The best stock ideas for the next five years

Broker reports and newspapers are full of investment ideas and stock tips. They have their place, but look closely and you’ll notice many recommendations are based on 12-month price targets and designed for institutional investors with a shorter-term outlook.

Rarely do you see recommendations designed for investors with a five-, 10- or 20-year outlook. Of course, it is impossible to value stocks so far into the future and, as the Global Financial Crisis showed, a passive buy-and-hold strategy can be dangerous in volatile markets.

But there is arguably too much “bottom-up” investment coverage on stocks or funds when what matters most for long-term investors is nailing “top-down” trends. Evidence abounds that choosing the right asset-allocation strategy is more rewarding than stock picking in the long run.

Moreover, identifying powerful industry trends and thematic ideas that will run for years, and positioning portfolios to benefit, can be rewarding.

The next big things

Consider some of the most powerful long-term trends. The move from print to internet advertising was no secret, yet many investors avoided stocks such as REA Group, Seek and Carsales.com because they looked expensive on Price Earnings (PE) multiples. Or they sold these stocks far too early.

The ageing population is another no-brainer. SMSFs that bought high-quality healthcare or property stocks leveraged to an ageing population have mostly done well. Yes, stocks such as Ramsay Health Care look fully priced, but they have huge demographic tailwinds behind them.

I believe an ageing population is one of four key demographic or social trends that will profoundly affect investment markets in coming decades. The others are: incredible growth in middle-class consumers in Asia and other emerging markets; the urbanisation of capital cities in developed nations; the continued move to a services economy; and the effect of digitisation on business models.

What happens when the number of Asian middle-class consumers increases by about sixfold to 3.2 billion by 2030, according to forecasts in the Australia in the Asian Century whitepaper? Or when the Sydney and Melbourne populations almost double by 2050, creating even stronger demand for new buildings, transport infrastructure, and extra space in the suburbs as more people live in apartments?

Or when products become increasingly commoditised, bought for the lowest price online, and we spend even more time and money on services? Or when the “internet of things” and other technologies radically reshape business models (as has happened already), creating new online services?

I could go on with these and other trends. But the point is: SMSFs need an eye on the most powerful trend that will run for years and decades – not the next quick idea, unless they have an active investment approach or are trying to outperform the market through trading.

What the pros say

With that in mind, I asked three professional investors to name key trends investors should watch over the next five years and beyond – their “foresight” idea. The twist was they also had to name a trend they had missed in the past five years – their “hindsight idea”. Although it sounds easy, buying stocks based on trends can tricky because the valuation usually captures the early part of the trend.

Sebastian Evans
Managing director
NAOS Asset Management

Foresight: Infrastructure and construction stocks are interesting. Think about the amount of money that needs to be spent in the coming decades to replace ageing infrastructure in capital cities as the population grows. We’ll need better rail, road and other utility infrastructure. Construction stocks such as Transfield Services, Leighton Holdings and Lend Lease Group could be entering a sweet spot. Transfield is our preferred pick. This trend has a long way to run.

Another favoured trend is traditional media. We feel the media industry might have just got over the “hump”, with a few newspapers overseas kicking goals as investors pay for content online. I expect more newspapers to focus on premium content and for more consumers to accept they have to pay for such content online. After so many years of pain, the media industry might do better than many realise in the coming decades, from current valuations. Our preferred picks on valuation grounds are Ten Network Holdings and APN News and Media.

Hindsight: Many investors underestimated how much the market would pay for dividend “yield”. Most stocks with high, reliable yields now trade on excessive valuation multiples. But investors have been willing to pay much more for yield because there are few alternatives, given record-low interest rates. This is a dangerous trend that will turn around at some point, creating significant capital losses that quickly wipe out the benefits of a few extra points of yield.

Nathan Bell
Research director
Intelligent Investor Share Advisor

Foresight: The recapitalisation of western banks will be one of the great trends this decade. After being decimated during the GFC, US banks have recapitalised and the same trend is emerging in Europe and the United Kingdom. At the same time, the US, European and UK economies are slowly improving, which is helping their local banks. We think Australian banks are expensive and that select offshore banks such as the Bank of Ireland and Bank of America Merrill Lynch offer better value. Obviously, to capitalise on this trend you must be willing to invest offshore.

Another key long-term trend is the move to online shopping. As with the recapitalisation of western banks, the best opportunities to play this trend are in overseas stocks such as United Parcel Service, Inc and FedEx Corporation. It is hard to get pure exposure to the move from traditional retailing to online retailing via the Australian sharemarket. UPS and FedEx are incredible businesses with dominant market positions. Yes, they are expensive, but both will benefit from the trend in online shopping, and the need to transport goods bought on the internet. This trend will last for decades.

The move from internet advertising to mobile advertising on smartphones is another long-term opportunity. Again, the best opportunities are overseas: Facebook Inc, for example. We also think the big internet stocks in Australia, REA Group, Seek and Carsales.com, will have a lot more staying power than many people realise. The market may not have fully valued their potential to expand overseas and build big offshore businesses, as was the case with Seek’s investment in China. Or their potential to disrupt markets in other ways, such as REA one day displacing real-estate agents.

Hindsight: We missed the strength of the Australian housing market after the GFC. We thought the housing market would come under intense pressure, as was the case overseas, and that it would weigh on housing-related stocks, such as REA Group. More costly, though, was underestimating the pricing power that REA Group had over real estate agents who have been spending more money to distinguish their advertisements. This meant REA Group didn’t need to sign up many new agents to rapidly increase profits. This stopped us from buying REA Group, which has been an exceptional performer.

Angus Geddes
CEO
Fat Prophets

Foresight: I am bullish on India and have allocated about 25% of my SMSF to opportunities there. India is about 10 years behind China, but has a lot of entrepreneurial energy, a rapidly growing middle class, and improving policy settings that will stimulate growth.

I remain bullish on Japan, having invested up to 30% of my SMSF there in 2009. That investment did little until 2012, when the Japanese market took off.

Although those gains have paused this year, the medium-term outlook is favourable. After 23 years of deflation and a bear market, the recovery in Japanese shares has a long way to run. I invested in Platinum Asset Management’s Japan Fund, which outperformed its benchmark index.

I have also become more bullish on China, and expect an explosive rally in Chinese stocks in the next six to 12 months. Despite its strong economic growth, China’s sharemarket has underperformed developed markets since 2007. Its sharemarket appears to be “rebasing” (using technical analysis) and at some point this year it will have to catch up to China’s economic outlook, which is not as bad as many feared. In my view, the supposed slowdown in China is last year’s story.

Hindsight: I underestimated the strength in small- and mid-cap telecommunication stocks. We had some telcos in the portfolio – M2 Group, Amcom Telecommunications and MyNetFone, but not enough. Partly, it was because I moved a lot of SMSF assets in 2009/2010 to capitalise on opportunities in undervalued offshore markets.

Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at June 13, 2014

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.