The market’s blinkered view on sectors is a recurring source of opportunity. When the economy slows, avoid retail at all costs, say the commentators. When rates rise, avoid listed property. When rates fall, buy tech and other growth stocks.
That’s nonsense. Yes, investors should always assess industry conditions and factor them into company earnings growth and valuations. But buying or selling sectors based solely on simplistic top-down commentary about sectors destroys capital.
In Factfulness, the late great Dr Hans Rosling warns of the ‘single perspective instinct’. That is, we are attracted to simple ideas that help us feel like we understand something.
As an aside, Rosling’s book is a favourite of mine. It’s about global trends, not investing. But the 10 traps Rosling identifies are rife in financial markets. Chapter eight on the single perspective is a standout. Beware simple ideas and solutions, warns Rosling.
In investing, these ‘simple ideas’ are often top-down market or sector forecasts – or noise, as I call them. These forecasts are so often wrong, yet we trust so-called experts (even central banks) that offer a single perspective from their field of expertise.
You might think I’m doing myself out of a job here. My role is to highlight interesting ideas for investors to do their own work on or talk to their adviser about. If you rely on one expert – a single perspective – for never-ending winning ideas, you’ll be disappointed.
I favour company analysis over top-down forecasts. That’s not to say sector trends or themes aren’t important. I like some thematic ETFs that provide exposure to trends, such as healthcare, which are not easily accessible in this market.
But when investing, treat each company on its merits. Favour bottom-up rather than top-down analysis. Good and bad companies exist in every sector and a small group maintain performance in all market conditions.
Most of all, focus on valuation. That is buying high-quality companies when they trade at bottom-quartile valuations, often because of crazy, erroneous top-down forecasts and other silly market noise that distracts investors.
Take retail as an example. A slowing economy is bad for retail sales and earnings growth. That’s true, but a slowing economy also creates opportunities for savvy retailers to snap up prime sites, renegotiate contracts or buy failed competitors.
Moreover, valuations of retail stocks already reflect slower future earnings growth. As investors are swayed by today’s market hysteria about retail woes, they drive prices too low. That creates an opportunity for long-term investors.
I highlighted some attractive retail opportunities in last week’s column, notably Lovisa Holdings, which is growing through rapid store openings, and Nick Scali, the well-run furniture retailer on a low Price Earnings (PE) multiple by its standards.
I have also highlighted a few interesting niche A-REIT opportunities in this column. Granted, higher interest rates hurt the sector, but some A-REITs are trading at too large a discount to their Net Tangible Assets. The market expects bigger falls in the valuation of underlying properties in A-REITs than current transactions in direct property indicate.
Transport is another example. Cyclical transport companies look like the last place to invest when the economy flirts with recession. Slowing growth means less demand for transport and logistics. Add to that rising fuel costs, higher wages, labour shortages, higher insurance costs … the list of transport threats is long.
Yet I keep finding interesting small-cap transport stocks. One I have written about a few times over the past few years – Lindsay Australia – has soared this year. Lindsay has benefited from the insolvency of Scott’s Refrigerated Logistics.
Expect to see greater consolidation in the fragmented transport sector over the next few years as baby-boomer owners approach retirement. Some will sell to larger listed players, unable to find a trade buyer, or get their kids to run their business.
Here are two small-cap transport stocks to consider:
- Alliance Aviation Australia (ASX: AQZ)
I’ve written favourably about the provider of contract and chartered aviation services a few times in this column over the past few years. Alliance rallied threefold in 2020 and into early 2021 but has given back some of those gains.
Eighteen months of delays and disappointments with its aircraft delivery have weighed on Alliance’s share price, as did complications with Qantas’s bid for the company, which the Australian Competition and Consumer Commission (ACCC) this year rejected.
As Alliance’s expanded fleet finds its way into service and new pilots of those aircraft are trained, the company’s earnings growth will quicken.
Alliance could earn over more than $100 million in FY24, based on extrapolating its growth from the recent trading update (it expects to earn about $57 million in FY23, most of that in from the second half). If that earnings growth is achieved, Alliance is on a forward PE of about eight times – or less than half the average small industrial multiple.
There’s also the possibility that Qantas appeals the ACCC takeover ruling. Qantas’s original scrip bid was priced at $4.75. Alliance now trades at $3.26, having been boosted recently by a positive trading update.
Still, Alliance is down from a 52-week high of $3.67. Beneath the gloom, the market is overlooking the full effect on Alliance’s earnings as more of its new planes enter service. That’s what happens when investors are distracted by top-down sector noise.
I note some good small-cap judges, such as the Prime Value Emerging Opportunities Fund, are positive on Alliance.
- Maxiparts (ASX: MXI)
I’ve followed Maxiparts on and off for years, mostly when it was known as Maxitrans. In July 2021, the business changed its name to Maxiparts after it sold its truck-trailer manufacturing business to concentrate on parts supply. That was a smart move.
The share price initially rallied on the deal, but Maxiparts gave up those gains last year, Like many micro-caps, Maxiparts struggled to attract the market’s attention.
Truck and trailer parts are an interesting business. As the economy slows, there are more trucks on the road than ever. We can thank population growth for that.
Supply-chain disruptions during COVID-19 made it harder to source new trucks. Greater use of older trucks means more wear and tear – and parts demand.
Moreover, as fuel, wage and other costs rise for trucking companies, it’s a good bet they will have to work their fleets even harder. Again, that should mean solid demand for truck and trailer parts that Maxiparts supplies and rising earnings growth for it.
As Maxiparts grows and builds larger economies of scale, its profit margins should expand. Maxiparts’ margins are a long way behind Supply Network, a star supplier of transport parts in the past few years.
NAOS Asset Management, a specialist investor in small- and micro-cap companies, has a significant position in Maxiparts. I can see why. Key suppliers of truck parts should benefit from rising demand in the next few years as there are more trucks on our roads, and as older trucks (outside the original-equipment manufacturer warranty) need parts.
Capitalised at $126 million, Maxiparts suits experienced investors who understand the features, benefits and risks when investing in thinly traded micro-caps.
Risks aside, Maxiparts has solid long-term prospects to grow organically and via small bolt-on acquisitions in its industry.
Elsewhere, Infomedia, in the auto-parts catalogue business, is another small-cap worth watching. I’ll have more to say on Infomedia in a coming column.
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at July 26, 2023.