Your Quarterly E-Zine
Edition 11 • December 2019

This website contains the latest edition of Forsyth Barr Focus, a quarterly on-line magazine written by senior members of Forsyth Barr's investment team.

If you experience any difficulty in accessing Forsyth Barr Focus,
please call 0800 367 227, or e-Mail editor@forsythbarrfocus.co.nz for assistance.

 

AVOIDING THE VALUE TRAP

Everyone wants to invest in good companies where share prices grow over time. Unfortunately, with most of the focus on relative company valuations rather than long-term business attributes, it is easy to get caught in the value trap.

As part of our review of the New Zealand equity market we slice and dice it in a lot of ways. This means we can group companies with various attributes together. Looking at the performance of these over time is a reminder of why company attributes can be as important as any short-term valuation metric.

Average returns for companies that fit the “Value” criteria have performed in line with the broader market but “Cyclicals” and those with high “Financial Risk” significantly underperformed the broader market.

A better place to invest was among companies with “Structural Growth” characteristics. The average returns for companies fitting these criteria significantly outperformed all other thematics.

Thematic and Style Returns

Source: Forsyth Barr analysis, Bloomberg

A useful tool in finding companies that fit these criteria is using Dividend Grower Screens. These screens look for companies delivering consistently growing dividends because of growing earnings. (Companies growing dividends just by raising pay-out ratios are screened out once pay-out ratios exceed 80%). Accordingly, the screening process should highlight companies with longer-term competitive advantages that allow earnings growth to persist.

We know from modelling returns for the selections found using dividend growth and consistency, that this improved returns relative to market but at a cost of higher volatility. Adding additional filters of positive forecast earnings and positive Expected Total Returns (ETRs) mitigated the bulk of additional volatility without reducing the return up-lift.

Interestingly, investors shouldn’t be worried about the level of expected 12 month returns. Without this filter volatility was higher but so were returns.

Our model tries to reduce risk as much as possible so we settled for ETRs being greater than zero, but our reports also highlight those that just miss selection because of negative ETRs. Investors may be paying a little too much for the earnings streams but equally investors should keep these companies on the radar for when the price is right.

Simulated portfolio returns using different dividend growth criteria

Source: Forsyth Barr analysis Bloomberg

 

By Brian Stewart
Senior Analyst, Strategy

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