Top 20 stocks - ii-uploads.s3.amazonaws.com

Top 20 stocks:

The good, the bad and the ugly

special report | june 2014

Intelligent Investor Share Advisor PO Box Q744 Queen Vic. Bldg NSW 1230 T 1800 620 414 F 02 9387 8674 info@.au shares..au

PO Box Q744

Contents

Queen Victoria Bldg. NSW 1230

T 1800 620 414

F 02 9387 8674

Of diamonds and dogs

3

info@.au A review of 2007's ranking

3

shares..au Lessons from 2007's ranking

4

Australia's Top 20 stocks ranked by investment

5

DISCLAIMER This publication attractiveness

is general in nature and does

Using Intelligent Investor's value-based ranking

6

not take your personal situation Prudence stuck on Blue Chips

8

into consideration. You should

seek financial advice specific to

your situation before making

any financial decision.

Past performance is not a reliable indicator of future performance. We encourage you to think of investing as a long-term pursuit.

DISCLOSURE As at 1 June 2014, in-house staff of Intelligent Investor held the following listed securities or managed investment schemes: ALL, AOG, ARP, ASX, AWC, AWE, AZZ, COH, CPU, CSL, EGG, ICQ, IFM, JIN, KRM, MAU, MIX, MQG, NBL, NST, PTM, QBE, RMD, RNY, SLR, SRV, SWK, SYD, TAP, TEN, USD, UXC, VMS, WDC, WES and WRT. This is not a recommendation. PRICES CORRECT AS AT 30 May 2014

3

Special report

Of diamonds and dogs

In 2007, we ranked the Top 20 stocks in order of attractiveness. Seven years later, the difference in returns between investing in the top and bottom five was more than 50%. This time, we're again looking for the diamonds and dogs in that auspicious list.

We'll also suggest ways you could use this ranking in a very practical sense: to build a core portfolio around Australia's largest stocks.

The top 20 stocks are the most widely owned in the country. Who doesn't have a place for at least one of the big four banks, a resources giant or an owner of one of the two dominant supermarket chains?

In this report we'll not only draw together our recommendations on Australia's largest stocks in one place but we'll also rank them based on their attractiveness.

In other words, you'll see which of the two current Buy recommendations in the Top 20 we like the best and which of the three stocks bearing negative recommendations we like least. Just as importantly, you'll also see how we rank the 15 Holds in between. That all begins on page 5.

We'll also suggest ways you could use this ranking in a very practical sense: to build a core portfolio around Australia's largest stocks. That's on on page 6.

Table 1 shows ver y ef fec tively that `Hold' recommendations are far from boring. There's actually great value in understanding which of the Top 20 stocks

offer better opportunities than others, even if most of them sport this bland-looking tag. To show how, let's start with the returns from the 2007 data.

A review of 2007's ranking

June 2007 was a heady time. Harry Potter and the Deathly Hallows was about to become the fastest selling book in history and the All Ordinaries Index was a few months away from its boom-time peak. No one had heard of the GFC, although there were rumblings and worries about banking practices and derivative products.

Market observers were intently discussing three Top 20 Aussie stocks that were hovering around the financially irrelevant but aesthetically interesting $100 mark: Macquarie Group, Rio Tinto and CSL (before its subsequent 3-for-1 share split). Seems like another world now doesn't it?

In this climate we ranked the market's Top 20 stocks, not by common yardsticks like market capitalisation or

Table 1: Prudence (profitably) stuck on blue chips - results reviewed

Perf Rank

Stock

rank (2007)

2007 price (29 June) ($)

2007

2014 price/

DividendsTotal

recommendationadjustments ($)adjustments ($)Return (%)

15

1

Westfield

19.96

Long Term Buy

14.09

5.75

?1

3

2

Westpac

25.66

Hold

34.52

10.71

76

4

3

Woolworths

27.00

Hold

37.855

7.98

70

2

4

Comm. Bank

55.25

Hold

82.05

21.34

87

7

5

ANZ

28.99

Hold

33.73

9.70

50

6

6

Telstra

4.59

Hold

5.38

1.97

60

19

7

Rio Tinto

98.79

Hold

60.07

9.29

?30

16

8

Mac. Bank

85.00

Hold

64.73

16.18

?5

12

9

Woodside

45.75

Hold

42.00

9.43

12

8

10

PBL

19.60

Hold

16.26

9.85

33

13

11

NAB

41.02

Hold

33.41

12.28

11

1

12

CSL

88.00

Hold

212.28

15.97

159

14

13

Brambles

12.18

Hold

10.576

1.93

3

10

14

Coles

16.12

Hold

12.38

7.28

22

10

15

Wesfarmers

45.73

Hold

43.53

12.05

22

20

16

QBE Insurance

31.20

Better Value Elsewhere

11.32

6.73

?42

5

17

St George

35.43

Take Part Profits

45.2212

14.27

68

9

18

BHP Billiton

35.03

Take Part Profits

37.49

6.54

26

18

19

AMP

10.12

Avoid

5.30

2.23

?26

17

20

Suncorp

20.17

Sell

13.36

4.37

?12

Average29.2

II Top 5

56.5

II Bottom 5

2.8

Share advisor

4

The nature of CSL's business also means it has more optionality ... With an annual research and development spend approaching half a billion dollars, there's always the chance of discovering another blockbuster drug.

revenue but by another, more useful, measure. [To see the full article, turn to page 8 and read Prudence stuck on Blue Chips ? Ed]

We placed them in order of attractiveness from a long term investor's perspective, comparing the value on offer with the price paid to secure it.

At the time, Intelligent Investor had only one positive recommendation on a Top 20 stock (Westfield), five negative recommendations and 14 Holds. But the gradation of these recommendation types into a clear ranking from most to least attractive was incredibly valuable, as the results summarised in Table 1 (on page 3) show.

The average return from an evenly-weighted portfolio of the Top 20 stocks was 29.2%, about 3.8% a year. By comparison, our top five picks based on value returned an average of 56.5% ? 6.7% a year. And that figure was achieved without the inclusion of the Top 20's best performer, CSL.

How did we deliver almost double the performance of the average returns from the Top 20? By identifying those stocks that turned out to be underperformers. Five stocks from 2007's Top 20 list delivered negative overall returns. We successfully identified three of those in the five stocks at the bottom of our 2007 ranking. They were QBE Insurance (which ranked 16th), AMP and Suncorp (which ranked 19th and 20th, respectively). Members did well simply by avoiding the losers.

We were also able to separate the better-performing big four banks from their lower-performing siblings. In fact, we almost got them in the exact order, except that we preferred Westpac (which delivered a 76% return) to Commonwealth Bank (87%). The third-rated of the four ? ANZ ? returned 50% while NAB, which was the only big four bank to miss out on a top 10 ranking, was clearly the worst performer with a paltry 11% return.

Readers may note that several of our recommendations changed subsequently. As QBE Insurance fell from being horrendously overpriced in 2007, we shifted to a more favourable view in 2010. In hindsight and after so many years of studiously avoiding it at much higher prices, we were too keen to add this impressive long-term performer to our recommended list.

Woolworths, Commonwealth Bank and Westpac also earned positive recommendations in 2010 and Macquarie Group became a Strong Buy in 2011.

These cases speak to the cycles of the stock market and reflect the nature of value investing. At the market's peak in 2007 only one of the Top 20 stocks boasted a positive recommendation from Intelligent Investor. A few years later when prices were more attractive, that number had shot up to six. Today, following a strong rebound, it's back to two.

We're pleased with the results of our previous ranking and hope that they underscore the way that your portfolio might benefit from the process of casting a value investing eye over the nation's largest stocks. You'll find our latest ranking on page 5. But first, a few observations from the results of the past seven years.

Lessons from 2007's ranking

What lessons can we learn from the results of our previous Top 20 ranking? Firstly, it's noteworthy that we missed the best-performing stock in our top five selections, but doing so didn't do us any harm.

CSL has returned a stellar 159% over the past seven years. It's a strong player in a global market which means it had, and continues to have, more growth potential compared to the likes of a big bank or a large retailer like Woolworths, all of which face a tough choice between a mature domestic market or international expansion into countries where they don't possess an obvious competitive advantage.

The nature of CSL's business also means it has more optionality. For instance, it has the potential to develop tremendously valuable products like its HPV vaccine, Gardasil. With an annual research and development spend approaching half a billion dollars, there's always the chance of discovering another blockbuster drug.

Takeovers were another theme driving performance. Both Coles and St George were in the second half of our value-based ranking but ended up being top-half performers thanks to takeovers by Wesfarmers and Westpac, respectively.

At the time Coles was playing second-fiddle to Woolworths, to the point where some analysts were questioning whether an unassailable gap was opening up between the two groups. And St George, like its regional peers, was finding it an uphill battle against the majors.

We have to be careful about the lessons we draw from these stocks, though. Suncorp was a poor performer which might have been rescued by a St George-type deal but wasn't. In short, we'd never recommend an investment on takeover potential alone. It would have to come as icing on an already attractive cake.

The results also highlight the dangers of acquisitions, which played a role in all three of the worst performing stocks.

QBE Insurance had been acquisitive, and successfully so, for many years. But a combination of a couple of lessthan-spectacular acquisitions, a turn in industry conditions and record low interest rates conspired against it.

In 2007, investors were paying more than four times book value for a company that had just posted a return on equity of 26.1%. In 2014, after two consecutive years of 7% returns on equity, investors are now paying less than 1.2 times book value. The true long-term value and returns on equity likely lay somewhere between those figures.

If QBE was partly savaged by a string of acquisitions, Rio Tinto and AMP were felled by single, large transactions. Both demonstrate the reason we've always been sceptical of such moves.

Depending on your view, Rio Tinto's Alcan acquisition was either ill-timed, ill-conceived, or both. Long the custodian of a counter-cyclical culture, the company's board performed a volte-face and authored this signature

5

Special report

Not a single member of the big four banks has made our Top five this time around.

top-of-the-cycle deal. It was an ugly ride down the far side of the `commodities super-cycle' boom-time slope.

AMP's acquisition of arch-rival AXA was driven by a combination of hubris and over-optimism. The price paid demanded ambitious assumptions that conservative investors shouldn't have swallowed. Throw in a `challenged' business model involving skimming fat fees from less sophisticated clients who are gradually waking up to their alternatives and you can see why it was in a close race for last place.

Those are essentially the same reasons which drive the company's rating in this year's ranking. The business challenges remain and the dilution caused by issuing so many shares to former AXA shareholders will weigh heavily for many years.

Australia's Top 20 stocks ranked by investment attractiveness

While we currently only have a couple of Buy recommendations, a few Sells and a preponderance of Holds among the Top 20 stocks, the 2007 exercise shows the value in identifying which companies are more attractive from a valuation standpoint, beyond the gradations of a simple recommendation.

Two years ago we also had Macquarie Group, QBE Insurance and Origin Energy on the list of Top 20 stocks sporting Buy recommendations. But with the All Ordinaries index up 34% since then, value investors should expect slimmer pickings, which is exactly what we find today.

Two years ago, a quarter of the Top 20 stocks offered good value for investors. Today, the figure is just 10%. Just two stocks ? Santos and Woolworths (and we're even pushing things here as the giant retailer is trading a little above our official Buy recommendation price guide) ? are on our Buy list.

At the other end of the scale, we have Sell recommendations on AMP, ANZ Bank and Brambles. AMP has the dubious honour of being at the bottom of the table this time around while also being ranked 19th out of 20 in our previous list. Given it's down 26% over the past seven years, including dividends, it's been an horrendous performer.

We don't expect the next seven years to be as bad for AMP shareholders but we simply can't get behind a company that seems mired in a dated business model and bears all of the problems of corporate indigestion that inevitably come from swallowing your largest competitor.

You might also note that not a single member of the big four banks has made our Top five this time around. That's in stark contrast with seven years ago when Westpac, Commonwealth and ANZ occupied three of the Top five places.

On the other hand, four resources-exposed groups have made our Top five this year, compared with a big fat zero in 2007. That was the right call, incidentally, with every one of the resources stocks in the 2007 Top 20 delivering a below average return over the ensuing seven years.

We're also mindful that CSL just missed a place in this year's Top 10 and, for the reasons discussed on page 4, could easily be a standout performer again.

Table 2: Top 20 stocks ranked by value

Rank StockCode Most recent reviewReco. & price ($)Current price ($)

1 Santos

STO

27 Feb 14

Buy ? 13.72

14.55

2 Woolworths

WOW

3 Mar 14

Buy ? 36.07

37.51

3 Origin Energy

ORG

24 Feb 14

Hold ? 14.66

15.41

4 Rio Tinto

RIO

17 Feb 14

Hold ? 69.46

60.07

5 Wesfarmers

WES

20 Feb 14

Hold ? 42.89

43.53

6 Telstra

TLS

13 Feb 14

Hold ? 5.16

5.38

7 QBE Insurance

QBE

15 Apr 14

Hold ? 12.00

11.32

8 BHP

BHP

21 Feb 14

Hold ? 39.28

37.49

9 Woodside Petroleum* WPL

25 Feb 14

Hold ? 37.99

42.00

10 Commonwealth Bank CBA

19 May 14

Hold ? 80.40

82.05

11 CSL

CSL

13 Feb 14

Hold ? 66.98

70.76

12 Macquarie Group

MQG

26 May 14

Hold ? 59.87

60.33

13 Westpac

WBC

19 May 14

Hold ? 34.28

34.52

14 Westfield Group

WDC

21 May 14

Hold ? 10.92

10.85

15 NAB

NAB

19 May 14

Hold ? 33.49

33.41

16 Suncorp

SUN

27 May 14

Hold ? 13.42

13.36

17 Insurance Australia Grp IAG

10 Jan 14

Hold ? 5.85

5.94

18 Brambles

BXB

12 Sep 13

Sell ? 8.88

9.61

19 ANZ Bank

ANZ

19 May 14

Sell ? 30.56

33.73

20 AMP

AMP

10 Jul 13

Sell ? 4.40

5.30

Sell price ($) Above 20.00 Above 50.00 Above 20.00 Above 80.00 Above 50.00 Above 6.00 Above 15.00 Above 50.00 Above 45.00 Above 90.00 Above 75.00 Above 75.00 Above 40.00 Above 12.50 Above 40.00 Above 15.00 Above 6.00 Above 8.00 Above 25.00 Not provided

Buy price ($) Below 15.00 Below 36.00 Below 14.00 Below 55.00 Below 35.00 Below 4.25 Below 11.00 Below 30.00 Below 30.00 Below 55.00 Below 45.00 Below 40.00 Below 22.00 Below 9.00 Below 22.00 Below 9.00 Below 4.00 Below 5.00 Below 18.00 Not provided

*Woodside Petroleum was downgraded to Sell on 2 Jun 2014, subsequent to this rankings finalisation.

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download