Big money is made in the stock market by changing expectations, and being aware of the risks and industry trends very early. That has been a secret behind our stock picks in the food sector such as Freedom Foods, Tassal and Warrnambool Cheese, which have more than doubled in value.
Three of Australia's top small cap fund managers met this writer recently to discuss the big themes hitting little companies. We did this last year and had tremendous success picking up trends that continued through 2013 - these included the hunt for income, the rise and rise of cyclical stocks, the stimulus rally and a falling Australian dollar versus the greenback.
This time we spoke to Australian Ethical Investment's Andy Gracey, Celeste Funds Management's Frank Villante, Cadence Capital's Karl Siegling and Invesco's Cynthia Jenkins.
Theme 1 The wealth effect Money printing in its various forms has inflated asset prices and helped people feel happier about their economic circumstances, so they are spending. This benefits property developers and wealth managers.
The fund managers disagree on whether this will benefit the economy as a whole via the Keynesian multiplier effect. Some, including Cynthia Jenkins, see that there could be an end to companies solely relying on cost-reducing to increase profits; while others, such as Frank Villante, don't believe this will occur.
Theme 2 High price earnings multiples will continue A corollary of this is that, all things being equal, the market should continue to rise. "In a low interest rate environment, assets can do nothing but go up. That is a rule of asset pricing," says Karl Siegling. The market PE has increased from about 13 times last year to 14.5 times.
All agree that it should at least stay high, and may well go up.
Theme 3 An ageing population Baby boomers are genuinely starting to put their feet up, buy investment properties, get more diseases, lose some of their eyesight, and draw on government assistance.
Andy Gracey has a big weighting in his fund to healthcare and medical science, but he also realises that it is not the easiest industry as an investor to get a return from: "The services (for aged care) have to be cost effective. With pathology, for example, the government has been effective in clawing back some of the increased volume."
Still, the familiar names in the sector, Vision Eye (VEI), Primary Health Care (PRY), Ramsay Health Care (RHC) and Sonic Healthcare (SHL) remain well positioned for earnings growth.
Theme 4 Outsourcing Karl Siegling says that 20 years ago it would have cost hundreds of thousands of dollars to operate (or run) a funds management business, whereas today your costs would be in the tens of thousands.
For example, you would have paid about $150,000 to get stock prices onto a computer screen. Today this would cost you a few thousand. Instead of paying a head hunter an advance and an employee's first year's salary, you pay Seek $150 for an ad. He is also a big fan of jobs outsourcing website Freelancer.com, and was lucky enough to get stock in the float. Freelancer is up 158per cent on its issue price.
"The next leg of outsourcing is the bespoke type. I can sit at my desk and co-ordinate a new business card or logo design for $450 and be done in an hour."
Richard Hemming edits the fortnightly newsletter Under the Radar Report: Small Caps.