The bears are back in town (apologies to Thin Lizzy) and profit reporting season where most companies report their half year or full year profit results has also just concluded. We will have a quick look at some of the themes that have emerged below. Meanwhile in the broad market its all (downwards) action at the moment. After four years of generally rising prices (enough time for any investor to get complacent) we are having our first true blue correction for a long time. Since late April the All Ordinaries Index has fallen 15%. It has fallen 11% in the last four weeks alone. For those of you who are statistically minded that is a minus 143% return on an annualised basis. If we allow for say a 5% dividend the return improves to minus 138%. At that rate the index will go to zero about June next year and no one who receives age pension is going to have to worry about the negative changes to the Centrelink assets test that will happen in 2017.
As always when the market is not being cooperative and making lots of noise one needs to keep one’s focus on what is within your control and what is important and try as best possible to ignore what is out of your control and what is not important (albeit very noisy). Previous blogs (available at www.lifestylefstas.com.au) have demonstrated that in the longer term short term market movements (no matter how spectacular they may appear at the time) are not relevant to investment returns for longer term investors other than to perhaps create buying or selling opportunities. As a group companies that have high quality ratings, have favourable longer term prospects and have been bought at rational (undervalued or at least not overvalued) prices have been rewarding robust investments regardless of the market gyrations on the way along. Let’s call them the Green Lights Team. See the September 2014 blog “Is Cash Trash” at www.lifestylefstas.com.au for a discussion of green lights investing. Companies that have poor quality ratings or don’t have favourable longer term prospects or have been bought at irrational (overvalued) prices (like happens in four year bull markets) or worse all three more often than not produce disappointing results regardless of what the market as a whole does over time. This is the Red Lights Team.
So if the stocks that you hold are in the Green Lights Team you can have reasonable confidence that share prices will at some time in the future reflect underlying value and will recover in price. It doesn’t mean of course that they will not fall in price in a falling market in the shorter term. What tends to happen is that when the market is falling the Green Lights Team don’t fall as much as the market and when things pick up again they recover better. If you currently have cash up your sleeve even better you may get some great opportunities to add good quality businesses to your portfolio at very rational prices. Unless your portfolio is all Green Lights stocks you should now be in this position (i.e. having cash available) by having been patient and waiting in cash for green lights opportunities to come up rather than overpaying for shares to go along with the crowd. You have also had many months to sell red lights stocks at attractive prices. If your stocks are in the Red Light Team then watch out. When the market recovers these stocks may not.
So what is important? Profit reporting season certainly is because it is when we can review our stocks to see if (assuming they are in the Green Lights Team) they continue to be high quality, have favourable prospects and form an updated view as to what is an appropriate valuation for any particular stock. After all things can and do change and what was Green Lights could become Red Lights and vice versa. While stocks need to be considered on an individual basis some general themes have emerged from profit reporting season. The more interesting results can be grouped into a number of categories. First there are larger stocks with slowing profit growth (includes Telstra, Commonwealth Bank, Computershare, Woodside and Origin Energy). Secondly we have a group of smaller companies returning to favour or turning around (includes SMS Technology and The Reject Shop). Then there are stocks that are significantly overvalued but keep rallying in price even though they shouldn’t. Perhaps the standout example here is Domino’s Pizza. There are good quality businesses like McMillan Shakespeare that continue to perform as businesses and shareholders have been rewarded. And finally there appear to be stocks that the market doesn’t seem to understand. Despite favourable prospects and share prices that don’t seem particularly overvalued investors don’t want to know them (includes REA Group and Seek). And of course there are many more examples.
How do each of the above stocks stack up when it comes to quality, future prospects and value? Well if I have to do monthly professional development exams is it not reasonable that you as an investor should have to do something similar from time to time? Let’s spread the love around. I invite you to email me (email@example.com) with how you think each of these stocks measures up with regard to the three Rs of share investing i.e. quality, prospects and value. Or alternatively list the stocks in your portfolio and let me know what your thoughts are on these three criteria and I will respond with an assessment.
Meanwhile back to that darn market. If any of your stocks are Red Lights Team it is often never too late to sell. And even though the market is irrelevant in the longer term one still has to get through the present. While the Buddhist philosophy of living in the present is a sound approach for many things it doesn’t necessarily help with share portfolios right at this very moment. If thinking about your portfolio (or watching it on a daily or hourly basis) creates a powerful urge to sell Green Lights Team stocks (a delusion if ever there was one) one needs to be equipped with the wherewithal to resist the urge. One technique that never fails is to, when the selling urge arises, have a glass of red. And if after that the urge is still there have another glass of red. And keep repeating the process until the urge goes away or one is no longer thinking about the market. Or maybe not thinking about anything at all if you were particularly diligent about the process.
That’s probably enough to cheer you up for this month.
If you would like further information send me an email or give me a call or go to www.lifestylefstas.com.au