Rudi's View | Jul 25 2024

By Rudi Filapek-Vandyck, Editor

Part Two of this week's Weekly Insights should be read in conjunction with Part One, published on July 24th:
https://fnarena.com/index.php/2024/07/24/rudis-view-how-to-invest-allans-300k/

Dear Allan,

if one is an investor in Quality and Growth, as am I, there is always the danger of a brutal swing in market momentum to the other side where our portfolio has no exposure. The key reason for this happening is usually related to market positioning.

Lots of investors like to 'hide' in the Winners, while plenty of others like to curse the Winners and hide in the Laggards instead. Sometimes the Winners have been on a winning streak for too long and momentum reversal becomes the easiest way forward.

There have been multiple of such attempts over the past ten years or so, and when you're in the midst of it happening it's incredibly frustrating, but it's always good to keep in mind these momentum switches have tended to be temporary phenomenons only. The longest duration I can remember was about four months, late in 2016.

Most investors don't think in the same way as I do, but my view remains that, given the multiple strong megatrends at work in the current era, Growth and Quality are never going to remain out of favour for long. The post-GFC era thus far is proving exactly that.

Now that I've explained the basic pillars underneath my personal views and investment approach, let's take a closer look into what I would do if I were in your position.

Healthcare & All-Weathers

The covid pandemic has thrown the healthcare sector into a multi-year bear market. Who would've thunk it? This is not an Australian phenomenon, it applies all around the globe, with a select group of exceptions like GLP-1 innovators Novo Nordisk and Eli Lilly.

Given the quality of companies in this sector, and ongoing robust growth profiles, this is not a sustainable set-back for this industry and recent price movements suggest the Quality Growth companies in the healthcare sector are coming back to life. This is extremely exciting, if you're a similar enthusiast as I am for this type of companies.

My five cents worth is the Quality in healthcare will start performing first, and the rest might catch up at a delay. A lot will depend on corporate margins and profits, but it's more than feasible, I think, the August reporting season locally might mark the turnaround for the likes of Cochlear ((COH)), CSL ((CSL)) and ResMed ((RMD)).

There's a good argument to be made those share prices are performing already with CSL shares back at $310 and ResMed's above $31. I'd definitely be looking to get on board this new uptrend (if I weren't already). They all have pros and cons and ResMed's threat from GLP-1s is probably the most obvious (I understand not everyone is comfortable with it).
 

Rudi's View | Jul 24 2024

In this week's Weekly Insights:

-More Coverage In Stock Analysis
-How To Invest Allan's $300k
-FNArena Video
-Special Report on Ai

By Rudi Filapek-Vandyck, Editor

More Coverage In Stock Analysis

Some among you may have already discovered this, but FNArena's Stock Analysis has an additional tab EXTRA COVERAGE.

Click on it and you'll discover which additional brokers from BC Extra are covering the stock you are researching.

The Stockbroker Research history is still limited to the eight sources we monitor daily, but the next step will be to add history to the EXTRA COVERAGE too.

Enjoy, while we continue to make our service better and better.

How To Invest Allan's $300k

Last week, one of FNArena's many loyal subscribers, let's call him Allan, sent in the following question: (I am paraphrasing) Rudi, I've sold a commercial property. Now have $300k in the bank. I want to invest, but can you provide me with some inspiration?

We all know where Allan's reticence stems from. The ASX200 is weakening, but has been on a tear lately, setting a fresh all-time record high less than one week ago.

Lot's of talk around of 'bubbles' and inflated share prices, as well as about The Great Rotation into share market laggards that haven't had much momentum over the past 18 months or so.

First Things First

I can see a lot of similarity with late 2014-early 2015 when shares rallied hard, in particular those that offered yield at that time. There we were, starting up the FNArena-Vested Equities All-Weather Model Portfolio, having 100% cash ready to invest, and already battling with our very first Grand Dilemma.

It is from this experience I can share my first piece of advice: do not put any pressure on yourself. If you do, you will make mistakes and the one thing you should aim for is to not force yourself into anything you might come to regret later on. I know this is not easy, but try to dislocate from what happens in the share market right now.

Irrespective of that money sitting idle in the bank, you should be in no hurry, no hurry at all. Give yourself six months (I am not kidding), longer if circumstances require so, and be the patient decision-maker with a longer term horizon. You'll thank yourself for it whenever you are able to reflect back.

Back in 2015, that strong rally came unstuck after less than six months. By July banks and cyclicals were in a fierce draw-down that would last until February the following year, and then still required another seven months to grab market leadership from what by then had become known as the Expensive Defensives.

I am not suggesting the playbook for 2024 looks similar, but things can change in a matter of weeks, or even days. Share markets, at least at face value, have performed above expectations for the first seven months of 2024. The Great Rotation is, at this point, not more than a fictional scenario for which the necessary building blocks are not in place.

Advice number one: take a cold shower if necessary. Block those eternal bulls on X (formerly Twitter). Convince yourself you are about to take the first steps in a journey that will involve thousands more steps. Do not hurry!

I am genuinely looking forward to sharing this exercise with Allan and all readers of Weekly Insights, but first I must share the basics that underpin my own research and investment approach, to make sure everybody understands the How and Why of my considerations and choices.

Quality Above Value

There will always be room for disagreement and different personal preferences, of course, but sharing my observations and conclusions first might lead to a better understanding when we arrive at my various ideas and choices.

First up; while just about everyone is constantly focused on figuring out where the next 'cheaply priced' opportunity is hiding, my personal observation is, over a longer-term horizon, corporate quality is much more important.

In simple terms: your typical value investor will always tell us to find an asset that is worth $1 and buy it when it is on sale for 30c (or something similar).

The problem I find with that type of investing, is most of the time the value won't grow beyond $1, not even if we let time do its work. Thus while the upside seems pretty straightforward, once achieved it is time to move on, and that's assuming the market will ever push that share price to its full value.

This becomes even more questionable in case of low quality business models, in particular when heavily reliant on the economic cycle. Low quality businesses tend to generate more disappointing newsflow, which might well push out the recovery further, or lead to a much lower share price first.

Rudi's View | Jul 10 2024

All-Weather Portfolio in FY24; Growth Not Value

By Rudi Filapek-Vandyck, Editor

We all experience the share market through our own portfolio, which might explain why so many voices remain downbeat, if not straightforward negative about the local market and its prospects.

In contrast to general sentiment, the ASX200 just clocked off its second successive double-digit financial year return, coming in at 11.78%. One year ago, FY23 returned 14.80%.

Total return over the past ten years has averaged no more than 8.06%, and that number includes the past two years, so the absence of the sound of champagne corks popping seems a bit odd. But share prices have been more volatile than many can bear during the best of times.

Above all: the bifurcation underneath the headline performance remains extreme, with many more stocks not performing and a select group of popular names generating all the rewards. Investing in the share market is seldom a walk in the park. Whenever it is, the sunny conditions don't last for long.

Outside of the Winners circles, Australian equities have been overwhelmingly frustrating, deflating, gut-wrenching, and, at times, de-moralising. Unless one's portfolio owned plenty of supercharged Winners. But even then, the optics remain important and Australia looks bleak against the outsized gains yet again achieved in the US.

The Nasdaq100 index, as its website proudly shows, has returned 55% over twelve months, 177% over five years, and 419.34% over ten years (all data as of 4 July 2024).

We need not look any further as to why general sentiment is far from ebullient among local investors. But as said, total return has been above average for the second year in a row, and the all-important banks have been among the strong outperformers.

The FNArena-Vested Equities All-Weather Model Portfolio does not invest in popular banks or resources companies, but instead attempts to identify local companies of higher quality, with robust growth prospects, underpinned by continuous re-investments and a leading market position.

This focus has served the Portfolio well. Total return pre-fees for FY24 has been 18.28%. Last year, total return slightly underperformed on 12.71%. The year prior, in FY22, the Portfolio kept the damage limited to -2.59% for an average three-year return of 10.43% p.a. against the ASX200 Accumulation index's 6.27%.

Many Lessons To Be Learnt

What usually happens is I start now highlighting the Big Winners that have contributed to the sizeable Portfolio outperformance, but maybe it's equally important to acknowledge not all Portfolio constituents have been a Winner over the past three years.

As per always, disappointments do occur and the biggest disappointment for the All-Weather Portfolio has been education services provider IDP Education ((IEL)).

When asked in late 2022 about my favourite stock for the year ahead, I had little hesitation to nominate IDP Education. The company is a global market leader in its field and benefiting from the desire of parents in emerging countries such as China and India to send their offspring to universities in the UK, Canada and Australia.

Competitiveness has increased in the sector, but what really changed sector dynamics is a deliberate push back against student immigration by governments in those destination countries. Instead of reaching for new highs, the share price has more than halved over the past 17 months.

Observation number one: this has not prevented the Portfolio overall to put in a market-beating performance. Other inclusions like CSL ((CSL)) and ResMed ((RMD)) have equally not kept up with the index in recent years, but none of this means the Portfolio cannot still (out)perform.

Harry Hindsight is a wise man, of course, and always knows best after the facts. Admittedly, if I'd known with 100% certainty these share prices were heading for much lower price levels I would not have hesitated to sell and get back on board near ground zero, but investing is seldom that straightforward, just ask the many shareholders in large swathes of micro- and small-caps and in lagging value stocks today.

Rudi's View | May 29 2024

It's Special vs Cheap, But Who's Most At Risk?

By Rudi Filapek-Vandyck, Editor

From the moment one starts looking for that 'special' corporate quality on the ASX, it is but a matter of time before the focus zooms in on IT services provider TechnologyOne ((TNE)).

Last week's interim financial update provided plenty of input as to why this Brisbane-headquartered, $5.7bn market capped member of the ASX100 is hands down one of the highest quality companies listed on the local exchange.

Rather than dissecting the finer details from the H1 financials, not necessarily all positive, I think it is of much greater importance to explain, in broad terms, what makes this local gem of such high quality.

It might help others, like you maybe (?), to understand what exactly makes this company so special, which might also help in discovering other 'special' companies or rejecting their claims to similar greatness.

An Exceptional Track Record, What Is The Secret Sauce?

In a world that is eagle-eyed focused on growth, TechOne's track record has been exceptionally consistent, growing earnings per share at around 15%, year-in, year-out. It was this consistency that attracted the attention of a short report in 2020, claiming management surely was cooking the books, because, well, no company is able to grow at such consistency for such a prolonged time.

Well, it's 2024 now, and TechOne's still doing it. That malicious short report is long forgotten about, and the share price recently rallied to a fresh all-time record high, intra-day, above $18. When the shorters stood ready to attack in 2020, the price temporarily sank below $8.

The share price, up from below 50c in 2004, is only what is visible to investors every day. The real story that lays underneath is the business approach that prioritises building close relationships with customers, and then making certain the service and products provided suit their needs.

In the fable of the hare and the tortoise, TechOne very much resembles the tortoise. Growing 15% per annum doesn't seem extremely appealing when others can do 100% and more, but can they do it consistently over two decades? TechOne has, and the market has increasingly been paying attention.

When a company grows at a pace of 15% per annum, it doubles in size in less than five years. By 2009, that share price was ready to surpass $1. By 2014 it was trading above $3. By 2019 the price was above $7. At last week's interim release, management gave indications growth is likely to accelerate in the coming years.

Analysts, or at least most of them, got the message and are now projecting 17% EPS growth for the years ahead. Some continue to see potential for further upside surprises, in particular since the UK business hasn't genuinely started contributing just yet. The magic ingredient of the TechOne business achievement is customers are increasingly happy to purchase more products from the same company.

What is usually pointed out about TechOne, including by myself, is its customers, mainly local governments and higher education institutions, are extremely "sticky" with last week's published churn percentage of 1.8% somewhat of a shock. History sees this percentage seldom rise above 1%. Don't worry, management is confident that number will be back below 1% shortly.

TechOne is far from the only company that can rely on customer loyalty, but it has been able to turn that loyalty into a sustainable platform for growth by selling existing customers more products. Not sustainable, I hear you say? Management remains confident there's still a lot more that can be achieved from the same database of prospects and existing customers.

Consistent Investing Builds Success

There's an easy argument to be made the real growth driver stems from the company investing circa one quarter of its revenues in new product development and improved services year-in, year-out. It's these new products that lift the take-up among existing customers.

It's not difficult to see here is a circle of trust at work and TechOne does enjoy a positive reputation in its core markets, also illustrated by the fact the company seems to have established itself as provider of the highest level of cybersecurity among ERP peers in Australia; not an unimportant halo to wear when dealing with government and local councils.

Rudi's View | May 15 2024

In this week's Weekly Insights:

-More Positives Than Negatives
-New Market Leadership?
-2024 The Year Of Gold Miners?
-All-Weathers Welcome Soul Pattinson
-Model Portfolios, Best Buys & Conviction Calls

By Rudi Filapek-Vandyck, Editor

More Positives Than Negatives

Judging from corporate updates, both internationally and locally, the general context has created a tricky framework for investors, as also yet again confirmed by Fletcher's Building's ((FBU)) disappointing trading update on Monday.

It's not as if management and shareholders look over their shoulders feeling lots of excitement, but on Monday the shares dived yet another -10% for a total loss in capital since August 2021 in excess of -60%. The fact the New Zealand builder regularly pays out a dividend hardly compensates for the suffering endured.

Last week offered similar experiences from Sims ((SGM)), GrainCorp ((GNC)), Baby Bunting ((BBN)), Lindsay Australia ((LAU)), and Tourism Holdings ((THL)), among others.

Yet, the impact on consensus profit forecasts in Australia has almost been negligible. That's because for every disappointing market update there seems to be another one that manages to surprise on the upside. Think of REA Group ((REA)), Orica ((ORI)), and AGL Energy ((AGL)), but also Westpac ((WBC)) and National Australia Bank ((NAB)), and others.

The out-of-season results reporting in Australia is about to hit the accelerate button with companies including CSR ((CSR)), Aristocrat Leisure ((ALL)), and Incitec Pivot ((IPL)) scheduled to release operational financials this week, followed by ALS Ltd ((ALQ)), Elders ((ELD)), James Hardie ((JHX)), Nufarm ((NUF)), TechnologyOne ((TNE)), Webjet ((WEB)), and Xero ((XRO)), among others, before the end of the month.

Add-in the fact Australian companies are increasingly updating through quarterly trading updates and there's a fair argument to be made investors locally nowadays are subjected to semi-quarterly reporting seasons a la Wall Street.

Face value experiences to date are mixed at best, see also the examples mentioned, but analysts and market strategists, both here and in the USA, are nevertheless of the view things are looking better than previously forecast.

Earnings forecasts in the US have risen as a result of March quarterly corporate updates. The underlying picture in Australia remains more volatile, also because mining operations and agricultural businesses have been impacted by bad weather, but so far it appears the balance is tilted towards more positives than negatives.

On Morgan Stanley's assessment, consensus is still forecasting average EPS to fall for the ASX200 by -6.8% for FY24, then to rise by 4.7% and by 4.6% in respectively FY25 and FY26. These numbers have only changed minimally over recent weeks.

While concerns over inflation, bond yields and delayed interest rate cuts, in combination with markets trading on above-average multiples, are dominating sentiment and financial news headlines, corporate updates have likely contributed to the cautiously optimistic tone that has returned post April's correction (if we can call it that).

Analysts at Macquarie have come to the same conclusion having witnessed 114 companies presenting and updating over three days the week prior (7-9 May) at the Macquarie Australia Conference. This year marks the 26th edition of what has arguably become Australia's most important corporate event.

Retail proved the stand-out negative surprise of this year's conference, suggest Macquarie analysts, as market updates from the likes of JB Hi-Fi ((JBH)), Temple & Webster ((TPW)), Endeavour Group ((EDV)), Super Retail ((SUL)), Coles Group ((COL)) and Vicinity Centres ((VCX)) either implied market forecasts won't be met, or confirmed Australian households are spending less or buying cheaper alternatives.

But net-net this year's conference was positive, concludes Macquarie, with companies including AGL Energy, HMC Capital ((HMC)), AUB Group ((AUB)), and Medibank Private ((MPL)) lifting their guidance, while trading updates from the likes of PolyNovo ((PNV)), Pinnacle Investment Management ((PNI)) and Regis Healthcare ((REG)) proved better-than-expected.

Macquarie's forecast is for the net positive trend for Australian companies, that looks to have started in the last AGM season in late 2023, to continue into the August results season. Daily evidence suggests, however, there remains plenty of room for disappointments, reflective of the polarised dynamics that nowadays characterise the global economic picture.

As far as the outlook for the share market goes, I am still siding with the optimists, as I have since October last year, though I also believe investors should be prepared for a lot more volatility.

Anticipating exactly where the next corporate disappointment might come from is a mug's game, so it's probably best portfolios have exposure to companies that should perform well medium-to-longer term, irrespective of the potential for an unexpected short-term set-back.

I'd be inclined to think my recent writings offer plenty of background and ideas:

-https://fnarena.com/index.php/2024/05/09/rudis-view-arcadium-lithium-goodman-group-paladin-pexa-treasury-wine/

-https://fnarena.com/index.php/2024/05/08/rudis-view-opportunity-in-data-centres/

-https://fnarena.com/index.php/2024/05/01/rudis-view-quality-reigns-and-how-to-identify-it/

FNArena's Corporate Results Monitor only covers actual financial results, and we do our best to keep up with the pace throughout the rest of the month: https://fnarena.com/index.php/reporting_season/

At the macro-level, I remain of the view that the prospect of interest rate cuts, delayed or otherwise, remains a positive carrot for markets, unless economies stumble into recessions.

Below are some of the more interesting views and research updates I came across recently. Things to consider?

Rudi's View | May 09 2024

By Rudi Filapek-Vandyck, Editor

Best Buys & Conviction Calls

As promised in Monday's Weekly Insights, below are the latest Model Portfolio changes observed. But first, let's have a look at Jarden's best ideas among ASX-listed smaller cap companies ("Emerging Companies").

Jarden's Top Pick remains Temple & Webster ((TPW)), regardless of the shares having rallied already.

Other Key Picks are:

-Lovisa Holdings ((LOV))
-Siteminder ((SDR))
-Nick Scali ((NCK))
-Universal Store Holdings ((UNI))

In extension, specific sector analysts have highlighted their specific convictions for:

-Inghams Group ((ING))
-Light & Wonder ((LNW))
-NRW Holdings ((NWH))
-Telix Pharmaceuticals ((TLX))
-Regis Healthcare ((REG))
-National Storage ((NSR))
-Ingenia Communities Group ((INA))
-Karoon Energy ((KAR))
-Capricorn Metals ((CMM))
-Domain Holdings Australia ((DHG))
-Pepper Money ((PPM))

Rudi's View | May 08 2024

Opportunity In Data Centres

By Rudi Filapek-Vandyck

The concept confounds many an investor, and market commentators too; from the moment the market understands there's a whole lotta growth up for grabs on the horizon, share prices move to above market-average multiples which, at face value, makes the stocks in question look 'expensive'.

But are they really? Is the opportunity already gone?

In many cases the answer is: no, the opportunity is still there. If the promised growth comes through, and management executes on the opportunities available, there's often plenty of room left for upside surprises, which, when looking back withhindsight, only makes that share price from the past, 'bloated' though it may have looked in-the-moment, actually a cheap 'bargain'.

One such prime example from the recent past has been delivered by healthcare imaging services provider, Pro Medicus ((PME)) whose share price has been trading on forward-looking multiples above 100x. But as the emerging global leader in its field added new contract after new contract, it forcedanalysts to regularly upgrade already bullish forecasts, with forward-valuations and price targets rising further on the back of it.

In simple terms: Pro Medicus shares looked 'expensive' back in 2020, when the price crossed the $30 mark. Last week they surged above $110. And while most analysts have valuations that are well-below that price level, Macquarie believes they are being too conservative. AI and new services and customers are still on the horizon. Macquarie has set a price target of $120. For now.

Goldman Sachs sits on $134.

In investment terms, Pro Medicus shares gained 52.8% in 2020, followed by 82.8% in 2021, then retreated -13.4% in 2022, only to advance a further 77.2% in 2023 and, thus far in 2024, another 15%. That's one helluva return for a stock that along the way attracted comments ranging from 'absolutely crazy', to 'bubble', to 'egregiously overvalued'.

For good measure: nothing from the past four years indicates this company will not encounter a growth hiccup at some stage, or worse, and its shares might well come back down to earth if that happens. But shouldn't investors equally be aware that such concerns, and calls of 'the next example of irrational exuberance', have been expressed way too liberally, and way, way too early?

For all we know, this company is nowhere near to about to run out of growth. Certainly, management at the helm thinks so. Thus far any weakness in the share price has been but an opportunity to get on board.

Never ask a barber whether you need a haircut. Never ask a value investor whether to invest into the next emerging growth opportunity.

Data Centres Are In Strong Demand

A similar dilemma has opened up with the emergence of generative artificial intelligence ('GenAI'), mostly in the US, and in the slipstream of the next tech (r)evolution, the surging demand for data centres.

Already, fund managers have been taking profits on their Goodman Group ((GMG)) shares that have appreciated by 45.7% in 2023, and by a further 33.6% in the first three months of 2024. Shares in NextDC ((NXT)) have gained 52.7% and 29.6% respectively and have been described as 'overvalued'.

But what if both companies are still only at the early stage of a strong demand growth period that has many more years to run? Might those elevated valuations in the here and now mirror Pro Medicus shares from years past?

A fresh research update by analysts at Morgan Stanley is certainly challenging all who are questioning the ongoing opportunity on offer.

With the local market for data centres to more than double by 2030 (150% projected growth), it's rather difficult not to expect a whole lot more upside for companies leveraged to that demand, assuming, of course, management teams execute and the global landscape does not come irrepairably unstuck, like through war or much higher bond yields.

Three things make this research exercise unique:

-it incorporates the latest updates and insights from US companies, today's heartland of GenAI and data centres

-the research is a deep, multi-disciplinary collaboration between analysts across technology, media and telcos (TMT), REITs, Utilities & Sustainability, and Mining/Resources sectors

-the research is uniquely focused on the Australian market

Let's start with the basic outcomes. Morgan Stanley's 12-month price target for data centres operator NextDC has been raised by 13% to $20 (Monday's share price $17), while the target for Goodman Group has lifted to $35.30 ($33.94 on Monday). The target for Macquarie Technology ((MAQ)) is $100 ($84 on Monday).

Supporting these upgrades is US feedback that growth in AI and GenAI, and the associated rapid rise in demand for computing power, is accelerating. This, in return, boosts demand for data centre capacity. Conclusion: a golden period has opened up for companies such as the three mentioned. Those worried about capacity catching up will have to wait many more years, all else remaining equal.

Not many investors would be aware, but Australia already is a global Top Five data centres hub, with capacity similar to London, but lagging the US, Europe, the Data Centre Alley of North Virginia, and Beijing/Shanghai.

Morgan Stanley's current projections imply additional investments made in new data centres will total between $21bn-$28bn over the next eight years, providing companies with an incremental revenue opportunity of $5.6bn-$8.4bn per annum. These numbers, states the report, could well prove conservative.

Rudi's View | May 01 2024

In this week's Weekly Insights:

-Quality Reigns, And How To Identify It
-Macquarie's ASX Quality Compounders

By Rudi Filapek-Vandyck, Editor

Quality Reigns, And How To Identify It

I used to think investors' biggest challenge was related to a cheaper share price not always presenting a better opportunity, or that built-in urge we all have to be part of the next share market rally -FOMO! by any other name- but as my experiences grow, and my daily observations accumulate, I am now of the view the biggest challenge is coping with change.

Given we are experiencing a once-in-a-lifetime period of innovative disruptions and technological breakthroughs, adapting to change may well become the all-important factor that separates the Winners from Losers, both in the real economy as among listed equities, but equally so for those investing in them.

GenAI and GLP-1s are now on everyone's radar given a strong presence among share market winners, but very few are equally aware about the small revolution that has taken place over the past two decades in terms of how to 'value' those companies and their brethren operating in cybersecurity, online retailing, and capital-light software and technology services generally.

Admittedly, in a market dominated by banks and resources companies, and with a large swathe of investors solely focused on franked dividends, there's never been too much urgency to catch up on modern day methodologies to value young-and-upcoming, fresh, modern-day business models. But even the ASX is changing noticeably.

According to my quick analysis, six of the ASX Top20 companies are now consistently trading on above-average PE ratios, while that number grows to eleven if I expand the focus to the ASX50.

The local market's sweet spot, companies ranked between 51 and 100 on market cap, offers plenty of growth achievers on higher multiples that look poised to develop into potential ASX50 members in the decade ahead.

But the likes of Car Group ((CAR)), Pro Medicus ((PME)), WiseTech Global ((WTC)) and Xero ((XRO)) do not only provide investors the opportunity to outperform the local benchmark, their ascendancy is also impacting on traditional measurements to determine whether the local share market as a whole is 'expensive' or not.

Simply put: drawing a straightforward comparison with how the index traded in the past should no longer cut it, if ever that was the case given BHP Group's ((BHP)) heavy weighting today.

Even if we ignore the counter-cyclical PE formation for Australia's largest index weight (high in downturns, low when the sun shines), the elevation of the likes of CSL ((CSL)), Goodman Group ((GMG)), Macquarie Group ((MQG)) et al means the average PE ratio for the Australian share market has by default increased vis a vis the lower references from the past.

So where exactly is today's 'equilibrium' in between undervalued and overheated? Since no such research has been conducted to date (not to my knowledge), we do not know the answer, other than it will be higher than the market's long-term average which is usually placed below 15x times forward earnings per share (EPS) projections.

The current average has already been impacted as the prior corresponding average was long quoted as 14.4x previously. My 'hunch' is today's number might be closer to 16x. Post August weakness, and the recent return of buyers, the average PE ratio for the ASX200 is now a smidgen above 16x.

My 'hunch' might not be too far off, or so it seems. Early conclusion: don't jump to the 'market is overheated' conclusion too quickly; the past does not offer apples with apples comparison (at least not on this widely used market valuation metric).

The same principle also applies to overseas indices, of course.

Value Versus Quality

A much more important change has taken place for investors' ability to identify winners and losers on the market. Still, the large majority thinks of low PEs when looking for opportunities, but there's a growing mountain of evidence suggesting low PEs have no predictive powers when attempting to find tomorrow's winners (beyond that brief rally).

Instead, achieving oversized investment returns over the past decade or so has been closely linked to High PE achievers such as the ones mentioned earlier. So, are we experiencing the next bubble waiting to burst? Is the late Benjamin Graham ringing alarm bells from his grave?

Hardly. Today's scholars will tell us the legendary Graham was much more flexible than his value-seeking disciples tend to be. What usually is ignored when investors base their investment philosophy on the principles explained and documented in The Intelligent Investor is that Graham never simply focused on buying 'cheap' assets - he'd also apply a quality filter.

'Quality', rather than 'Growth' or 'Value', has increasingly captured institutional investors' attention amidst changing market dynamics. There's one easily identifiable reason for this: those portfolios that own a variety of high PE achievers, be they on the ASX or on Wall Street, have significantly outperformed portfolios that stuck with AMP Ltd ((AMP)), Healius ((HLS)), Aurizon Holdings ((AZJ)) and other low PE 'value' opportunities.

Yes, indeed, share market dynamics have changed, posing enormous challenges for those investors not willing or unable to adapt. That sound you're hearing in the background is from Charles Darwin's grave.

The discovery of 'Quality' as a major defining factor has not happened overnight. Most indices and data providers, including MSCI and S&P, have compiled their own indices and stock selections representing 'Quality' and in most cases the outperformance of Quality over broader benchmarks looks pretty straightforward.

As we're talking about stocks trading on above-average PE ratios, times of significant bond yield resets are not favourable, but outside of 2022 and comparable periods, Quality indices typically outperform during tough times, either economically or because of elevated risks, and during times when 'Growth' outperforms 'Value', when 'Momentum' trades dominate, and when bond yields embark on a downtrend.

Most importantly; unlike 'Value' and 'Growth' which each tend to have specific periods of (out)performance, Quality works under most circumstances, most of the times. It's not difficult to see the attraction for investment portfolios that like to stay with the winners and avoid as much as possible the losers, without having to churn excessively.

The problem is, however, there is no universal concept or definition of what defines a Quality company, as also illustrated by the observation that all Quality indices and selections available are based on different filters and methodologies.