...when the resource flame is out, market participants buy into a handful of companies, in the process making them very expensive on valuation metrics.
...buying good companies is one thing, buying them at very elevated valuation levels only serve to provide a poor risk reward outcome once their flame too dies down.
Why fundies are starting to hate these 10 ASX darlings
Fund managers are grumpy. It’s always a battle to beat the index and passive flows, but the market has crowded into a narrow group of winners that now look expensive.
Aug 23, 2024 – 9.06am
For chief executives and institutional investors, the real business of earnings season doesn’t really get under way until well after the analyst calls, media interviews and glad-handling of results day is done.
Investor roadshows provide a chance for fund managers and equities teams inside the super funds to grill chief executives and chief financial officers behind closed doors – and a chance for CEOs and CFOs to butter their backers up. It’s a time to both interrogate the numbers in detail and zoom out to examine the big picture. Both sides get to take each other’s temperature, challenge, and, occasionally, air the odd grievance.
While it’s always fascinating to hear what questions investors are asking of management, Chanticleer was struck by how several executives summed up the mood of the investors across the other side of the table.
“It’s tough out there if you’re active,” a manager says. “The weight of money is killing you at the moment, and it doesn’t look like it’s going to end soon.”
History says most active managers struggle to beat their benchmark at the best of times, but the June quarter, and the first part of the September quarter, have been particularly hard to stomach because of the sharp rise in bank stocks, and the unique rocket ship called Commonwealth Bank.
Managers who’ve been caught out with not enough exposure to the banks and too much exposure to the resources sector – the other big barbell of the ASX – have suffered a double blow.
Unless you’ve been living under a rock, you’ll be familiar with the many reasons CBA stock looks overvalued, including its highly elevated multiple compared to history and local and international peers, its lack of growth prospects and the persistent rise in bad debts, albeit from low levels.
As one fundie says, few active fund managers with an eye for fundamental valuation can bring themselves to own too much of it. But that makes it even more difficult to beat the ASX 200.
“Everyone is underweight CBA, and that’s probably the right call. But it’s an uncomfortable call at the moment, and it probably will be for the next six to 12 months.”
For local active managers, CBA stands out as the most angst-inducing stock on the ASX. But it is part of a bigger group of very popular stocks that are making life hard for fundies at present.
This group of market darlings are highly lauded for their business models and management teams and are precisely the sort of quality stocks that many institutional investors usually love.
But they are all eye-wateringly expensive. Consider this list and the accompanying comments Chanticleer has collected from the market this week.
Pro Medicus: great company run by great people, but now trades on a forward price-to-earnings ratio of 147 times, while Nvidia trades on 46 times.
Wesfarmers: great company, great management. But it’s a conglomerate trading on 33 times earnings when only one business – Bunnings – is really deserving of that multiple.
Reece: incredible track record of success and compounding. But its growth outlook is poor in Australia and the US is a 30-year story. Trades on 39 times, whereas Microsoft trades on 31 times.
JB Hi-Fi: one of Australia’s best retailers and its July sales were good. But its PE ratio now looks rich compared to history.
ARB: another compounder with an amazing founder’s mindset. But it trades on 30 times earnings, compared with Google-owner Alphabet, which trades on 21 times.
WiseTech: founder delivers and is the ASX’s favourite tech stock, which has surged 28 per cent since its profit was announced on Wednesday. But trades on 102 times, more than double Nvidia, suggesting a huge amount of growth is priced in.
Goodman Group: stunning rise, founder is brilliant, and it’s the best way to play the artificial intelligence game. But the 44 per cent rise in the last year leaves it trading at 27 times.
Life360: everyone’s next big thing, but it’s a relatively immature company looking very expensive after a 155 per cent rise year to date.
Telix Pharmaceuticals. everyone’s other next big thing, now trading on 78 times. Apple trades on 33.5 times.
To be clear, fundies love these companies for their strong business models, wide moats, trustworthy management teams and, for the most part, their predictable and quality earnings. But all have run hard in the last 12 months and their natural inclination is to trim these and rotate into better-priced opportunities.
There’s just one problem: managers aren’t sure what to buy next.
“People are finding themselves sitting in expensive winners they would prefer to trim. But where do you go?” is how one investor sums it up.
Managers say the phenomenon known as the incredible shrinking ASX plays a part in this. There have been painfully few new floats in the last two years, and a spate of takeovers that have reduced investors’ options in several sectors.
Building products is a great example: a fundie looking to rotate out of Reece could have previously looked at CSR or Boral, but both have been acquired this year.
But the big problem is the widening gap between the crowded trades mentioned above and the also-rans of the market that doesn’t seem to be closing.
“The winners get more expensive and the losers get cheaper and there’s no reversion,” one value manager says.
He’s felt like the crowding into winners has been happening for nine to 12 months and has been happy to buy companies that at other times would turn out to be good bargain plays.
“We’re always a bit contrarian – but it hasn’t worked,” he says, his frustration obvious.
Several managers say uncertainty is a big part of this story. We all see the impact of cost of living pressures in our daily lives but don’t see it yet on the ASX. We’re all worried about geopolitics, about government debt levels, and about the potential for flash crashes like we had earlier this month.
Even CEOs are unsure what’s coming. One fundie likes to ask executives to compare the current operating environment to one from the past: this profit season, most chief executives have struggled to do so.
So what do investors do? Quite sensibly, they hide in quality stocks. Maybe growth at Reece, JB Hi-Fi or ARB will slow this year and next, but at least investors can be sure their management teams will navigate any softness with their usual skill.
Occasionally, there have been moments of relief for bargain hunters. The manager bet on bedraggled packaging giant Orora, for example, after what he believed was a $3 company traded as low as $1.89. It took a takeover offer to get the stock jumping again.
This may be the way that some left-behind stocks are re-rated: they fall so out of favour that they’re bought out.
But the more likely scenario is that this bull market, now well into its second year, eventually runs out of puff. That will make the big winners above look more reasonably priced, and give managers the chance to buy more of them.
It might also help encourage investors to take a broader view of the market, giving left-behind stocks fresh energy.
Do rate cuts stop the ASX grinding higher? Possibly. While the Reserve Bank has made it crystal clear it is on the sidelines for six months, managers say this reporting season has shown that the economic weakness they see in their daily lives is starting to infect company profits – including through rising arrears at the banks, increasing bad debts at utilities and the ugly housing construction environment.
One market veteran says it may be a matter of timing.
“Historically, September and October is when you get a bit of action in markets. We might be setting ourselves up for that. Maybe we get a bit of volatility and people will be able to buy some stuff.”
