prices and index movements thus far.

They are largely the consequence of heightened fear and uncertainty, mixed with plenty of contrasting narratives and a firm belief, still, that all shall work out in a positive manner, eventually.

Simply put: we haven’t reached panic station yet; markets have been volatile, and scary at times, but all in all this ongoing process of re-adjusting to the new growth outlook is occurring in an orderly fashion.

This is both comforting and scary. Viewed through a glass half empty approach, it means we aint seen nothing as yet, and share markets can fall a lot deeper if the plot thickens going forward.

Let’s take a small step back and note the ASX200, when measured from January 1st, is still only down -3.94%, courtesy of an outsized negative March performance that saw the index retreat by -4% after a weak February had already wiped out all the strong gains booked in the opening weeks of January.

Of course, the first quarter of 2025 is now the second negative quarter for the local share market in succession, so our mood and perception are heavily dependent from what point we start looking back to measure what has been happening.

When we look under the bonnet of the local index, a far more disparate picture emerges.

Shares like Pro Medicus ((PME)), Goodman Group ((GMG)) and NextDC ((NXT)) are down by -20% or more year-to-date, while a2 Milk ((A2M)) –can you believe it?– is up more than 37%.

Equally important, shares in CommBank ((CBA)) are only down -1.5%, and they did pay out an interim dividend. Ditto BHP Group ((BHP)) whose share price is only off -3.4% year-to-date.

Naturally, in a market that is beset by and guided through all kinds of narratives, those who have been calling for an end to “The Grand Bubble” are now brimming with confidence their predictions are finally coming through, but I wouldn’t bet my money on it.

It’s quite natural for the Winners to be punished hard when the overall environment turns Risk Off.

For starters; this is where investors and traders turn to when they seek to secure the profits made. A heavily polarised market also invites heavily concentrated exposures and portfolio positioning.

Plus, it doesn’t take long before the technical set-up for those Winners reverses into the negative and now you see the traders and momentum followers piling in to the downside.

Us humans being humans, it doesn’t take long before narratives appear that justify what is happening. The one that has gripped markets in recent weeks is that AI is simply a temporary fad, not the societal change it has been labelled previously. Falling share prices, of course, have become the ‘evidence’ this is the case.

As is always the case, there’s a lot of ‘copying and pasting’ going on in terms of short term strategies for the ASX.

Nvidia & Co falling out of favour in the USA thus translates into selling pressure for the likes of Macquarie Technology ((MAQ)), Southern Cross Electrical ((SXE)), HMC Capital ((HMC)), and Megaport ((MP1)), to name but a few that are carrying the AI exposure label.

The FNArena-Vested Equities All-Weather Model Portfolio has exposure to Dicker Data ((DDR)), Goodman Group ((GMG)) and NextDC ((NXT)). All three have received the cold shoulder from traders and investors recently, for that exact same reason.

AI is out of fashion, for now, but I am personally inclined to look forward to when these companies make a come-back into positive attention yet again.

In a market that doesn’t know whether the sun might shine tomorrow or for how long exactly, each of these share prices can continue weakening for a lot longer. I regularly see dismay and disbelief from investors about how low some share prices can fall, but fundamentals are not the key driving force during prolonged Risk Off periods.

As we all instinctively know, and as history shows us time and again, prolonged periods of Risk Off create opportunity through illogically cheaply priced assets, but there’s also the uncertainty about not knowing for how long the current uncertainty might last, and about how ‘cheap’ share prices might ultimately be when the sustainable turnaround arrives.

To marry one with the other, the above-mentioned All-Weather Model Portfolio has increased its cash holding to circa 18%, lifted exposure to gold (ETF) to 7% and shifted the overall skew to a more defensive positioning.

Exposures are still there to some of the highest quality growth companies on the ASX –think REA Group ((REA)), Car Group ((CAR)) and TechnologyOne ((TNE))– but those exposures are now smaller than last year, on average and as a percentage of the pie, while the largest allocations are now Telstra Group ((TLS)), Woolworths Group ((WOW)) and HomeCo Daily Needs REIT ((HDN)).

None of this will stop any further losses in case Risk Off and negative news continue to define the outlook for the share market, but it does keep a lid on the short-term damage endured, while keeping the Portfolio in the race in case good news arrives.

Bell Potter’s Preference For Quality

While reading through some of the more interesting research reports released this week, I came across two strategy insights worth highlighting.

Bell Potter’s latest strategy update makes the case, yet again, that quality equities remain an investor’s best friend through market tribulations, and when given enough time to prove themselves.

Investors like to think that high risk equals better returns but that’s only sometimes the case and risk will bite back eventually, if one keeps ignoring it. Bell Potter refers to research conducted by Robert Novy-Marx which has highlighted profitability itself as a powerful predictor of future returns.

Companies generating strong, sustainable profits, suggests Bell Potter, typically have structural competitive advantages, disciplined capital allocation, and efficient management practices. Such companies deserve to be labelled Quality and investing in them tends to result in superior shareholder returns over extended periods.

But Quality also works from a general risk perspective, with Bell Potter arguing Quality investing generates steady returns in buoyant markets, but also tends to shine when things get hairy and the economic outlook turns challenging and uncertain. Quality tends to outperform during tough times, even though this may not necessarily become apparent on a day-to-day basis.

I can relate to this type of research and analysis, as my own research into All-Weathers feels closely intertwined. And while Trump and tariffs this time around are creating a very different environment from anything that has happened over the past two decades or so, there’s no doubt at Bell Potter that Quality will shine and outperform over the next twelve months.

Characteristics to look for, according to this week’s strategy report include:

-Earnings stability and resilience
-Strong balance sheets
-Profitability (consistent high return on equity) and resilient margins
-Sustainable competitive advantages

Examples mentioned are all well-known, international household names, such as Microsoft, Apple, Eli Lilly, Visa and Mastercard, and, yes, the aforementioned Nvidia.

In case there was any doubt: Quality is the preferred factor to invest in for Bell Potter, both for the long term as the short term.

Macquarie’s Fundamental Framework

This week’s research exercise by quant analysts at Macquarie echoes some of Bell Potter’s views in that investors are often too easily misled by share prices that look ‘cheap’ but then turn out not so great investments. Simply buying ‘cheap’ is a flawed strategy.

Macquarie quant thinks it has found the answer by developing a broader framework that also takes into account risk and sustainable profitability, which then isolates those companies that seem ‘cheap’ against their fundamental profile as opposed to ‘cheap’ against forecasts or asset valuations.

Underlying Macquarie’s research lurks the observation from Warren Buffett there is no fundamental difference between investing in Growth or in Value, as both factors are connected at the hip.

Macquarie’s research has discovered investors should pay more attention to ‘risk’ as detailed analysis from past market moves suggests risk is the dominant factor for investment return, not growth or value. Profitability comes second and growth itself sits only in third place.

I am not going to bore you with all the finer details about the research and the strategy framework developed by Macquarie quant, also because this is still very much a work in progress, as also indicated in this week’s update. But the observation stands that simply buying higher risk, ‘cheap’ looking share prices is not the best strategy to employ.

It pays off to identify those companies that stand above the pack and have that little special to offer. Both Bell Potter strategists and the Macquarie research agree on that point. Macquarie’s research exhibits some overlap with Bell Potter’s in that it too suggests companies with the better fundamentals offer a lower-risk strategy.

Is market turbulence in 2025 creating the ideal circumstances for investors looking beyond simplistic ‘cheap’ in the here and now?

Macquarie quant has identified the following 29 ASX-listed companies as “Fundamentally Cheap with Above Average Sentiment” from the ASX300:

-Australian Finance Group ((AFG))
-Amcor ((AMC))
-ANZ Bank ((ANZ))
-Aristocrat Leisure ((ALL))
-Beach Energy ((BPT))
-BlueScope Steel ((BSL))
-Brambles ((BXB))
-Breville Group ((BRG))
-Codan ((CDA))
-Coles Group ((COL))
-Collins Foods ((CKF))
-Computershare ((CPU))
-Data#3 ((DTL))
-Fisher & Paykel Healthcare ((FPH))
-Fleetpartners Group ((FPR))
-Harvey Norman ((HVN))
-Helia Group ((HLI))
-IPH Ltd ((IPH))
-JB HiFi ((JBH))
-Magellan Financial ((MFG))
-Medibank Private ((MPL))
-MyState ((MYS))
-Nick Scali ((NCK))
-Perseus Mining ((PRU))
-ResMed ((RMD))
-Sonic Healthcare ((SHL))
-Supply Network ((SNL))
-Ventia Services ((VNT))
-Wesfarmers ((WES))

As per always, such research tends to generate both confirmations and surprises.

Subscribers have 24/7 access to my own curated lists, which are the fundamental basis for the All-Weather Model Portfolio:

https://fnarena.com/index.php/analysis-data/all-weather-stocks/

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).

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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 Tuesday, 1 April 2025. 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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