FNArena’s Weekly Insights – September 13 2021

In this week’s Weekly Insights:

-Appreciating The Mighty All-Weathers
-Conviction Calls
-Research To Download
-FNArena Talks

Appreciating The Mighty All-Weathers

By Rudi Filapek-Vandyck, Editor FNArena

One of the most persistent errors made by investors, on my observation, is a too stringent application of the ‘Buy Low, Sell High’ principle, usually translated as: only buy stocks that are trading on a below-average valuation and don’t hold on to them once the PE ratio is much higher.

It has been one of my long-standing favourite market observations: contrary to popular share market folklore, a stock with an above average valuation does not by definition become a Sell, and neither is the opportunity gone for a great investment return over many years into the future.

Recently I was again reminded by these facts by an excellent piece of research (see further below) involving ResMed’s ((RMD)) return over the past ten years. As most of you would be well aware, ResMed has been identified as an All-Weather Stock through my own research and the shares are firmly held by the All-Weather Model Portfolio.

This week ResMed entered the ASX50, but preceding this milestone has been a return of no less than 1262% over the past decade. Even for a long standing close observer like myself, that is quite the eye-catching number. Unfortunately, the All-Weather Portfolio is only in its seventh year running, so not all of these returns have been captured, but then again, I don’t see this success story coming to an end anytime soon either.

What mostly happens when such a piece of research has been published, is that your typical value-oriented stock picker or share market analyst tries to relegate the share price achievement to the past. One of the obvious ways to do so is by pointing out that back in 2011, this stock was trading on a PE of around 25x while today the forward looking PE is around 46x. Hence, the underlying suggestion then becomes: Sell, there no longer is further opportunity for PE expansion.

While this PE-expansion assessment might be correct, it is but one factor that has contributed to the extraordinary return since 2011, and it by no means prevents this company from achieving many more rewards for loyal shareholders. I also think investors are missing the bigger picture by only comparing the PEs of today and 2011.

A more correct assessment, I believe, is by comparing ResMed’s valuation in 2011 with the broader market, which back then was trading on an average PE of below 15x. In other words: ResMed shares ten years ago were valued at a substantial premium versus most other ASX-listed stocks.

When asked the same question ten years ago, today’s value-oriented nay-sayers would not have recommended ResMed shares as an excellent Buy-opportunity. Because at such a market premium, the shares did not look “cheap”.

Yet, over the following ten years the return from those seemingly “overpriced” shares has been nothing but phenomenal. I haven’t done the numbers, but I don’t think any of the “cheaply” priced alternatives back then has managed to generate anything remotely close to the reward that has befallen loyal ResMed shareholders over the period.

As a matter of fact, when I think of those stocks that have equally generated outsized returns over the period, the same basic characteristics apply as ResMed’s; think CSL ((CSL)) and Cochlear ((COH)), REA Group ((REA)), Seek ((SEK)) and Carsales ((CAR)), but also ARB Corp ((ARB)), Ansell ((ANN)) and TechnologyOne ((TNE)).

In contrast, last week I was dragged into a discussion on social media about the merits, or otherwise, of the proposed merger between BHP Petroleum and Woodside Petroleum ((WPL)). I think Woodside desperately needs this deal. As I looked up the share price, I noticed it is at the same price level as it was back in 2004 – 17 long years ago.

Throughout most of that period, in particular post-2011, Woodside shares have mostly looked “cheap” and “great value”, also offering an outsized dividend yield, but that has not generated much in terms of sustainable returns for shareholders (luckily they do pay a dividend).

Certainly, there have been rallies, and at times Woodside looked in a sweet spot, temporarily, but it’ll only take a few more years for its shareholders to look back and conclude history doesn’t consist of just one, but of two lost decades. So much for the “cheaper” entry!

I am certain all of us can add many more (apparently) cheaply priced examples: AMP ((AMP)), QBE Insurance ((QBE)), Humm Group ((HUM)), Slater & Gordon ((SGH)), and many, many more. Sure, at some stage they’ll have a rally and outperform ResMed and the likes, but great long-term investments they have not been, and why would they be in the future?

The answer does not lay in the low or high PE ratio.

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