According to UBS Global Equity Strategist David Cassidy, while the Australian equity market currently appears fully priced, there are plenty of discrepancies in respect of where stocks are trading vs. their own histories and Australia’s economy could create some Australian investment winners.
Cassidy presents his case on this topic within a research report published on Thursday.
Australian investment ideas – Some stocks expensive, others not so much
Cassidy and his team believe that the Australian market seems fully valued in an absolute P/E sense, but when looking at a relative value, there are pockets of cheap equities.
To arrive at this conclusion, UBS’s equity analysts divided the market into three different segments to search for attractive stocks. The segments are 1) a premium P/E, 2) a market multiple and, 3) a discount P/E. After establishing these three buckets, the analysts then sorted each stock’s relative P/E versus where it’s relative has traded over the last ten years.
The analysts find that even though they are using a relative valuation process, of the 77 ex-resource stocks from the ASX100 considered, 17 are trading “well in excess” of their ten-year relative P/E – “well in excess” in this case is treated as being more than 10% above their relative ten-year P/E.
The strongest explanation for this skew the analysts note is that they’re working with a cap-weighted market P/E. A lot of the market’s capitalization is trading at a relative discount i.e. the banks and Telstra. In contrast, many individual stocks are trading expensively versus history. To some extent, this is manifested in the market ex-financials (where the majority of the stocks by number sit) trading at 18.3x forward earnings, well in excess of average levels.
What’s more, four of the highly expensive 17 are currently in the midst of corporate activity which has buoyed their multiples i.e. Fairfax Media, Primary Health Care, Tatts Group and Tabcorp Holdings.
The takeaway from all of this is that while the Australian market as a whole looks expensive on an absolute basis, there are still some stocks which look cheap. It’s all relative:
“While the market appears reasonably fully priced there appear to be plenty of discrepancies in respect of where stocks are trading versus their own history. While we would not necessarily rule out stocks trading expensively versus their own history the primary focus of the note was to look for stocks trading cheaply versus their own history and investigating the buy case. In our view some of the stocks looking most interesting based on this analysis are Resmed and Carsales.com at the premium end, Boral and Brambles in the market multiple segment and Henderson Group and Lend Lease Group at the low P/E end.”
Australia’s economy – May 17, 2017
At the beginning of May, analysts at Australian investment bank Macquarie published a research note outlining why they believe Australia is the best place for investors to stash their cash over the next decade. Favorable demographics, steady economic growth, and benign economic environment were all reasons cited as being supportive of both Australia’s economy and positive investment returns through 2027.
After this positive update, Credit Suisse’s Asia Pacific/Australia Equity Research analysts have now stepped up with a warning.
Australia’s economy – Sell Australia’s ‘Darlings’
According to a research note issued by the Credit Suisse team today, some of Australia’s most highly prized stocks now trade at a 100% premium to the ASX 200. “Aussie market darlings” as the bank’s analysts call them, now trade on an average 12-month forward earnings multiple of 31 times, compared to the long-term average of 22 – a 60% premium to the wider market.
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Based on data going back to 1995, on every occasion but one when so-called darlings have traded at a forward P/E multiple of 30 or more, or 100% or more premium to the wider, market two-year forward total returns have been zero or less
Put simply, Australia’s most expensive stocks should now be avoided. However, there’s no reason to avoid the whole market entirely. Credit Suisse’s team goes on to point out that there is a host of smaller companies, which have the potential to become future market darlings, that are currently trading at a discount to their larger peers.
Based on past research, the analysts write in the report that they have found stocks tend to exhibit similar characteristics before they reach darlinghood. These pre-darlings are often “companies that are listed on the equity market, but do not need the equity market.” Specific characteristics include EBITDA margins of 20% or more, meaning that they do not need to depend on outside financing to support growth, and pre-darlings tend to have little in the way of debt with net debt to EBITDA ratios of around 1.5 or less. Companies traded on the ASX selected by Credit Suisse for their pre-darling status are currently trading at an average forward P/E of 18 and are expected to grow earnings per share by 15% per annum for the next two years. Here are some of the picks:
Australian investment – May 3, 2017 @ 20:50
Australia has long been touted as the perfect way to play a Chinese economic boom (or collapse) thanks to the region’s dependence on its much larger Asian neighbor. However, even though hedge fund managers and analysts have been betting against Australia and its booming housing market for years, Australia’s economy has remained resilient and economic growth has continued at a steady pace with 25 years of no recession.
On May 2, Australia’s central bank announced that it is leaving the country’s cash rate at a record low 1.5% despite the fact that inflation has returned to the bottom end of its 2% to 3% target rate. The bank says it is leaving this rate as it is to allow regulatory rules targeting riskier property loans to take effect amid hot housing markets in Sydney and Melbourne. And despite China’s economic wobbles, policymakers believe Australia’s economic growth will increase gradually over the next coupe of years to a little above 3% and the country’s already low jobless rate of 5.9%, is expected to decline further as underemployment declines and the labor market tightens.
As well as the central bank, business owners are also optimistic about the prospects for Australia’s economy. The latest Australian Institute of Company Directors biannual Director Sentiment Index found that the confidence of directors