This article was produced in partnership with First Sentier Investors.
There were a number of positive earnings outcomes in FY24, but all eyes have been keenly focused on company outlook commentary, which generally held a more cautious tone in this year’s August reporting season. Consequently, earnings revision trends were weaker than normal with smaller or cheaper companies faring worse than larger, higher quality peers.
First Sentier Investors believes the shifting macro and corporate environment continues to be favourable for a fundamental research process to uncover high quality companies that are capable of delivering attractive earnings growth over the long term.
First Sentier Investors head of Australian equities growth Dushko Bajic tells Professional Planner that many investors have been expecting a rapid slowdown in western economies for the past 18 months.
“This recession hasn’t come to pass, so I would argue that the stock market has been climbing that wall of worry,” Bajic says.
“Our view is that the economy is facing a cost-of-living pinch point, but not a recession. This is because the economy has been propped up by extended Covid stimulus, resulting in strong employment and a strong wealth effect from buoyant asset prices, both housing and financial.”
Robust finances
Consumers and the retail sector remain at the epicentre of macro headwinds as cost-of-living pressures and higher interest rates work to slow demand, Bajic says.
However, whilst recent company results observed an increasingly preference for value, Australian households continue to demonstrate a degree of resilience with low unemployment, wages and housing price growth supporting spending. Notably, the older demographic – households with little to no mortgage debt and established stable careers – have benefited from a slower draw down of their enlarged savings buffer which had been boosted by government stimulus from the pandemic period. Future interest rate cuts and potential tax cuts should continue to support the broader retail and consumer spending outlook.
Similarly, corporate balance sheets remain robust, owing to the quality of company capital management. However, headwinds to company margins have continued to be another key focus for market participants particularly in the cyclical sectors.
“The way we manage this [risk] is by selecting stocks in a portfolio that benefit from structural growth, who are generating productivity for their clients,” Bajic says.
“I am constructive on both the Australian economy and this type of portfolio when I look ahead to the next year or two.”
Valuing Growth
Cutting through the noise instead focusing on identifying high quality companies with solid earnings capabilities, typically industry leaders with structural growth is fundamental to our long-term investment process, Bajic says.
“Fortunately, our local stock market hosts a handful of high-quality growth companies that provide global leading products and services.”
Bajic pointed to WiseTech Global as an example, which has developed an industry leading logistics software, CargoWise, for freight forwarders with real time electronic bookings and cargo management enabling its customers to plan, track and control their operations more efficiently.
WiseTech has been able to grow their revenues, cash flows and profit at over 30 per cent per annum for the past decade as they have stretched their lead versus competitors through continued product innovation and in doing so, accelerate their customers’ ability to grow and become more efficient. There are others in the same boat – the key is to know what to look for when valuing growth, he says.
“The key to identifying these stocks lies in our research process, where we have a team of experienced analysts and portfolio managers out in the field searching for these opportunities and then constructing financial models that forecast and value the cash flows listed companies are likely to generate in the future,” Bajic says.
This may be easier said than done. Investors can become very short-term focused and fall into a trap of number chasing. This entails trading from one seemingly cheap investment to the next without having a framework for understanding the company’s business model and the balance of risks.
But only thinking about the short term may mean investors might miss the most successful businesses with the staying power in terms of profitability and sustainable cash flows.
“Being overly short-term interrupts the formula for being successful when it comes to investing, at the heart of which is time spent invested in the market and the compounding returns with stocks that can consistently outgrow their peers,” Bajic says.
Long-term view
Bajic reiterated that Australia punches above its weight when it comes to generating current and future global leaders across a range of industries. As long-term investors, the decisions made today can impact communities today, tomorrow and years from now.
While it can be tempting to dip out during periods of slower economic growth, taking a long-term perspective on investing enables the key positive attribute of investing to work hard for you – and that is the compounding of investment returns, both capital and income, over a long period of time.
A longer-term view can also help with stock selection, as sometimes the merits of an investment can be hidden by high valuation such as a high one year forward price to earnings ratio, he adds.
“If you only look forward one year, you can miss the long-term success stories, such as WiseTech and Pro Medicus [a radiology image viewing software provider], who can sustain strong growth rates of profit with a high return on capital that more than justifies its short-term valuation premium,” Bajic says.