Investing legend Warren Buffett said to “be greedy when others are fearful”. Or as the 18th century British nobleman Baron Rothschild put it: “buy when there is blood on the streets”.
Both billionaires referred to contrarian investing. That is, buying stocks when they are undervalued because of panic selling. And selling overvalued stocks when hype abounds.
That is easier in theory than practice. When bad news abounds, many investors struggle to believe a company will turn around. Conversely, when a company continually stars, investors extrapolate their bullish expectations too far into the future.
This is greed and fear in action – those two great investing emotions that wreck portfolios. We hold on to high-performing stocks too long because we want to make more money. And sell undervalued companies at the bottom when fear sets in.
It takes great discipline and nerve to overcome these emotions. My strategy to do so is twofold. First, focus on valuing companies and determining how their price compares to their fair value. Don’t try to second-guess where the stockmarket is headed. That’s a mug’s game.
Second, avoid market noise or at least have strong filters to block out flimsy reports that encourage bad decisions. Watching pay-TV business channels, for example, can do your investing head in as one expert says buy and another says sell five minutes later.
The company’s share-price chart is the best gauge of market sentiment and a guide to where investors resist and support price movement, although not an infallible one.
Consider how fear is affecting automotive-related stocks and creating emerging opportunities in the sector. New car sales in Australia are tumbling as the economy slows and consumers, battling high household debt and stagnant wages, defer large purchases.
The new vehicle market has had 11 successive months of negative growth and is back to where it was five years ago. New car sales slumped 14.9 per cent in December compared to the same month a year earlier, according to the Federal Chamber of Automotive Industries.
Investors believe the carnage has further to run. As national house prices fall, consumers feel poorer (the “wealth effect”), so cut back spending. Reserve Bank Governor Philip Lowe recently said cars and furniture were the main spending casualties from lower house prices.
It’s a no-brainer that consumers who are struggling with low wages growth will keep their current car longer before buying a new one. They’ll give up large discretionary purchases before they stop having a short holiday, eating out or cancel gym memberships.
Analysis of automotive-related stocks shows the damage. Car dealership Automotive Holdings Group has a one-year total return (including dividends) of negative 42 per cent. Luxury car dealer Autosports is off 35 per cent and Motorcycle Holdings has fallen 55 per cent.
It’s still too soon to buy these stocks – or be “greedy”, as Buffett puts it. Granted, the auto retailers look cheap but might get cheaper yet as car sales tumble. Expect the national house-price correction to quicken in 2019, taking new cars sales down with it.
There are better ways to play the auto sector. My preferred exposure is online advertising platform Carsales.com, the dominant online advertiser for new and used car sales.
Once a market darling, Carsales.com has fallen from a 52-week high of $16.45 to $12.50 – a big fall by its standards. The market could not get enough of leading online platform companies (Seek, REA Group and Carsales.com) a few years ago and they traded on large valuation multiples.
Carsales.com is not immune to the downturn. It reported a weaker-than-expected first-half result for FY19 and its shares tumbled. Profits from the company’s finance division, a smaller part of overall EBITDA, collapsed as fewer consumers bought cars and borrowed to do so.
I always break trends into structural and cyclical, when assessing companies. Those facing structural pressures – such as newspaper classified ads moving online – are best avoided. Combine that with a cyclical downturn – less advertising in a slow economy – and it can be fatal.
Carsales.com’s structural story is firmly intact. Its platform is by far the dominant provider of new and used car sales ads and customer leads for dealerships. Facebook, Gumtree and other sites have tried to take market shares from Carsales.com with mixed success.
Another structural driver – the migration of car ads from print to online – still has a long way to run, supporting Carsales.com’s long-term growth. That is also true for REA Group through its realestate.com portal and Seek in the job advertising market.
Third, Carsales.com’s technology and business model is highly scalable overseas to markets that are just starting their migration to online car advertising. Carsales.com’s international operations are growing strongly, albeit off a low base.
The cyclical story for Carsales.com over the next 12-18 months is tough, but not all bad. Talk is growing that the Reserve Bank will cut interest rates twice in 2019 to prop up Australia’s slowing economy. That should slow the pace of house-price falls and stabilise the market.
Carsales.com could benefit from higher volumes of used-car advertising as consumers gravitate to cheaper cars, and dealerships will be desperate for customer leads. It’s also possible that more consumers sell cars directly through Carsales.com than via a dealership, to achieve a higher price. That would boost its retail audience.
Do not expect a quick turnaround in Carsales.com’s market or operating performance, relative to expectation. The automotive market is severely challenged. But Carsales.com’s cyclical headwinds will eventually turn.
The key issue, as always, is valuation. At $12.50, Carsales.com is on a forward Price Earnings (PE) multiple of about 21 times FY20 earnings, consensus analyst estimates show. The stock has traded on a PE in the mid-20s for most of this decade.
An average share-price target of $14.34, based on the consensus of 10 analysts that cover the stock, implies Carsales.com is undervalued and offers a sufficient margin of safety to buy.
My sense is Carsales.com – and the auto sector generally – will worsen before it improves, so prospective investors need to be able to tolerate short-term losses.
Nobody knows when the bottom for Carsales.com stock will arrive, but investors who wait for clear signals of a recovery in the auto market will miss the best part of the rally.
As Buffett said, buy when others are fearful. It’s hard to think of a time this decade when investors were more fearful of the outlook for car sales and automotive stocks.
Chart 1: Carsales.comSource: ASX
• 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 March 12, 2019.