Picking the right sectors and companies
Broker reports editor |
23 October 2013
A report by the Boston Consulting Group addresses an issue of great concern for SMSFs. The relative underperformance of the Australian stock market despite relatively good economic conditions and low interest rates. Is it bad management of our public companies? Is it because they pay out so much of their profits as dividends, which keeps their share prices up, but leads to excessively defensive strategies? Is it just the vagaries of investor sentiment?
BCG describe it as the "great disconnect". The positive economic conditions led to expectations by investors that were not met (it is expectations that ultimately determine share prices). Here is what they have to say, in part blaming it on the decline of the mining and materials sector:
"The Australian economy has emerged from recent crises with an air of cautious optimism. Yet despite the relatively favourable conditions here, including good growth (3.1 percent over 2011–13) and a falling cash rate (currently 2.5 percent), our equities continue to lag global leaders.
In FY12-13, the ASX 200 provided a Total Shareholder Return (TSR) of 7.2 percent, lagging both the US S&P 500 at 12 percent, and Japan’s TOPIX.
"In Australia, the driving force behind our “disconnect” appears to be the failure of the ASX 200 companies to meet investors’ expectations of their fundamentals. The reasons for this become evident when analysing performance by industry.
"Without doubt, some parts of the Australia markets have flourished this year, with record profits from banks and respectable returns from the large supermarket retailers. But it comes as no surprise that de- clines in the Mining/Materials industry, which accounts for almost one-third (31 percent) of the market, have hampered overall market expectations.Indeed, over the last two years the size of the industry— measured by market capitalisation—has shrunk dramatically, from being twice the size of Banks in 2011 to reaching parity in 2013. Fur- ther analysis shows that this pattern of diversity of performances ex- ists not only between industries, but within them. For example, the wide range in Return on Equity (ROE) within Mining/Materials reflects companies with very different starting points.
"In a climate where attractive growth opportunities appear harder to come by, companies must still find ways to create sustainable value. The pathways they choose can be very different. While some compa- nies have aggressively pursued growth at the cost of margins, others have resigned themselves to a stable top-line while enforcing greater margin discipline. While the trade-offs between the two must be acknowledged, it is only with the right blend of growth and margins that shareholder value can be maximised."
BCG data suggests that investors would have done well to look beyond the ASX 200. This is interesting, suggesting that more innovative or aggressive strategies are not likely to come from our biggest companies:
"In 2011, EPS growth for the ASX 200 was forecast at 15 percent growth between FY11–13. Revised forecasts have set this figure dramatically lower at -4 percent. In contrast, while the S&P 500’s revised forecast for the same peri- od also fell short—10 percent down from 14 percent—the gap is clearly much smaller. In these circumstances, companies in the S&P 500 have been rewarded while those in the ASX 200 companies have failed to capitalise on comparatively strong conditions in Australia over the last two years."
A shortcoming of broker research in Australia is that it is largely concentrated on the the top 200 stocks. Stock picking from numbers 201-500 is difficult (buying index funds may be better and lower risk). It also seems to be a good idea to punt on oligopolies. BCG point out that banks, and consumer staples (including the supermarket duopoly) have performed extremely well. They account for around one-third (34 percent) of the ASX 200 and returned very healthy total shareholder returns (TSRs) of 21 percent and 16 percent respectively over the last two years.
Of course, past performance does not necessarily point to good future performance. Meanwhile, in the Mining/Minerals sector, market capitalisation has fallen 20 percent year-on-year from FY11–13, fuelled entirely by deteriorating expectation premiums. What matters, according to BCG, is to get the revenue growth and profitability balance right. In a sense this is obvious, but it is a point worth making.
"What is readily apparent from the analysis is that in order to deliver superior returns, companies need to achieve the right blend of both growth and returns. While reducing costs and targeting capital spend is to be commended, even without growth, the results show that most companies with top-quartile five-year TSRs (23 percent or higher) have revenue growth above the healthy median of 7 percent.
BCG’s research suggests that the level of returns a company enjoys plays a part in determining whether or not they should focus on growth, or returns. Many high ROE companies that grow, even at the expense of their profitability, tend to be able to achieve top- quartile TSR performance. In contrast, improvement in ROE is more important than growth for low ROE companies."