Question 1: I am confused by the performance of growth stocks which have nil revenue generation, do not make a profit, do not pay any dividend and/or have a business model that is based on the future commercialisation of a set of products currently under development. These companies appear to be speculative. Why would someone or an institutional investor buy this stock?
Answer: Most growth stocks are priced on a multiple that relates to sales (revenue). The higher the growth rate in sales, typically the higher the multiple. The underlying assumption is that they will become profitable, and due to economies of scale and other efficiencies, improve their net return as they take on extra sales.
Profitability is not always the best measure. A company can choose to be profitable by choosing not to invest in the business. A company can choose to invest all the money it makes and more in the business, and through depreciation or by expensing the investment, is unprofitable.
Typically, growth companies are investing heavily in growing revenue and so are unprofitable. At some point in time, they will scale back on their investment (or hold it flat as sales increase), and then become profitable.
Recall some of the tech leaders such as Facebook, Amazon, or Google – which weren’t profitable, but are now highly profitable as their business matures.
Question 2: Woolworths (WOW) is to launch the hotels business mid-year .Have you any insight as to how this may affect the WOW share price ? Would it be a sound move to purchase more WOW prior to listing of the new company?
Answer: I think the divestment of the Endeavour Drinks business (Dan Murphy’s plus Australian Hotels) is one of the reasons Woolworths has been doing well. It has comprehensively outperformed Coles over the last few months. It is not the only reason: Woolworths is beating Coles in the supermarket business; BigW is firing; Coles is in the midst of a re-investment program: but it is one of them. Not only will the divestment potentially unlock “value” for shareholders, but Woolworths will come back on the list of stocks that some ESG focussed investors can buy. (The Australian Hotels business is a big operator of poker machines.)
Would I buy more Woolworths shares ahead of the announcement? Not sure, it is always hard to know what is “already priced in”. As the old saying goes, buy the rumour, sell the fact. The AGL divestment announcement was a good example of this – it rallied in the days ahead of the announcement, and then got sold off very hard. I would, however, buy Woolworths in preference to Coles.
Question 3: What are your thoughts on the future of TPG Telecom (TPG) with David Teoh leaving?
Answer: It is a significant blow to the company, and that’s why the share price fell around 10%. The stated reason is that after 30 years, it was “time to move on”, but not unsurprisingly, there is speculation that there may be other reasons such as a “clash of culture” with the new Vodafone team. It might be some months before we really know.
This all said, I think the merged TPG/Vodafone group has the most growth potential of Australia’s 3 major telco providers (the other 2 being Telstra and Optus). and I am sticking with the group. The analysts largely agree, with a target price of $8.00 implying 26% upside from the last price of $6.30. There is a concern that there may be a share overhang, if David Teoh or any of his associates look to reduce their holdings.
Question 4: For diversified Australian share exposure, do you prefer an ETF (exchange traded fund) or a LIC (listed investment company) such as AFIC?
Answer: It depends on the discount or premium to NTA (net tangible asset value) for the LICs. Over time, the major LICs such as AFIC (AFI), Argo (ARG) and Milton Corporation (MLT) have largely delivered index performance. Rarely outperformed. But crazily, they are trading at a premium to NTA – AFI 7.4% at 26 February and Argo 2.8%. With ETFs, you are guaranteed to get index performance, less a tiny management fee. Nothing more, nothing less. Right now, I would buy IOZ or VAS (index ETFs) in preference to any of the major LICs.
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 regard to your circumstances.