ASX200 had a pretty rough old week, down -0.89% to trade at 6,076 around 2pm on Monday. How bad a week it was on the market was largely masked by resources stocks adding 2.25%, whilst everything else was down 1% or more. Property and Industrial sectors both fell 2.7%, IT down 2.5%.
Really the story here is rising global interest rates and their negative impact on the share prices of some ‘bond proxies’. Transurban (TCL, -5%, Sydney Airport (SYD, -6.4%), Macquarie Atlas Roads (MQA, -9%) and Auckland Airport (AIA, -5.4%) all were sold off. What’s a “bond proxy” I can hear half of you ask? It’s a share or company that has bond-like characteristics but isn’t in fact, a bond. What are bond characteristics? Well you pay some capital value up front and then over time the bond will pay you periodic interest payments. In the case of these popular shares, you buy the shares up front and over time, they pay you dividends. These dividends are generally very stable because they are reliant on predictable events like “people driving on roads” or “flying in planes” and the earnings these events generate as a result of the company owning a very large, expensive, dominant asset like “Sydney Airport” or “The Burnley Tunnel”.
If you don’t know what a bond is, or what debt or equity is in the context of listed investments and you own shares, please, do yourself a favour, call me, you need advice.
Why doesn’t Luke like Resources and Mining Companies very much?
I had someone recently ask me about resources companies and why I don’t generally own them for clients. It’s really pretty simple, it’s actually the core of what we try and do here at Seneca. We want to be able to predict, with reasonable accuracy, how much money a given company is likely to make in the uncertain future. Why?
Well, accurately estimating earnings will help us forecast potential dividends in the first instance, and to a lesser extent, the price others might be willing to pay for that company, otherwise known as the share price* (*how much money a company makes is not a perfect predictor of share price because investors are not perfectly rational and markets are not perfectly efficient, also everyone can have vastly different estimates of future earnings, resulting in surprise/disappointment when that future arrives and becomes the past).
Anyway, 3 main reasons I avoid significant exposure to resources companies:
1. Earnings volatility
Mining company earnings swing wildly year to year. Chart below shows 12 month forward, forecast percentage change in earnings for these companies. Note the scale. The average year earnings grow by 11%. However the standard deviation of those earnings is 55%. So a good year would yield 66% earnings growth, whilst a bad year would yield a 44% decline in earnings.
By comparison, the non-mining companies have grown their earnings, on average, by 5.2% over the last 10 years, with a 17% standard deviation.
2. Subsequently very hard to forecast accurately
This fact makes resource company earnings very difficult to predict for the analyst community. We can see this by comparing actual earnings (with hindsight) vs forecast earnings and noting the difference. Median resources company earnings per share growth, over the last 10 years has been -8.7% whilst the median forecast has been -2.7%, so a 6% differential.
For non resources, median earnings per share growth, over the same 10 year period has come in at 3%, whilst the forecast median growth was 3.5%, a differential of 0.5%.
Also note the difference in the averages stated above (under the earnings volatility heading) against these median figures. This is also a ‘clear as day’ marker of the volatility differential.
ASX200 Ex-resources has outperformed Resources by 150% over last 10 years and 60% last 5 years. Over the last 2 years Resources have outperformed by 90%. But I think the 20 year chart does this argument the most justice, 365% better off. And I think the volatility-differential is abundantly clear.
Then, there’s a few practical implications for the average retail investor. Like, for example, mining companies being primarily interested in long-term shareholder value creation. What does that mean? Well in my experience working for one of the world’s largest mining companies (where I designed and built the supply and demand model for coal markets) we looked at “life of mine” returns and expected rates of return over life of mine. That’s normally 20 years! And that mine will see booms and busts, high prices and low prices. The important thing for them is to control the controllable and keep costs down and customers happy, so they can survive the low prices and make hay whilst the sun shines when prices are high. This kind of strategy does not map very well in my opinion to your average retiree or pre-retiree. In fact, it doesn’t map well to young people either who, in my experience, just aren’t that patient.
So, that’s why I don’t buy many resource stocks.
Episode 4 of B2B with Development Ready
The retail sales figures came out last week from the Australian Bureau of Statistics. Low and behold, Amazon (NASDAQ: AMZN) did not manage to murder Australian retail in one fell swoop. Retail sales rose 1.2 per cent in November, which is the third straight month of gains and well ahead of analyst expectations. Numbers may have been boosted by Black Friday sales, but I don’t buy the much touted argument that Apple’s (NASDAQ: AAPL) iPhone X was as big a hit with the punters as people seem to think. Did anyone buy an iPhone X?Anyway, JBHifi (JBH) was a star performer last week, adding another 5.8% (added 8% last week as well) and is now trading over $28. Super Retail Group (SUL) and Harvey Norman (HVN) also did well relative to the market.Amazon is not something to get complacent about. Whilst listed retail names have clawed their way back to long term average valuations, I’m not as confident as some in the market that from those ‘average’ valuations there is adequate compensation for risk. Certainly, the margin for safety at 10x earnings is significantly larger than at 14x earnings.
Beyond the bond proxies, retail and the miners, not much else to speak of. As a matter of administration, all returns are now back to normal, calendar year in the right column, for the weekly returns in the left column.
Episode 4 of B2B with Development Ready Development Ready is an online listing website for property that is either development approved (plans & permits) or has development potential. It was founded in 2013 by Nick Materia and subsequently he’s been joined by co-founders TC Bakhour and Will Pickering. I sat down with the 3 young men recently to talk about the business, marketing and handling hockey-stick growth all whilst constantly improving your offering for clients. I think this is a business to watch in 2018 and fits perfectly in my “disrupt the disruptors” trend, with Development Ready adding significantly more value not through ‘more eyeballs’ but instead, what really matters, more leads for their top-tier clients. Seneca clients will be hearing a lot more about Development Ready later this year.You can watch the interview here
Win a copy of ‘Man Alive’ by Jordan Travers
A few weeks back I did an interview with my friend Jordan Travers about his book “Man Alive” and his crazy cryptocurrency profits. You can check it out here bit.ly/2Bo4W.Anyway, Jordan will be on Channel 10’s The Project on Tuesday night and I’ve got 2 signed copies of his book to giveaway! If you want to go into the random draw, just reply to this email with your best joke. Winners will be selected on “how much I laugh at your joke” basis. Good luck!
* The information contained in this email is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser.