Opportunities in Australian stock market despite likely pullback says Dalton Nicol Reid

Jamie Nicol

The strong run in the first quarter of 2015 has left many investors questioning whether Australian equities have run too hard and are too expensive, says Jamie Nicol, Director, Dalton Nicol Reid.

The key dilemma for the Australian stock market remains that of valuation, but there are still attractive investment opportunities available said Mr Nicol.

“Certainly the PE of the market at 16.3x is looking high by recent historic standards. However the dilemma for the market is that it has rarely looked cheaper relative to the current low bond yields and interest rates.”

“Given the size of the market’s move (11% year to date) a pullback is quite possible.”

“We tend to think most at risk are those segments where valuations look stretched – high yielding stocks and those which have experienced very strong share price momentum.”

Despite this we continue to find opportunities in a number of segments in the market.

We see key opportunities in the following sectors:

Growth stocks

Over the past year a number of higher quality companies with strong structural growth stories have been reasonably flat despite a strongly growing market. We have seen PEs compress as the market has chased higher dividend paying stocks. This leaves structural growth stories looking cheap.

Our preferred method for valuing growth stocks is via a DCF valuation. Lower interest rates support valuations on these types of stocks because much of the value for long duration growth stocks is in the outer years. The lower the interest rate, the greater the value when it is discounted back into today’s dollars.
Stocks which fit this category include Veda Advantage and Seek.

China exposed stocks

The market remains negative towards China yet it has been undergoing reform and loosening bank reserve requirements. While there is little evidence yet of a bounce in the Chinese economy, Chinese equities have been rallying in anticipation of an improvement.
We could see improved conditions later in the year in China which is likely to support those companies exposed to China. This includes some of the resources companies as well as tourism and education exposed companies.

Domestic consumer stocks

These companies have bounced this year but remain heavily shorted and will be cycling through a softer sales period in May / June. We are also seeing a lift in sales prices (due to currency) which should result in strong sales albeit with a lower gross margin percentage. A reasonable budget could see a strong 4Q.

“So despite the move in markets we continue to see selective opportunities and continue to see the low interest rates as likely to support the market in the event of a pullback,” he said.