some good press for argo and rob patterson

Hold 'em or fold 'em
September 10, 2008
from smh.com.au

Where some people see a sharemarket gamble, experts see winning hands, writes Barbara Drury.

Investors can breathe a little easier now that the annual reporting season has drawn to a close. Corporate Australia finished the 2008 financial year battered but not beaten, giving investors the confidence to shift their attention from the rear-view mirror to the road ahead.

Commonwealth Securities compiled the results of 500 companies who reported earnings for the full year to June 30. Aggregate profits were down 10.5 per cent, with a fall in earnings per share of 15.2 per cent. However, when companies in the financial and real-estate sectors are excluded, overall profits were up 9.2 per cent and earnings per share rose 4 per cent.

The market was on the alert for unexploded time bombs ticking away in company balance sheets and while there were a few - notably Allco, Centro and Babcock & Brown - there were few surprises. When markets are as jittery as they have been in recent months, the last things investors want are more surprises.

The big question for investors now is what to do with the stocks they are still holding - do they hold 'em, fold 'em or use any opportunity to take some cards from the dealer? And that decision depends on your view of the market.

EXPECT THE UNEXPECTED

CommSec's chief equity strategist, Craig James, says companies successfully softened investors up to expect less-than-stellar profits and the majority of companies reported more or less in line with expectations. He is cautiously optimistic about the year ahead and expects corporate earnings could end up in a mirror image of 2007-08 - that is, instead of strong first-half and weak second-half earnings, the opposite could occur.

"With the Reserve Bank moving to cut interest rates, petrol prices down and [the] stabilisation [of] sharemarkets, people are likely to feel more confident as we move into 2009. But it's hard to forecast, which is why a lot of companies gave up on any forecast of future earnings," James says.

Robert Patterson, the managing director of listed investment company Argo Investments, has lost no time in adapting to the new landscape. "With this [market] volatility, opportunities throw themselves up unexpectedly. We have been a buyer and we continue to nibble away," he says.

Two success stories of the past reporting season were Argo and Australian Foundation Investment Company. Unlike some of their flashier funds management competitors, these worthy listed investment companies know a thing or two about the merits of a long-term buy-and-hold investment strategy.

AFIC boosted net profit by 60 per cent to $416 million, while Argo increased its profit 71 per cent to $294 million, lifting earnings per share by 57 per cent and 55 per cent respectively. This was despite holding a handful of banks, which bore the brunt of this year's market sell-off.

Patterson, who has been with Argo for 39 of its 60 years, continues to steer a steady course through the current market turmoil. "We've been adjusting our portfolio at the margins, weeding out those stocks that are not rewarding us and focusing on stocks that continue to grow dividends," he says.

Argo has increased its exposure to BHP Billiton and Rio Tinto over the past few years and although the big miners are customarily low-yielding, Patterson says the true dividend growth has been strong.

Argo is in the happy position of having no debt and $228 million in cash with which to play. James believes this will put it in a strong position to take advantage of continuing market uncertainty.

FLAT DIVIDENDS

Unlike the market crash of 1987, which was swift and severe, Patterson says this one is more like death by 1000 cuts. Even so, he suggests, with a touch of gallows humour, that this is the period of "rest and relaxation" we had to have after such a huge boom.

Patterson concedes this year will be tougher because of the time lag involved in the dividends it receives. "We're looking at flat dividends [this year] after good growth for several years," he says.

Paul Zwi, the head of equity research at Centric Wealth, is also ready to dip into the sharemarket but he remains cautious. "[The reporting season] has given the market a level of confidence that it's OK to start nibbling and getting back into the market," he says.

However, he is also mindful that this crash is not going according to script.

"Every time you think there's a respite around the corner, you get whacked again. After years of being told you would do well to buy shares on price dips, investors who tried that this time around have been punished."

Colin Nicholson, a professional investor for more than 20 years, is even less optimistic. "I don't think we've seen the bottom but I could be wrong," he says.

Robert Lipman, the head of Investec's wealth management arm, believes earnings growth will be lower this financial year but not disastrously so. He points to broker forecasts of 8 per cent earnings growth in the 2009 financial year. "That's not a disaster," he says.

He says investors take a cautious view because there is still earnings risk in global financial markets. "In an uncertain scenario you don't want to be buying aggressively, even though prices are down on a year ago. But do think about getting close to your equity benchmark."

STICK WITH QUALITY

"In all my experience, reliance on a sensible asset allocation strategy is the driver of long-term investment success," Lipman says.

If investors have not thought about their overall asset allocation, then this is a good time to do so because it encourages a level of self-discipline and reduces the likelihood that you will panic when markets gyrate. Say you decide you want 35 per cent of your investable funds in Australian shares over the long term. In a market downturn the value of your shares may drop to, say, 25 per cent of your overall investment portfolio.

When that happens, a disciplined investor will take advantage of the lower prices to top up their shareholdings and bring their asset allocation back to their benchmark level of 35 per cent.

"The thing that really matters is to have a benchmark and the discipline to reweight back to benchmark. Even if you don't pick the timing perfectly, reweighting does lead to a good long-term outcome," Lipman says.

But most analysts agree there is a long way to go before the global economy turns the corner - so there's no rush to buy. "If you are holding cash, you might begin dollar-cost averaging into the market to buy solid companies with good dividends and franking credits," Lipman says.

Dollar-cost averaging involves putting a small portion of your money into the market at regular intervals to avoid the perils of trying to time market highs and lows. "Providing you have a two- to three-year view, that's not a silly thing to be doing," he says.

Nicholson agrees that patience and discipline are the keys for long-term investors in the present market (see box) but he prefers to wait for evidence that a company's share price is on the upturn.

"Wait for the bull market to come to you - you can't force it," says Nicholson, who argues that investors have time on their side and plenty of stocks to choose from if they miss an opportunity.

"This is the time to work out a clear strategy and clear criteria that stocks have to meet. When you do go ahead and start buying again, buy well-managed businesses with low price-to-earnings ratios, high dividend yields and low debt-to-equity ratios," he says.

HIGHER CASH BALANCE

Once you identify a good investment prospect, Nicholson says, you have to keep your eyes on it and wait for clear evidence that the price is moving higher. However, he thinks it will take a long time for the market to work the rubbish out of its system.

"A lot of people have been burnt in industrial stocks and I'm afraid a lot will be burnt in resources. I'm afraid resources stocks are near the end of their run - maybe not BHP and Rio but commodity markets have always been cyclical, so why will this time be different?" he asks.

James is more sanguine about the potential for companies to continue to leverage off China and the resources boom. He says many companies in the capital goods and commercial services sectors, such as Leighton Holdings, are still upbeat and their order books full.

James says telecommunications companies, notably Telstra, should be fairly stable as consumers are likely to give up fast food and cafes before they ditch their mobiles and internet connection. The rollout of broadband services across the country also will flow through to much of the sector.

James also sees opportunities in the health-care sector, where growth is driven by an ageing population and industry consolidation. "They won't be knocked around by oil prices changing or the credit crunch," he says.

The reporting season reinforced Zwi's view that during market slowdowns you should stick with quality stocks. However, you need to keep monitoring them and be alert to buying opportunities. For example, four weeks ago Westfield was trading at $13.90 but last week it was back above $17. Over the same period, Woodside Petroleum rebounded from $52 to $64.

Centric has a shortlist of a dozen stocks it believes will outperform the market over the medium term (see box below). Zwi says it is still appropriate to maintain a higher than normal cash balance but Centric advises clients with money earmarked for investment to buy a selection of stocks in monthly tranches over the next half-year or so.