Australian reporting season - the expensive become more expensive - Milford Asset

Australian reporting season – the expensive become more expensive

Roland Houghton

Investment Analyst

Roland joined Milford in May 2016 as an Investment Analyst in the Sydney office. His role at Milford is to research, meet and analyse a range of companies to identify potential opportunities. He is based in the Sydney office. Roland graduated from Victoria University of Wellington in 2014 with a Bachelor of Commerce, double majoring in Finance and Marketing. During his studies he worked at GMI in their KiwiSaver department, and after completing his degree, Roland worked as a junior Portfolio Manager at a boutique funds management company based in Sydney.

Reporting season in Australia has come and gone and although there are similarities year to year, there are always some unique and interesting outcomes. The most spectacular of which this year was the strength in the more expensive companies.

The absolute return in some high growth companies was astounding. Several rallied despite reporting disappointing results – two of these, WiseTech (WTC.ASX) and Altium (ALU.ASX), were particularly interesting.

WiseTech’s earnings result before interest, tax and depreciation (EBITDA) for FY19 came in roughly 6% below the market’s consensus estimate. Now, WiseTech is a great company but considering its valuation prior to the result (and hence the market’s expectations), you would expect reporting earnings below the market’s consensus estimate would have been taken poorly and reflected with a drop in their share price. However, this was not the case with WiseTech’s share price jumping 27% on the day. WiseTech now trades on a 93x price-to-earnings ratio (P/E Ratio)! In other words, investors are willing to pay $93 for every $1 of earnings from WiseTech. This is up from about 73x before the result, representing a whopping 28% expansion.

WiseTech Share Price vs Forward Earnings Multiple

Source: Factset

Altium, which missed the market’s consensus earnings estimate by about 6%[1], saw its share price rally by 31% on the day. It’s P/E ratio is now 45x which is about 13% higher than prior to the result. Both companies talked-up their longer-term opportunities which was well received by the market.

When analysing the top and bottom performers for the ASX 200 through August this trend of expensive stocks outperforming is clear. The share prices of the 10 strongest companies appreciated by an average of 31% with their P/E ratio expanding by a massive 28%.

Source: Factset

Source: Factset data with Milford analysis

In some cases, as shown below, the P/E ratio expansion was greater than the share price performance. This indicates analysts reduced their expectations for next year’s earnings. According to JPM Research, the top quintile (by P/E) of companies saw 9.6% average share price rises even though earnings-per-share (EPS) actually decreased by 3.9%.

Source: Factset data with Milford analysis

One of the possible explanations is what’s called ‘short covering’. Short selling a stock is where an investor tries to benefit from the share price falling. They do this by borrowing a stock, selling it and hoping to buy it back at a lower price. The short interest (the % of total shares in a company that have been short sold) in some of the best performing stocks for August was quite elevated leading into reporting season. However, short interest dropped rapidly as people bought back the shares they had short sold as they tried to mitigate their losses (short covering). This increase in buying activity added to the upward share price momentum (see charts below). Now admittedly P/E ratios are not the best way to measure the value of rapidly growing technology companies and there were other factors at play as I mentioned, but what’s clear is the market (i.e. investors) are willing to pay more for uncertain future earnings, despite current earnings disappointing.

Although we believe it’s important to have some exposure to those we deem the highest quality of these expensive companies, it’s paramount in heated markets to remain focused on business fundamentals rather than getting caught up in the hysteria and momentum of the market.

Disclaimer: This is intended to provide general information only. It does not take into account your investment needs or personal circumstances. It is not intended to be viewed as investment or financial advice. Should you require financial advice you should always speak to an Authorised Financial Adviser. Please note past performance is not a guarantee of future performance.

Disclosure of interest: Milford Funds Ltd. holds shares in WiseTech Global as well as several of the companies in the above graphs on behalf of clients.  

[1] Sourced from Factset

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