Tony Featherstone Columnist

Tony is a former managing editor of BRW, Shares, Personal Investor, Asset and CFO magazines. He writes a weekly column for BRW and The Australian Financial Review, specialising in small listed companies,IPOs, entrepreneurship and innovation.

View more articles from Tony Featherstone

How trend-trading can help avoid value traps

Published 04 June 2012 08:55, Updated 12 June 2012 05:06

+font -font print
How trend-trading can help avoid value traps

Buying time: Some sections of the sharemarket can look like a candy store Jennifer Soo

After heavy falls, some sections of the sharemarket can look like a candy store. A popular stock drops 20 per cent and its price-earnings (P/E) ratio falls and the dividend yield rises. You glance at the share price chart and buy the stock based on where it has been, rather than where it is going.

Then the company announces a profit downgrade, and another, and maybe another. The forecast single-digit P/E ratio was artificially low because it was based on rubbery earnings projections and next year’s dividend is certain to be cut. The sweet-looking stock becomes a portfolio jawbreaker.

Most investors, including me, have made that mistake. Don’t get me wrong: it often pays to buy high-quality companies after market corrections. For example, BHP Billiton and Rio Tinto look cheap after falling in May and I like the big bank stocks on single-digit P/Es and 7 per cent yields. But great care is needed employing this strategy with micro-cap and small-cap stocks.

I favour a different approach. Rather than look for the stocks that fall the most, seek stocks that rise in difficult markets. That approach will seem counter-intuitive to value investors who look for companies trading well below their intrinsic value during corrections. But chartists who use a trend-trading approach know the best approach is to “let the trend be your friend”.

I love spotting listed companies that do well in tough conditions but whose achievements are drowned out by a volatile market. Think of it this way: if a small company is making gains in a troubled sector and its share price is trading near its 52-week high in a bear market, what will it do when interest rates are cut again later this year and the economy strengthens?

A strong operating performance also says much about management. So often investors praise chief executives when their companies perform well in buoyant markets, when instead they should put a premium on management that performs through the cycles, the ups and downs.

To find outperforming stocks, I ran a simple data sort across the market with two filters: capitalisation of more than $50 million and a one-year total shareholder return of more than 100 per cent. Twenty-seven stocks out of the 2225 listed met that criteria. Two are stocks I follow and believe have further to run in the second half of this year.

The first is Maxitrans Industries. I covered this small transport stock in February when its shares were 46¢ and said it was due for a pause, which lasted barely a month before they shot to 60¢. Management upgraded profit guidance – yes, upgraded – in April. As one company after another downgrades guidance, Maxitrans goes against the trend in a weak market.

It also made two smart acquisitions and the chairman snapped up another 100,000 shares at 60¢ in May, which is often a sign that company insiders believe the shares are undervalued. Maxitrans’ spare parts business is going gangbusters as trucking companies replace ageing parts to keep up with the mining boom.

The other stock is Buru Energy, an oil and gas explorer and producer focused on the Canning Superbasin in the south-west Kimberley region of Western Australia. It is among the market’s most promising energy stocks.

Buru shares soared from a 52-week low of 60¢ to as high as $3.70, before easing to $3.17. Prospective investors may be put off buying into it after such big gains. It is speculative and only suits experienced investors comfortable with exploration stocks. It was spun out from the 2008 merger of ARC Energy and Australian Worldwide Exploration.

Buru’s Ungani oil discovery looks like a beauty and its gas projects are just as promising, which explains why there is talk that some global energy companies want to get involved. It may be possible to justify Buru’s valuation on the basis of its oil development and appraisal projects alone. I’ll report on it in more detail in coming weeks.

Another company trading near its 52-week high is micro-cap technology products distributor Dicker Data. It listed in early 2011 through a $1 million float and was barely covered by analysts or the media. I follow the IPO market closely but, in an end-of-year float rush, did not pay as much attention to Dicker as it deserved.

The company has had remarkably consistent growth in sales revenue and net profit over five years, it increased profits substantially last financial year in a tough market and is well funded. It should do even better when the economy improves. Its shares have rallied from a 20¢ issue price to 45¢.

Comments