On: June 14, 2015 In: Blog, Columns, Expert Advice, Feature, Most Popular Comments: 0

Written By Michael Kodari

Humans by nature don’t like to go against the grain. Humans prefer following a crowd but it’s often shown that if you can hold your nerve and wait for an opportunity, it can lead to favourable investment outcomes.

With the onset of the modern day 24hr news cycle, investors can find themselves bombarded with superfluous information. Geopolitical tensions here, central bankers there, at the end of the day investors need to strip investing back to its barest and simplest form. After all, the equity market is all about investing in quality businesses, not stocks.

Investors often lose sight of what it is they’re actually doing, distracted by the flashing lights and rapid movements on their trading platforms. When you put your money into ‘stocks’, you are purchasing part of a business, entitling you to a portion of that business’ future earnings stream and profits. Businesses that have a track record, or a pattern of delivering results consistently, typically exude certain characteristics and traits that enable them to repeatedly deliver positive outcomes for their shareholders.

When an individual considers investing in the stock market it is vital that they follow a strategy, a plan of attack, which has the ability to improve one’s chances of success. As straightforward as it may seem, human beings by nature tend to be ill-disciplined, often throwing away the playbook in search of a quick buck.

 

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In what has been a busy year for the equity market, the half yearly reporting season has come to an end. Overall the company results were in line with market expectations, and the earnings forecast for the full year remained on target. As it stands, the market P/E ratio of 18.9 exceeds the long term average and for as long as company earnings growth remains subdued, valuations will appear stretched by traditional measures. Nevertheless in saying that, the market conditions are unique and there are unique drivers at play.

Essentially, equity and fixed income securities compete for investment dollars. The idea is when interest rates are low, investors prefer stocks and when interest rates are high, investors prefer fixed income or cash. At present, rates are low and are likely to fall further.

In addition it’s important to consider that at the time of writing, the AUD has fallen from around 93 US Cents to 76 US Cents in the past 12 months. That’s an 18% decline with a further fall expected to come in time as interest rates fall. Given that some of the largest investors in the ASX are US (and Japanese) pension funds and hedge funds, the ASX is now 19% cheaper in US dollar terms than it would’ve been otherwise, making our market a lot more attractive to overseas investors in relative currency terms.

In AUD terms the ASX has risen from 5400 to 5944 or 10% in the year since April 2014. However, on the other hand in USD terms the ASX has fallen from 5022 to 4511 (5400/0.93 to 5944/0.76), or negative 10% over the same period due to an 18% decline in the currency. The ASX yields an average of 4%, which is higher than the rest of the world due to the favourable franking credit system. Bearing in mind that the current interest rates in the US, Japan and Europe are zero percent, not only is our market attractive in US dollar terms, but on a yield basis as well. So when you consider that the ASX is basically the only developed market to be off the pre GFC highs, there seems to be plenty of upside left for the market.

As we enter the 2nd quarter of 2015, I thought we could take a look at two businesses across two sectors that not only have a good chance of taking advantage of the present global dynamics, but have the potential to be solid outperformers for the years ahead.

Past performance is by no means indicative of future performance, however in the case of these companies, sound business fundamentals are backed up by favourable macroeconomic themes, which when combined improve an investor’s chance of success.

2015 has seen the start of a new phase in the European economic saga as the ECB committed to deliver the much anticipated quantitative program worth at least 1.1 trillion euros designed to fight off the fears of deflation. In the ensuing aftermath, European stock markets, as well as markets around the world, surged evoking recent memories of the Federal Reserve’s own QE programs and the broad scale asset price rises that followed. There is no question that this time circumstances are different to the US and the euphoria may not prevail, nevertheless should global markets and more specifically European stock markets react in a similar way, then there is a certain ASX listed equity that stands to benefit from the wave of optimism.

Henderson Group (HGG) – Diversified Financials

Henderson Group is one of Europe’s largest investment managers, based in the UK and servicing institutional, retail and high-net-worth investors across a variety of asset classes. The company is included in both the FTSE 250 and ASX 100 indices. Naturally the performance of HGG is correlated to the performance of global equity markets, but more particularly the UK, European and US markets, which have mostly outperformed global peers in recent years.

Asset management businesses tend to benefit from being low capitalintensive operators, with fixed staff costs being the main expense. Therefore once scale and industry recognition is established like HGG has achieved, then it becomes possible to generate sizable profit margins and operating cash flows. One sector with undeniable momentum behind it is the healthcare sector. With the population demographic aging, demand and reliance on the healthcare sector will continue to grow in the coming years. It is estimated that the number of people over the age of 70 will double in Australia over the 2006- 2021 period, thus fundamentally changing the shape of the Australian economy. But the benefits aren’t limited to the domestic environment with the overseas economies facing similar changes. While developed nations manage aging populations, emerging nations with their burgeoning middle classes offer an additional benefit.

ResMed Inc. (RMD) – Healthcare

The company states that its aim is to develop innovative products to improve the health and quality of life of those who suffer from sleep related disorders, and works to raise awareness of the potentially serious health consequences of untreated sleep-disordered breathing. During the years to come it is expected demographic shifts such as age and obesity rates, as well as heightened awareness and increased diagnosis ensure a favourable outlook. The National Heart Blood and Lung Institute estimates that 12 million Americans suffer from sleep apnoea and, according to ResMed, fewer than 4 million are diagnosed or treated each year. It’s clear from those figures that there’s an enormous pool of undiagnosed patients in both existing markets like the US, and emerging markets such as Asia.

Financially the business is very sound. RMD has been generating high cash flows for many years and as a result is debt free with the capacity to conduct further share buybacks, which will support earnings per share for some time to come. Earnings and ROE have been consistently growing year on year for a 10 year period, while importantly the outlook for the year ahead is positive bearing in mind the additional tailwinds for the business coming from the declining Australian Dollar. .

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Michael Kodari is the Managing Director of KOSEC – Kodari Securities, www.kosec.com.au