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Top picks and value investments

Corporate reporting season is well and truly underway and market watchers have been broadly pleased with the latest rounds of profit reports. So how should you be reading the flood of results in terms of your investment strategy and where is the smart money sitting as the economy continues to rebuild?

Managing director of Intelligent Investor, Steve Johnson, caught up with Peter Switzer, to share his views on how to outline some stocks he’s backing right now.

Value for money

It is by no means a simple task to weight up a company or value it – so how does Johnson approach the task?

“My first approach is to try and understand the business,” says Johnson, adding that each business is a different beast.

He says the simplest way – and the most popular for those starting out in the investment game – is to consider the earnings of the company in question. Then, to ask yourself what you’re prepared to pay for this business in relation to the earnings you think it can sustain over time.

“So we look at last year’s earnings as a starting point but then we need to try and adjust that and say, well, what do we think is a sustainable level of earnings for this business?”

Patience is a virtue
But it’s not always so straightforward.

“Sometimes, it might get more complicated,” says Johnson. “Sometimes, we’ll buy a business because it’s trading at less than its cash backing.”

But these, he says, are odd opportunities that seldom arise.

And while the unearthing of such an instance when you’re trawling through the accounts would – for most people – be cause for excitement, Johnson remains cautious.

“I like to watch a company for a couple of months,” says Johnson. “There are lots of other people out there who are looking at the same stocks at the same time.”

If patience is a virtue, and only fools rush in, the Johnson’s strategy seems a sound one.

One to watch

From the theory books to the current market, Johnson pegs QBE as one to watch: despite generating 80 per cent of its revenue from outside, it’s done remarkably well in the face of the Global Financial Crisis. Still, Johnson keeps a close eye on the forces driving those numbers.

Insurance companies such as QBE, he says, make their profits from their client’s premiums.

“And many insurance companies actually pay out more than they get in, but because they get to invest the money for a period of time, they end up making a profit out of it. So when you consider what’s happened to investment markets over the last 12 months, for any insurance company to make a profit at all is a sensational result and we’ve got QBE here not only making a profit, but making a profit that’s 19 per cent higher than the previous year.”

Again, it’s important to know what numbers to look for.

“I should put that into context, though: they’re out there spruiking the 19 per cent, but they raised a lot of capital through the year - if you give me a lot of capital, I can go and put it in the bank and make higher profit. So, the thing to focus on is earnings per share – they were six per cent higher, which is still an astounding result.”

Good things in small packages

Johnson has also been impressed by some of the smaller stocks, among them bull bar manufacturer ARB, and admits to having followed for a number of years. He has no reservations in recommending them – his staff and a selection of his clients have bought into the action – and ARB’s spate of success has, once again, been reaffirmed by recent reports.

“They’re a really, really successful Australian export story,” says Johnson. “Year after year after year, they just seem to build on their profit. The share price goes up and up and up.”

As he watches the price climb, he admits to asking himself on a number of occasions if then was the time to sell – and each time he administers a swift slap across the face to ensure he doesn’t.

Another company in Johnson’s watch list is RHG (formerly known as RAMS). He says since he last spoke to Switzer, their share price has climbed significantly.

“That distinction between price and value is not quite what it was a few months ago but I still think that business is worth more than its underlying share price,” says Johnson.

Portfolio staples

And back to the blue chip end of the market, Johnson says it’s time for a little less conversation and a little more action when it comes to acquiring what should be portfolio staples.

“We’ve seen an incredible market rally, but a lot of the really good blue chip businesses in Australia haven’t rallied along with the rest of the market. They didn’t fall, but they haven’t rallied either – companies like QBE, like Telstra, even Woolworths.”

Woolworths, he highlights, has been down over the past three months while the market is up 40 per cent.

“So I think, for the average investor out there, that blue chip end of the market is where you should be thinking now. All of the really easy gains have gone, there was stupid pricing out there in the market three or four months ago, but that’s disappeared, now it’s time to start thinking, ‘I’m going to buy that good business, I know it’s going to be here in 20 years time and I know it will pay a good dividend’.”

While Australians are not spoilt for choice, Johnson says there is certainly quality which is ripe for the picking.

“We have some truly world class businesses in Australia,” he says. “There aren’t a lot of them, but the CSLs, the Cochlears and the Wesfarmers – produce results year after year after year.”

For advice you can trust, contact Switzer Financial Services.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Published on: Wednesday, September 02, 2009

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