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Top eight share questions for '10

Peter Switzer
9 December 2009

Out of good taste let me sanitise an old saying that has relevance to my view on experts and what they think about the stock market in 2010 — opinions are like rear ends, every one has got one!

That’s why I like to listen to lots of opinions but especially from those with good track records.

Paul Taylor has managed the Fidelity Australian Equities Fund since it was established in June 2003.

Today, the fund is one of the best performing Australian equities funds in the country, providing an annualised return after fees of 16.83 per cent a year, out-performing the market by more than 4.5 per cent a year, since inception. (Note, this calculation is based on a couple of assumptions that others might dispute, but Fidelity has been a strong performer.)

Taylor answers eight of the must ask questions for stock players for 2010.

1. Where do you see the Australian economy and sharemarket heading in the next 12 months?

Recent Australian economic and corporate earnings data have shown signs of improvement:

  • Investment growth is positive
  • Industry capacity utilisation levels have started to rise
  • Private consumption has accelerated
  • Unemployment remains below six per cent
  • The population is growing strongly.
He thinks there will be a big restocking of companies, which will drive up economic growth.

“I believe that we will see earnings upgrades for the market over the next 12 months as this expected strong economic growth aids companies sales growth levels and margins,” he says. “As a general rule, the market normally underestimates the decline in margins on the way down and also underestimates the improvement in margins on the way up — and I do not see this cycle as any different.”

The big picture tells him that 2010 will be positive.

“Combining this good environment with an overall Australian market that looks attractively valued on a long-term means that I see a relatively positive Australian share market performance for the next 12 months,” he says. “It is also important to remember that we have just seen the second worst stock market decline in Australian history and, while we have seen some recovery from the March lows, if previous cycles are any guide there is still reasonable upside in the market.”

Taylor says in 2008 it was companies with good balance sheets that did well but when the March big bounce of share prices kicked in, cyclical stocks took over. Companies such as BHP Billiton and JB HiFi who react to a rising economic cycle take over.

“I believe these cyclical companies with attractive valuations and good earnings upgrades will continue to do well in the short-term,” he says.

But he expects a change as we head into 2010.

“There could be a transition towards growth stocks that have stable and predictable earnings and the market feels comfortable with the certainty of their growth rates,” he suggests. “As we move into a potentially lower growth environment, companies with high certainty in their growth will be bid up by the market. I would expect to see that transition from cyclical companies towards growth companies as we progress through 2010.”

And for long-term investors Taylor is definitely very, very bullish!

“Australia has been the best performing market in the world long-term and I believe the structural reasons for this strong long-term performance are still very much in place for at least the next decade,” he points out. “Australia has historically benefited from its strong population growth, its excellent and low cost natural resource base, its strong corporate governance environment, its good diversity of quality companies and its high dividend yield and high real dividend growth.”

His confidence is based on the fact that these key structural drivers are still very much in place. The current cyclical recovery and the resilience of the Australian economy will benefit investors, he says, but these long-term structural drivers are the key reason I believe investors should be looking at Australian assets.

2. What sectors and stocks do you like most at the moment?

Taylor likes companies leveraged to the domestic economy, such as those involved in:

  • Consumer
  • Financial services
  • Media.
“The fund is overweight discretionary retailers as well as food and staples retailers that have strong franchises, good management teams and good industry structure,” he reveals. “It is also overweight diversified financial companies due to their attractive valuation and favourable growth prospects.”

Here are the companies that he is most overweight with in his fund:

  • Seek
  • Rio Tinto
  • Commonwealth Bank
  • Oil Search
  • Wesfarmers.
3. What do you think of the banks and financial services sector?

Taylor says our banks have done exceptionally well and generally financial companies tend to do well in the first two years of a recovery.

“Given the already very strong performance of the banking sector I would tend to favour the diversified financials sector, as it offers some of the most attractive valuations and favourable growth prospects,” he advises.

His fund is overweight:
  • Commonwealth Bank
  • National Australia Bank
  • Macquarie Group
  • AMP 
  • QBE Insurance.
4. Do you hold any mining companies?

“Yes, the fund holds several miners, including Rio Tinto and BHP Billiton,” he says. “The quality miners are well positioned and have reasonable valuations. The fund has exposure to the larger and stronger resource stocks that have low production costs, long mine life and are well positioned to benefit from the structural growth trend of continued demand from Asia.”

5. Is the Australian property sector offering good value yet?

Taylor’s fund is underweight this sector.

“We have been concerned with property fundamentals like capitalisation (cap) rates, rental growth and gearing levels,” he says. “The market is still going through a cycle of higher cap rates, which means lower property valuations for office buildings, retail shopping malls and industrial properties. REITS have also been disadvantaged in a lot of the capital raisings, as they have been very dilutionary.”

However, he sees some light at the end of the tunnel.

“I think we are getting close to the end of the cycle,” he tips. “We will start to see the end of the cap rate expansion and the end of weaker valuations in property through the December quarter 2009 and the March quarter 2010. As we start to get to the end of the downgrade cycle the more I become interested in the REIT sector.”

6. Do you hold any small caps?

He has no bias but just looks for value wherever it is.

“The fund is invested in smaller companies like Navitas and Domino’s Pizza,” he says. “These are quality companies with good management teams, strong balance sheets, good valuations and attractive growth options.”

7. Do you have a cap on the number of shares you hold in the Fund?

He has no set number but believes the optimum number of companies held should be between 30 and 50.

“Less than 30 companies is not a diversified portfolio, while holding more than 50 companies and the fund starts to get too close to the overall market and becomes difficult to significantly out-perform it,” he argues.

8. How do you value companies?

He doesn’t have one valuation metric.

“The best approach is to employ a whole range of valuation metrics, such as price to earnings ratios, enterprise value to EBITDA (earnings before interest, tax, depreciation and amortisation), free cash flow yields, dividend yields and net present value analysis,” he explains. “Certain valuation metrics are more appropriate at different parts of the cycle. By undertaking a range of valuation techniques we can better assess the true value of a potential investment.”

Word of warning

Paul Taylor’s insights are really valuable and that’s why I have passed these onto you. But a word of warning about his stock tips. These are not recommendations but simply matter of fact. Of course he must like them now but remember a fund manager is generally not a buy and hold investor. These guys and girls in these sorts of funds are always looking for good value but over time, these value judgements can change.

All that said, Paul Taylor’s views are worth thinking about.

For advice you can trust, contact Switzer Financial Services.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.


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