After a week of turbulent trading, portfolio manager Emma Goodsell of the $6 billion Airlie Funds Management is seeing some buying opportunities even as she warns the market could be near a peak.
Building products firm James Hardie is one company she views as being priced at interesting levels after last week’s savage sell-down.
“It’s a high-quality business and it usually trades at premium,” she says. “It’s a good opportunity after the sell-off. In the short term it’s moved down with the US homebuilders but it has a superior business model.”
James Hardie provides building products to the US market and Goodsell points to the stability of the firm’s gross margin over the past decade. “They made over $200 million of EBIT at the height of the global financial crisis. It’s their pricing power through the cycle.”
The ASX fell more than 4 per cent last week and suffered its worst one-day performance since February on Thursday, when it dropped more than 2 per cent. US stocks also went on a rollercoaster ride during the week, with the Dow Jones Industrial Average shedding more than 1000 points in two sessions before recouping a portion of that loss as the week drew to a close.
Investors shuddered in the face of US long-dated bond yields that have been rising more quickly and by a greater magnitude than many in the market had expected in markets that were already trading on sky-high valuations.
When thinking about how to invest through volatile markets, Goodsell quotes Sir John Templeton, regarded as one of the world’s greatest stockpickers during his time, who famously said that bull markets are born on pessimism and die on euphoria.
“For a long time we’ve had elevated valuations but it seemed as if we’ve been lacking that euphoria and I think that this is the first six-month period that I have noticed that euphoria come back into the market, which probably means we’re near the top,” Goodsell says.
Enthusiasm for some parts of the market was noticeable in the August reporting season where some of the most expensive stocks saw their price-earnings ratios extended even after reporting in-line results, she says.
“The moves that we saw in stock prices didn’t always make sense to me on the basis of the quality of the results.”
Goodsell points to Australia’s technology sector when talking about areas of the market where there may be a potential disconnect between share prices and earnings prospects.
The technology sector consists of a select basket of stocks including companies such as Afterpay, Appen and WiseTech. Investors have pushed these firms to nosebleed levels in some cases in the hope that they will be able to deliver strong future earnings growth.
“When you approach the valuation of a technology company today, where the earnings might not be reflective of the earnings of the future, you would expect that they would deliver their results and, if everything is tracking in the way that you thought that it would, then it’s growing into its valuation.
“Yet a company like WiseTech delivers an in-line result and then gets 50 per cent added to its valuation,” she says, adding: “when things don’t make sense, they usually don’t stay that way for long”.
“At Airlie we think about valuation in a probabilistic way,” she says. Companies may succeed and deliver on expectations but elevated valuations “skew the probabilities to the downside if you are wrong on your assumptions”.
One company that has managed to garner earnings upgrades and a price-earnings re-rate is CSL, she notes.
“We’re happy to own it because, looking three years out, it’s always going to look expensive but it’s one of the best healthcare businesses in the world. There are not that many businesses around the globe where demand for their core product has grown at a 10 per cent rate for 30 years.”
Add in that the competitive environment is moving in CSL’s favour with major rival Shire about to change ownership for the third time in three years and the prospects look good for the company, she says. “When you have a distracted competitor and a long capex cycle it can set you up for a long period of market share gains,” she notes.
Energy company Origin looks too cheap, she believes. “You don’t need a heroic set of assumptions to see them being in a position to pay a 60¢ dividend in two years which at current share price would put it on an 8 per cent to 9 per cent dividend yield which we think is too cheap.
“What is rare is making high returns and having high re-investment opportunities,” Goodsell says, adding that Australia has a lot of high-returning legacy business which struggle to put their cash to work to earn a decent return.
“In those instances you should give it back to shareholders,” she says, pointing to airline Qantas as an example.
“We like cash-rich and asset-rich businesses. Suncorp and Wesfarmers are two that recently we would have given a tick to for good execution, good capital management and in that vein we see an opportunity for Caltex to increase their payout ratio.”
As the debate rages about the value of active versus passive investing styles, Goodsell says the thing she is focused on is that there is always opportunity in a market where prices change rapidly.
“If you look at the ASX top 20, they have seen their valuations change on average by 30 per cent over 12 months. The collective earnings power and value of those businesses isn’t moving by a third in a year but prices are changing very rapidly.”
Airlie was founded by former Perpetual stockpicker John Sevior and David Cooper in 2012. Matt Williams, who succeeded Mr Sevior as head of equities at Perpetual, joined the firm in 2016.
Magellan Financial Group bought Airlie in February. The coupling with Magellan meant that Airlie has started to offer retail targeted products for the first time this year after historically targeting institutional and wealthy investor markets.