The market's on an upswing, but will the good times last? Four experts give their views - and name their top 10 stocks.
It's been a swell party for Australian share investors over the past year, with the market up 20 per cent in the 12 months to the end of March. But there comes a time when all partygoers begin to ask themselves if that's all there is, while latecomers wonder if they've missed all the fun.
Money asked four independent stock pickers with very different approaches to share investing if they think the corks will continue popping or whether it's time to call it a night.
Even those with a cautious 12-month view, such as Angus Geddes of Fat Prophets and Tim Schroeders of InvestorWeb, believe there are pockets of the market that will outperform.
John Price of Conscious Investors, who emulates Warren Buffett's stringent value method of stock selection, rates the current market environment as "average" in terms of investment opportunities.
Tim Lincoln of Lincoln Indicators is an incurable optimist, and every party needs one of those.
Each of the four was asked to provide a list of 10 top stocks, although Price could name only six. Only one bank stock made the cut and all but Geddes gave the resources sector a wide berth.
Westfield Holdings is the only company that makes it onto two lists, which reflects the market's preoccupation with strong management, a dominant market position, a proven track record and strong future orders at a fair price.
Angus Geddes
Geddes of Fat Prophets is bracing for a volatile six months on the Australian market, as downward pressure on the US market accelerates. He expects we could follow Wall Street down by 10 to 15 per cent this year.
He is cautious about the market overall, but has selected a 10-stock portfolio he thinks will do well over the next 12 to 18 months, with a heavy emphasis on gold and energy.
With oil above $US40 ($52) a barrel and gold above $US400 an ounce, both sectors are likely to continue to outperform.
"I think we'll continue to see geopolitical issues dominate the market with terrorist attacks, and gold is reacting to that in a way it hasn't done for years," he says.
Geddes thinks the Australian dollar will fall back below US70 cents and that this will help gold and oil producers. "Oil Search has tremendous cash flow and not a lot of hedging, so it would do well if the Australian dollar falls," he says.
Industrials with a high sensitivity to the exchange rate, such as winemaker Southcorp, would also benefit.
Fat Prophets is also targeting industrial stocks with cheap valuations and high dividend yields, which have been knocked around by the market but have the potential for a dramatic turnaround.
"We are looking at industrial turnarounds that are not just defensive but negatively correlated with the market, so they move up when the rest of the market is going down," says Geddes.
Southcorp, Tower, Mayne,
Burns Philp and Village Roadshow have all been through the wars, and their share prices have suffered accordingly, but look poised
for re-rating.
Financial services group Tower is emerging from restructuring with low gearing and is a potential takeover target, with Promina raising cash. Geddes can see it being re-rated from its current $1.35 to $1.70.
Mayne has a low valuation, low debt, limited share price downside and management working hard to improve returns.
Burns Philp is still carrying a lot of debt but is attending to that with moves such as the sale of its herb and spice division. It also has the advantage of being in a defensive industry (food) if the market falls.
Village Roadshow is extremely unpopular with the market, but Geddes is confident that management knows what it is doing. The company recently bought back preference shares and is generating enough cash from the movie business to offer more buybacks to support the share price. "I think it's $3.50 minimum, so it's really undervalued [at current levels of about $1.80]," he says.
There is undoubtedly a high degree of risk involved in taking a punt on a turnaround, but Geddes says companies with a strong balance sheet could implement share buybacks if the market falls and this could mitigate the risk factors.
John Price
Where Fat Prophets seeks to maximise 12- to 18-month returns with one eye on short-term market forces, Price of Conscious Investors is looking for stocks you might hold for the rest of your life.
Over very long periods, things like exchange rates and employment ups and downs are not as important as the quality of the business.
"There is still value in the market, so take your time and don't worry about missing out. It's better to have money in cash and wait for opportunities," says Price, a former professor of mathematics and finance at the University of NSW who developed the Conscious Investor stock selection software to emulate the methods of Buffett.
Stock selection is done in two steps. First, screen the entire market for companies with little debt, strong and consistent growth in sales and earnings over at least five years and a high return on equity (ROE). Price describes ROE as how much a company is making with what it has.
To make the grade, companies must have ROE of at least 15 per cent. They should also have products and services with a clear competitive advantage - that is, something that makes them special, such as a brand name, location or patents and licences.
This first screen threw up the six companies listed below.
The next step - waiting until these companies are selling at profitable prices - whittles the list down to two or three: Westfield Holdings, ANZ and possibly Cochlear.
Price says Westfield is a good example of competitive advantage, because once it constructs one of its shopping centres it controls that area and competitors are unlikely to set up shop nearby.
In the past 10 years, Westfield has averaged a total return (capital growth and dividends) of 24.8 per cent a year. The stock traded as high as $18.78 a few years ago, but is currently about $12.85.
By comparison, ANZ is trading at close to its high of $19.68, but Price says this does not yet reflect its recent earnings growth.
Cochlear has a world-beating hearing product and is one of only two manufacturers. Recent difficulties in the US have sent its share price tumbling from $36.20 to $20, a level Price thinks makes it worth looking at.
Price is a big fan of Harvey Norman because of the proven skill of Gerry Harvey and his wife Katie Page to recognise consumer trends and capitalise on them. They did it with computers and now home theatre, and Price trusts they will continue to anticipate the market.
ARB, which manufactures equipment for off-road vehicles, has developed a brand name that consumers are willing to pay a premium for.
Perpetual Trustees stands out because of its size and brand name, which consumers equate with high levels of integrity. Perpetual has recently enjoyed a strong run but is trading below its record high and has produced an average annual return of 29.7 per cent over the past 10 years.
Tim Schroeders
Like Fat Prophets, InvestorWeb takes a 12-month view and, while cautious about the overall market outlook, Schroeders believes discerning investors can still find hot spots in the economy and companies that are likely to profit.
InvestorWeb looks for companies with a strong franchise or brands not exposed to weak sectors of the economy and management with a proven record of delivering in a challenging corporate environment.
Schroders, its senior investment analyst, explains: "We want unique features going forward, not companies just dragged along by a relatively benign growth environment."
Westfield makes the cut for Schroeders for its 40 years of profit growth, its dominant market position, strong future development pipeline and management succession plans.
Schroeders believes non-residential construction and mining-related projects will provide opportunities for companies such as Coates Hire, Orica, Pivot and PRG.
Coates Hire has a dominant market position in commercial equipment hire and a clear strategy, and management continues to turn around the UK operations. The share price has appreciated strongly, but Schroeders is confident it can maintain its momentum.
Orica has also enjoyed a fantastic run in recent years, but Schroeders is happy with management's clear strategy. "[CEO] Malcolm Broomhead has delivered a great culture and the company has a leading market position in commercial explosives and strong paint brands," he says.
PRG is the largest contract commercial and industry property services group in Australia and the US, with strong order books and a relatively low prospective price-to-earnings ratio (P/E) of 12.5.
QBE is the pick of the insurance sector, thanks to excellent management with a proven ability to manage risk and profits that continue to come in at the higher end of expectations.
Hospital operator Ramsay Health Care gets the nod for its dominant position in a growth industry and a track record of delivering solid earnings growth.
BHP Billiton is the only resource stock on InvestorWeb's list, largely because it is hard to find resource stocks that haven't overshot fair value in the past six months.
InvestorWeb also has a buy recommendation on WMC, but Schroeders says BHP edges it out of the top 10 because there is less that can wrong, it has a superior organic growth profile, with prices for iron ore, coal, copper and oil all strong, and the miner's latest profit surprised on the upside.
Tim Lincoln
Every bunch
needs an optimist and you don't get much more optimistic than Tim Lincoln, head of Lincoln Indicators and its Stock Doctor share screening software.
"The current market is fantastic and the last reporting season was fantastic - there are more opportunities now than there were six or 12 months ago, even with significant price rises," he says.
Stock Doctor's approach is based purely on an analysis of balance sheet fundamentals. Lincoln says about 40 companies meet all his selection criteria in the current market, so his top 10 is a random selection of companies that produced outstanding results in the latest reporting period, as well as those with an interesting story to tell.
For example, Fleetwood Corp has a niche market in mobile homes and caravans, GUD has a stable of icon brand names such as Victa and Sunbeam that it has turned around and Select Harvest is an agricultural producer of everything from almonds to pesticides.
Among the better-known names, Coles is a turnaround story with management taking the tough decisions and finally getting it right; Toll Holdings has stuck to its core transport business, acquired all the right businesses and gone from strength to strength.
Stock Doctor screens for a healthy profit, return on assets and earnings per share growth greater than 8 per cent, a P/E less than the industry average, liquidity (to ensure you can buy and sell your shares easily), a positive share price trend, a market capitalisation greater than $100 million (larger stocks are generally less risky and more readily tradeable), growth opportunities and dividend income.
Lincoln is not concerned about paying top dollar for a stock if recent growth in earnings has not yet been factored into the share price.
In fact, GUD and Arc Energy are the only stocks on Lincoln's top 10 that have a P/E below their industry average, but all 10 are considered undervalued when recent earnings growth is considered.
Lincoln says his investment criteria tend not to throw up many resource stocks because of their volatility and patchy earnings. Small West Australian oil and gas producer Arc is the exception, with the strong oil price boding well for future earnings.
