Buying big internet portal stocks during market corrections or sell-offs has been one of my favoured strategies over the past decade. The goal is buying exceptional companies when they are cheaper during irrational market sell-offs.
Seek, REA Group and Carsales.com are the go-to portal stocks. Like other blue chips, they were hammered earlier this week as global equity markets tumbled. REA, for example, shed almost 5 per cent from Friday’s close and Seek was down a few per cent (more on them shortly).
First, some comments on the market fall. I do not see this sell-off as an abrupt end to the global equity bull market and precursor to a bear market. Grizzly bear markets are typically associated with recessions and there is no sign of them on the horizon.
The world economy is expanding in a rare, synchronised period of global growth. The International Monetary Fund this year upgraded its growth forecast to 3.9 per cent, from 3.7 per cent. Other prominent forecasters have also lifted growth predictions.
The United States economy is humming. Massive tax cuts will support the US economy over 12-24 months and greater infrastructure spending is a medium-term tailwind. If anything, the US economy is revving a little too hard – the bears fear that rising wages growth will translate into higher inflation and more interest-rate rises than the market expects.
Still, it’s hard to see a sustained bear market against this backdrop. That does not mean the market is immune from savage corrections or bursts of volatility when valuations run too far. But corrections without recessions tend to be shallower and shorter.
Moreover, it’s likely that much of the heavy selling in global equities was sparked by algorithmic, computer-based programs rather than a reaction to economic news or company fundamentals – a point the US Federal Reserve noted. The rise of algorithmic trading and index funds is an unknown risk for global equity markets when investors rush for the exits.
Although markets bounced on Tuesday night (our time), I’m not convinced the sell-off is over, that volality will subside quickly and that it is business as usual for the bull market. Or that the correction is the simple, “healthy flush out” that markets need to advance higher.
Two days of heavy selling are not sufficient to bring the US equity market, which has been on a tear in the past 12 months, into equilibrium. US equities are still badly overvalued, meaning further corrections and volatility spikes are likely.
That will translate into more sell-offs and possibly a correction (10% fall from the previous peak) in Australian equities. It’s too early for aggressive bargain hunting, although taking advantage of market weakness to start building positions makes sense.
Put another way, re-enter the sharemarket slowly and cautiously. Watch and wait for better value over the next few months. Don’t buy in one go, believing the selling is exhausted.
Internet portals are good place to start for long-term growth investors. REA Group, Seek and Carsales.com are great companies. They have delivered high return on equity over many years, have capital-light business models, fat margins and strong market positions. The problem is not performance or quality: its valuation. The portals usually look dear.
Investors focus on simplistic valuation metrics, such as Price Earnings (PE) ratios, and assume the big internet portal stocks are out of reach. But a forward PE of about 33 times FY18 for REA group recognises its growth prospects and its justified valuation premium.
REA Group is my pick of the portals. The owner of realestate.com.au has fallen from a 52-week high of $81.10 to $70.40, despite reporting a first-quarter FY18 result in January that beat market expectation. REA was due for a pullback after soaring from $50 in early 2017.
The bear case for REA is based on rising interest rates, here or overseas, sparking a property downturn, which in turn leads to lower listing volumes and advertising on realestate.com.au.
Certainty, rising bond yields in the US would increase the cost of capital for Australian banks. They would pass it on through higher interest rates to local borrowers. A 50 basis-point increase in rates, outside rises in the official cash rate, would hurt heavily geared borrowers.
I expect flat property prices in Sydney and Melbourne (for houses) in 2018 and an orderly slowdown in the national property market. Local interest rates are unlikely to rise much this year, if at all, and never-ending hype about a proprety crash is nonsense.
Some inner-city apartment markets (ie Brisbane) are a worry, but the conditions for a property crash (sharply higher interest rates and rising unemployment) are not here yet. I cannot see a big fall in advertising listing volumes crunching REA’s earnings and valuation.
Moreover, if listings contract, REA might exploit its pricing power – a strategy it has used successfully in the past. That is the great strength of leading portals: the “network effect” of their site gives them latent pricing power. Real-estate agents might not like REA lifting advertising rates, but they miss a huge chunk of prospective home buyers if they avoid its site.
Chart 1: REA GroupSource: The Bull
Seek, too, has long-term merit. A pick-up in ANZ’s job advertisement series is a good trend for employment websites. One can envisage companies spending more on advertising to recruit talent as the labour market tightens this year.
But at the current price, Seek still looks a little overvalued, its stock trading above the consensus target ($17.24).
Chart 2: SeekSource: The Bull
Meanwhile, Carsales.com reported a half-year FY18 result this week broadly in line with market expectation, headlined by 27 per cent growth in net profit.
But the stock shed 3 per cent on the news in a rising market (on Wednesday) in what looked like an overreaction. Some brokers downgraded their recommendation on Carsales.com from buy to hold, on valuation grounds.
The fall has brought Carsales.com closer to value territory. It’s $13.92 price compares to Morningstar’s $13.70 valuation and the consensus price target, based on the average of 14 firms, of $14.33.
Rarely do the big portals trade below the consensus target for too long.
Chart 3. Carsales.comSource: The Bull
• 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 you should consider the appropriateness and accuracy of the information, 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 Feb 7, 2018.