Too many investors have a herd-like mentality with sectors. They avoid retail stocks when consumer spending is slowing; and media stocks when advertising volumes are falling.
They dump the banks amid concerns of weakening lending growth and rising regulatory risks; and global miners when it looks like global economic growth is contracting. Then they indiscriminately buy these and other sectors when conditions turn.
Basing investment decisions solely on top-down views is dangerous. Some firms excel when market conditions sour because they take market share off weakened competitors. Or buy them at fire-sale prices. Others struggle in growth markets because they cannot keep up.
Investors must judge every opportunity on its merits. The question is not whether retailers will struggle as consumers spend less and save more, but how much of that expectation is already reflected in the share price. A retail stock could be a screaming buy if its price falls too far.
That’s not to say sector views are unimportant. Self-Managed Superannuation Funds (SMSF) and other long-term investors have much to gain from long-term sector exposure. For example, adding exposure to global technology or lifescience stocks.
A sector view is especially important in cyclical industries. Extra care is needed when buying building-material companies at the top of the construction cycle or retailers when consumer spending is booming. But a sector view is one of many factors in the investment decision.
Consider the retail sector. Gloom about its prospects abounds. An unfolding correction in house prices will make consumers feel poorer and less inclined to spend. Rising utility bills, stagnant wage increases and the prospect of higher interest rates are other threats.
Then there’s the competitive impact of Amazon’s arrival in Australia – not as bad as initially feared but retailers would be foolish to be complacent about the ecommerce giant. Growing international competition and aggressive price discounting are other headwinds.
If one believes the bears, retail stocks must be avoided at all costs. Certainly, many have fallen sharply and I expect more discretionary retailers to go bust in the next few years. Smaller, traditional retailers do not have the capital to invest sufficiently in online transformations.
But blanket negativity creates opportunity for eagle-eyed investors. Jewellery provider Lovisa Holdings, for example, has fallen from a 52-week high of $12.53 to $6.75 amid the retail malaise.
I have written on the fast-fashion provider several times for The Bull this decade and it has been a cracking performer: the three-year annualised return (including dividends) is 47 per cent. But the stock has weakened this year, arguably too much, despite good operational progress.
Lovisa is an example of retailers less affected by the Australian housing downturn. For a start, it has 360 stores offshore and plans to open many more. Its disposable jewellery offering, aimed at teenage girls who buy instore, is less affected by house prices and online retailing.
Kogan.com is another retailer that defied sector trends before tumbling. The market could not get enough of it in 2017 and early 2018, its shares soaring fourfold. Kogan.com almost hit $10 in March 2018 despite fears that Amazon’s arrival in Australia would crimp its sales.
The stock looked badly overvalued at those levels, having run too far, too fast. Its share price fell when company founders attempted to sell stock on several occasions. Directors selling large parcels of shares – or signalling they want to – creates expectations of a stock overhang that weighs on the price.
A disappointing trading update in October 2018, blamed on GST changes and international competition, sent the share price to a 52-week low of $2.61 last year. Then, just as the market gave up on Kogan.com, its price soared to $4.20 after announcing record Christmas sales.
Kogan.com said active customer numbers increased 32 per cent to just over 1.5 million at the end of 2018. Other retailers would kill to expand their active customer base by a third in just 12 months and have strong Christmas sales (holiday sales, generally, disappointed in Australia).
It’s hard to see Kogan.com’s recovery continuing at the same pace given the retail malaise, ramp up of Amazon’s Australian operations and market concerns over the founder’s decision to unload shares. Kogan.com is not the market darling it was in early 2018.
But the company has a rapidly expanding customer base and growing product lines as it sells everything from pet insurance to electronic gadgets, mobile phone plans and white goods. Product diversification and the price appeal of Kogan.com’s branded products are attractive.
Kogan.com has shown it can grow quickly in a challenged industry and take share off competitors. As consumer spending slows amid the housing correction, it’s likely that the migration from bricks-and-mortar retailing to e-commerce will quicken as consumers chase online bargains.
A weakening retail market might play into Kogan.com’s hands both operationally and through its share price as investors avoid retail stocks. As a micro-cap, Kogan.com suits experienced investors who are comfortable with higher risks.
Chart 1: Kogan.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 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 February 6, 2019.