Back in February 2016, Jeremy Bendeich from Avoca Investment Management shared his list of stocks that were vulnerable to earnings misses, which formed a handy acronym - ‘BITBAD’. Blackmores, IPH, TPG, Bellamy’s, A2 Milk, and Domino’s Pizza. Since then, four of the six are down more than 20%. A simple average of the six would’ve produced returns of -14.8% at the time of writing. So how did he identify these risks? And what looks vulnerable today? Watch the video or read the transcript for the analysis he used to highlight growth stocks potentially vulnerable to a selloff in 2017.
We revisited what we did in 2016 and we thought, "Well, let's look at a growth stock that we think is an amazing company. We can use that as our benchmark growth stock." We said, "Let's look at Google." We think Google has one of the best business models in the world. It's trading on a PE ratio of around 17x June 2017 earnings and about 15x June 2018 earnings, once you strip out the $110 billion in cash, and it’s growing EPS at about 17%.
We then lined up a whole bunch of stocks in the Australian market; Iress, CarSales, RealEstate.com.au, and Dominos. We looked at their PEs relative to Google and compared their EPS growth. It just stood out that there's still a massive gap between what Australian growth investors are prepared to pay, compared to what American growth investors are paying for Google. In some cases, Iress and CarSales had forecast EPS growth that was 30% lower over the next three years than Google, yet were trading at a 30% PE premium relative to Google.
There's warning signs here that some of these market darlings won’t be able to perform in 2017.
The reason Australian growth stocks are trading at such high prices is two-fold. It's a weight of money; that's been a crowded trade. There's a lot of money in the Australian superannuation sector that is being allocated to domestic equities. Now you're seeing an increasing valve where people are needing to release that into international markets. We're seeing companies like Magellan and other international fund managers building businesses on that very issue that you have identified, that there's just too much money chasing too much of a good thing in Australia.
We've looked at some of the out of favour stocks. Southern Cross Media's been a good performer for us this year. We still think it's going into an earning's upgrade cycle. It trades on a PE of about 11-12 times, with a reasonable balance sheet and a good dividend coming into this first half result we're quite confident that this stock will deliver. It's got a mix of radio and TV; it's a little bit out of favour.
That’s the style of stocks that we've had to kick the tables on and really dig down.
Greencross is another interesting stock that we've been accumulating around the low sixes. It had some issues with like for like store growth, but we noticed last night MARS is bidding for Woof and paid 15 times EBITDA for the Woof business, which runs veterinary services and clinics in the US. This transaction implies quite a high underlying value for a business like Greencross.
It's been a combination of kicking the tyres on some out of favour stocks and of finding some beaten up growth stocks. We are style neutral, but it's still not easy. I'd say at this point we haven't seen any large opportunity set emerging for ‘no brainer’ trades. They're all hard work and require a lot of analysis to build the confidence to take positions.
Avoca Investment Management was established in 2011 by John Campbell and Jeremy Bendeich in partnership with Bennelong Funds Management. The team is focused on capital preservation through prudent, long-term investment in emerging leaders.
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