This article appeared in the November 2010 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
By Martin Roth, author
One of the surprises of the recent results season was that it attracted so much negative commentary in the media, despite some healthy profit growth from many companies.
At the time, the financial press was replete with stories of some kind of looming disaster - a double-dip recession in the US, sovereign default in Europe, a sharp slowdown in China - that could send markets crashing, regardless of the quality of individual companies. No doubt such fears were an influence on the commentators.
Any, or all, of the above calamities might yet strike and the effect on sharemarkets could be bad. Yet there are also many reasons for believing that conditions are going to improve, and that astute investors who are seeking the quality companies, rather than worrying about the direction of the overall market, could realise some impressive gains.
Each year I analyse the results season for my book, Top Stocks. To make it into the book, a company must be in the S&P/ASX All Ordinaries index (meaning it must be among the 500 largest companies), must have been listed for five years and made a profit and paid a dividend in each of them, and must meet stringent profitability and debt benchmarks.
The latest edition comprises 105 companies and a clear trend was evident. Eighty of them achieved an after-tax profit rise in their latest reporting period, including seven with triple-digit profit gains and a further 55 with double-digit increases. But, most impressively, 68 boosted profits at a faster rate than revenues, meaning that profit margins were up.
Weak economy overcome
Of course, there can be many reasons for this. In part it was a natural reaction to a recovery in business, after a sudden decline. For resources companies it often reflected higher commodity prices. But it also suggested that some companies had taken advantage of the economic downturn to cut costs.
Naturally, as the economy continues to recover, some expenses, such as salaries, are likely to increase again. But certainly some companies are now operating from a lower cost base than just a couple of years ago. Even in a weak economy they could continue to increase profits.
The table below shows 50 companies in Top Stocks that achieved growth in after-tax profit and earnings per share (EPS) at a faster pace than revenues.
Companies with profits growing faster than revenues.
|Listed company||Year-on-year after-tax profit growth (Latest reporting period) %||Year-on-year EPS growth (Latest reporting period) %||Year-on-year revenue growth (Latest reporting period %|
|Cedar Woods Properties||84.9||78.7||1.3|
|Hunter Hall International||58.1||55.2||-4.7|
|Little World Beverages||51.1||50.0||18.5|
|Wide Bay Australia||30.4||24.9||5.0|
|IRESS Market Technology||30.0||17.4||4.4|
|Domino's Pizza Enterprises||15.6||15.9||-1.1|
|SMS Management & Technology||14.8||13.3||7.3|
|Credit Corp Group||13.1||13.3||6.2|
|Harvey Norman Holdings||7.9||8.0||-2.2|
Source: Top Stocks 2011
Things are happening in IT
Each year while Top Stocks is being written, certain themes present themselves. Some years ago I noted the steady entry to the book of pharmaceuticals companies. This was at a time when companies such as CSL and Cochlear were much smaller and not the superstars they are today.
One theme that is becoming evident now is the rise and rise of Australian high-techs. Just 10 years ago, only one high-tech company, Computershare, made it into Top Stocks. Last year there were eight. This year 11 companies from the Information Technology (IT) sector and two from Telecommunications Services are in the book.
Of the 11 broad sectors that comprise the Australian sharemarket, IT is by far the smallest, accounting for less than 1 per cent of total market capitalisation. (By contrast, IT is the largest sector in the United States, representing about 18 per cent of the market.)
For 11 IT companies plus a couple from Telecommunications Services to be among the 105 companies in the book suggests that something is happening.
The 'tech-wreck' that began in 2000 led to the demise of many technology companies and some years of consolidation. Now it seems that an increasing number of high-tech companies are reporting regular profits and dividends, and are growing big enough to make it into the All Ordinaries index.
Two examples: Brisbane-based IT consultant Data#3 has just reported its eighth straight record profit. It has no debt and $64 million in cash holdings, and looks set for continued strong growth. Melbourne company M2 Telecommunications has just doubled in size, thanks to two acquisitions. Its sales have grown by more than 10 times in just four years, and it continues to expand. It is forecasting profits will rise a further 40 per cent in its June 2011 year.
Technology spending is going to grow in Australia - the national broadband initiative will ensure that - so this is clearly a theme to watch. Most of the relevant companies are still small, but the potential is large.
(Editors' note: Do not read that as a recommendation to buy IT shares. Do further research or talk to your financial adviser first.)
Another promising theme is agribusiness. This has become a major global investment theme, thanks to rising prices for agricultural commodities, some shortages and steadily growing demand, particularly from Asia. BHP Billiton, when it launched its US$40-billion takeover bid for Canada's PotashCorp, made it clear that it saw a very bright future for global agribusiness - and helped spark a rally in fertiliser company shares in several countries.
Australia's proximity to Asia and forecasts for some bumper harvests, especially on the east coast, mean the potential for local companies is high. Sadly, investment opportunities are limited. GrainCorp, which operates seven bulk grain export terminals, stands to be a big beneficiary. Two other relevant companies are Incitec Pivot (fertiliser) and Ridley (animal feed).
What else? I continue to believe that 'green' technology has a bright future, although the Rudd Government's scrapping of several incentive programs has put a dent in the near-term outlook. Again, however, investment opportunities in Australia are limited.
Finally, of course, massive LNG projects in Western Australia and elsewhere are going to continue to throw up numerous investment opportunities. Much of the potential is already in the pricing of the relevant shares.
But by monitoring this theme and through acquaintance with the smaller companies that are involved, especially those providing a wide range of ancillary services to the big companies, it should be possible for astute investors to realise some good gains.
About the author
Martin Roth is a Melbourne writer and the author of the annual Top Stocks series of books. He has also written two novels, Prophets and Loss and Hot Rock Dreaming. Learn more about Martin's book at his website.
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