Who’s afraid of high share prices? They might be good for you
How many times have you been told to look for lowly valued stocks and ignore the ones flying too close to the sun? Here’s why that’s wrong and some soaring ASX options to consider.
Years and years of market observations on top of my own research and analysis have taught me one very important lesson: there’s no one size fits all when it comes to investing and putting a valuation on shares.
The second important lesson I’d like to add is that rules and principles change over time … and most people don’t like change.
From the moment I started to research the highest quality and better performing stocks on the ASX, I ran into the everyday dilemma investors face: according to the commonly quoted general rules we should all be looking for lowly valued stocks and ignore the ones on high multiples, because buying “cheaply” is the ideal starting point for long-term returns.
Except this isn’t the case.
What actually happens in share markets is more reliable, better quality businesses are rewarded with a premium valuation and they still outperform their lower priced peers who might enjoy their moment every now and then: But overall offer a much shakier track record because they don’t have a ‘moat’.
They are also much more dependent on the economic cycle, or more often pay out a meaty dividend instead of investing in future growth avenues.
You don’t have to take my words for it, but I invite you to compare the long-term track records of the likes of TechnologyOne (TNE), Hub24 (HUB), Aristocrat Leisure (ALL), Xero (XRO), REA Group (REA), Car Group (CAR), et cetera with companies that are trading on much cheaper valuations such as Aurizon Holdings (AZJ), Helius (HLS), Lendlease (LLC), Ramsay Health Care (RHC), and many, many others.
But what about cheap stocks
Do those ‘cheaper’ alternatives catch a favourable wind every now and then? They most certainly do. But they’re not fit for a marathon, which, in my view, is what investing is all about.
The key hurdle for any investor who considers venturing into the higher quality segment of the Australian share market is almost without exception the higher valuations on display; either vis a vis peers in the same sector, or in comparison to peers offshore, or simply because of a sizeable premium versus the rest of the market.
Unless you simply decide to close your eyes and follow market momentum during the good times, you’re never going to overcome this hurdle, except when you accept that markets have profoundly changed post GFC. We have to keep in mind how to value businesses that grow irrespective of the economic cycle, with capital-light requirements, recurring revenues, extremely high margins and overflowing with cash.
To the value investor it is nothing short of heresy to suggest a company trading on PEs as high as 100x can be a much better investment than their preferred hostage to the cycle trading on a single-digit multiple, but that’s exactly the experience from the past decade and a half.
One of success stories from that period, WiseTech Global, listed on 11 April 2016 and has seen its share price multiply by more than 30x times tor a total return of around 3000 per cent. Very important detail: the average PE multiple this stock has traded on is circa 75 times.
Note: not seven, not five, but SEVENTY-FIVE! Current multiples gp WiseTech are 108x on FY25 consensus forecasts and 75x on FY26 forecasts.
Tech bubbles
This is also the key reason as to why so many have been calling out ‘the greatest bubble of all time’ and the ‘everything bubble’.
I think those alarmist calls are misguided and wrong. For starters, modern day businesses are a far cry from their predecessors from the old economy past; they are a far superior breed, as also expressed through various key financial metrics.
Hanging on to old-fashioned valuation methods is most likely not the best way to deal with the changing environment, especially when a megatrend like Gen. Ai comes along.
Having said all of the above, as investors we also must acknowledge this year’s outperformers including Goodman Group (GMG), Pro Medicus, TechnologyOne, and others have enjoyed an exceptionally favourable environment in which not only the US market supported continuous investor interest, but frequent positive operational surprises have provided ongoing fuel for additional share price rallies.
At some point, you have to assume, things will become less straightforward and those share prices might yet again become more volatile. One observation to add is that higher PE multiples certainly attract more volatility, as has happened to all the companies mentioned at some stage in the past.
How to deal with this ‘risk’ is largely a personal choice. If you’re confident in the longer-term uptrend that is supporting the outlook for the companies you own, you may elect to simply let volatility run its process. Yes, at times it can be stomach-churning, and those bubble-critics on the sideline will make you feel extra-bad about it, but such is life in the share market.
One of the most valuable lessons I learned from the decade past is that it’s seldom a great idea to sell out completely of these great businesses, unless valuations have gone genuinely wacky, or the outlook has dramatically deteriorated.
Even then, how many times has everyone among us thought Pro Medicus is now really flying too close to the sun, only to be proven wrong, yet again?
Rudi Filapek-Vandyck is Editor of share market research service www.fnarena.com.au
