Performance is as much about avoiding the blow-ups, as it is about picking the winners. So for Livewire’s ‘Easter Eggs’, we outline three sectors to avoid completely, before then spotlighting two stocks we think stock-hunters should take a look at this Easter.
Three sectors to avoid
First, avoid the banks: Royal Commissions can be very bad for a company’s future prospects (go ask James Hardie). And this one is generating a lot of bad news for the banks, with implications for many parts of their business. Insurance, mortgage broking, financial advice and lending practices have all been in the frame so far. It is likely we will see legislative changes that will reduce the banks operational flexibility, and in time, their earnings.
Second, Telcos: Competition between the listed players is intensifying. The telecommunications industry is not what it was. Profit margins are falling. The NBN is a monopoly supplier of fixed broadband to all the telcos, which lowers the barrier to entry and reduces their ability to differentiate, except on price. Mobile is only going to get worse too, with Vodafone now having substantially improved its network and TPG beginning to build one as a new entrant. Let alone the 5G capex ahead.
Third, Resources: The last resources cycle bottomed two years ago and has staged a major recovery. Globally, the macro outlook has been very positive (until the recent trade war rumblings), but commodity prices are a binomial outcome. Buying resource companies at the top of their trading ranges is not a high probability strategy.
Where should a stock hunter look this Easter?
If we use the above as a guide, we want to avoid businesses suffering from: increasing scrutiny, intensifying competition, and macroeconomic sensitivity.
And, because the final determinant of a stock’s value is its future earnings, we want to find stocks that should grow their earnings strongly over time.
Lovisa (ASX: LOV) makes and retails costume jewellery. It’s a vertically integrated retail concept that has been very successful in Australia, New Zealand and Asia and is now being rolled out to the rest of the world. They have a proven cookie-cutter approach to fitting out and running the stores, which has resulted in quick paybacks and high ROAs. We have seen the stores gaining traction in the UK and they are now spreading across to Europe (Spain, France) and have opened in Los Angeles.
NextDC: “Where the cloud lives”
NextDC (ASX: NXT) is Australia’s largest independent network of data centres. The consumer and business demand for connectivity, streaming, on-line storage, and cloud-based software as a service just keeps growing. This has been reliably filling up NextDC’s data centres, which rapidly increase in profitability as they fill. And it has pricing power; the business passes electricity price increases through to its clients, who appear to be quite insensitive to them.