Post the August reporting season, I’ve been spending a lot of my time reading and digesting the monthly updates from some of Australia’s leading fund managers.
The value and growth camps are split firmly down the middle.
Value investors warn of the “vastly inflated” share prices of today’s stock market darlings — companies like Afterpay Touch (ASX:APT), WiseTech Global (ASX:WTC) and CSL Limited (ASX:CSL).
Favourite stocks amongst the value-set include Sims Metal Management (ASX: SGM), the world’s largest scrap steel producer. The Sims share price fell close to 30 per cent during the month as the market panicked about the outlook for Turkey.
Shaken but not stirred, the new Firetrail Australian High Conviction Fund took the share price weakness to add to its already overweight position in Sims. Read more here.
It’s growth, growth, baby…
Meanwhile, the growth camp is having a whale of a time.
The Hyperion Australian Growth Companies Fund soared a stunning 8.4 per cent higher in the month of August alone, driven by holdings in high quality but traditionally very expensive growth stocks, including WiseTech, Hub24 (ASX:HUB) and REA Group (ASX:REA).
To put that monthly return in context, the S&P/ASX 300 index has gained 8.3 per cent in the past 12 months.
Rather than crowing from the rooftops, Hyperion simply states that profit results generally met expectations and importantly were supportive of its long-term view for sustained growth in intrinsic value.
Growth vs value
It’s the age-old dilemma. Buy fair companies when they are trading at attractive valuations, or like Hyperion, pay up for good companies and wait for them to grow into their valuations.
We’re all suckers for a bargain, me included. When it comes to stock market investing, we are drawn to companies whose share prices have fallen, assuming cheaper means better.
The problem is twofold…
1) They are often cheaper for very good reason — inferior companies going through tough times. You want to avoid these like the plague. As Warren Buffett says, turnarounds seldom turn. I’d be giving companies like AMP Limited (ASX:AMP) and G8 Education (ASX:GEM) a wide berth.
2) Just because a company’s share price has fallen doesn’t necessarily make it cheap. CSL Limited is a case in point. Its share price has fallen over 10 per cent from its recent peak. Yet all that does is take the share price back to where it traded a month ago, a time when CSL shares looked over-valued.
Here’s why I wouldn’t be buying CSL shares at this price
CSL will be a fascinating case-study for value versus growth investors.
Plenty of top fund managers hold CSL shares, no doubt drawn to the company’s competitive advantage and to its growth profile.
With the top echelons of the ASX 200 home to low growth companies — think the banks, Woolworths, Wesfarmers, Telstra and now also BHP — CSL is one of the few large-caps that is growing earnings at a double-digit rate.
CSL trades on a price to earnings ratio (P/E) of around 40 times earnings. Martin Conlon at Schroder Equities Opportunities Fund says a large, mature company like CSL should trade at a much lower valuation. Read more here.
Unlike smaller companies like Hyperion’s WiseTech and Hub24, with a market capitalisation of around $90 billion, it’s going to take many years for CSL to grow into its valuation.
My back of the envelope calculations suggest the CSL share price could be trading around today’s levels in 2025. CSL shares are currently trading around $203.
Seven years for zero per cent returns. No thanks.
Of course, in the short-term, share prices can become completely disconnected to their underlying value. CSL shares looked expensive at $200 in mid August, but it didn’t stop them running to $230.
And between now and 2025 you can be sure CSL shares will be trading well above and well below today’s $203.
I don’t mean to rain on the CSL parade. It’s one of the ASX’s greatest success stories.
I wish CSL well in the future, and hope it exceeds my lowly expectations, given I don’t have a dog in the fight… unlike many fund managers, who are judged against the returns of the benchmark index, often the ASX 300 index.
Because of its size, the movement of the CSL share price has a disproportionate impact on the ASX 300.
As a fund manager, when the CSL share price is rising, if you don’t own it, you probably under-perform the benchmark.
Good-bye performance fee and bonus.
For you and I, beating the index is probably neither here nor there. We just want to make money in the stock market.
For the record, the ASX 300 index has gained around 8.3 per cent over the last 12 months, not including dividends.
It’s a decent return, for sure, one you can largely match by investing in a low-cost index fund like the Vanguard Index Australian Shares Fund or an exchange traded fund like the Vanguard Australian Shares Index ETF (ASX:VAS).
I’ve long been on record as saying I expect the popular ASX blue chips to offer modest returns in the years ahead. Read more here.
Small companies with big growth prospects
That’s why I focus my investments on smaller companies, including investing in a number of small company funds.
Sure, there are risks. Smaller companies rarely have the competitive advantage of a Commonwealth Bank of Australia (ASX:CBA) or a BHP Billiton (ASX:BHP). And you won’t get the chunky 5 per cent fully franked dividend yield of the blue chips with most small caps.
Offsetting that, because of their size, smaller companies can grow very quickly, and for a long time.
In terms of its $3.6 billion market capitalisation, Afterpay Touch is no small-cap these days. It’s a nose-bleed valuation when compared to FY18 revenues of just $142 million.
But in terms of growth opportunities, the world looks to be its oyster. Its ‘buy now, pay later’ technology is already taking the US market by storm, and last month Afterpay announced it was entering the lucrative UK market.
Afterpay shares are high risk, for sure. In fact, the Afterpay share price has already slumped 33 per cent from its euphoric high of $23 reached at the end of August.
Although I don’t own Afterpay shares directly, it’s a big position in a couple of funds in which I’m invested. Go Afterpay.