Despite gloom, bright spots appear

With the mining boom coming off the boil and the profit growth of the banks peaking, what is left for investors on the Australian sharemarket? Where is the next lot of corporate earnings growth going to come from? The reporting season shows how tough it is for many companies. Earnings of Australian listed companies are down about 2 per cent, overall, from a year ago. Bank profits were 1 per cent higher. But the big news was the fall in profits for the resources sector of 17 per cent.

BHP Billiton reported a fall in full-year underlying earnings of 21 per cent. Iron ore prices have fallen because of less demand from China. Prices of other commodities have also fallen. Building materials company Boral, with its exposure to the US housing cycle, were also among the biggest disappointments.

There were some bright spots, though. Casino operator Crown reported earnings growth of more than 50 per cent and carsales.com.au delivered earnings growth of more than 20 per cent.

But investor sentiment remains weak with our sharemarket underperforming global shares since late 2009. While Australian share prices have been flat over the past year and stuck at 2005 levels, US share prices are about 20 per cent higher than a year ago. Australia has been outdone even by the much-troubled eurozone, where share prices are 10 per cent higher than a year ago.

While the main reason for the poor performance of the Australian sharemarket is the poor performances of the resources sector, the problems are more widespread. The head of investment markets research at Perpetual, Matthew Sherwood, says the reporting season has shown that a lot of business models are struggling in a low-growth environment.

"The key theme was the lack of top-line revenue growth," he says. There was also a lack of statements from companies on the outlook for this financial year, showing a general lack of confidence, Sherwood says.

Cautious sentiment

The chief economist at AMP Capital Investors, Shane Oliver, says the sharemarket is being held back by Australia's relatively high interest rates and investors' preference for term deposits rather than shares.

And the strong dollar continues to hurt exporters. Cautious consumers, concerns over the slowdown in China and eurozone problems are also contributing to the weakness. Sectors such as banking, mainstream media and retailers say conditions have not improved since the end of the financial year.

While some of the internet-based businesses, such as carsales.com.au and realestate.com.au, and some healthcare companies, produced rosy outlooks for the current financial year, they represent only a small part of the Australian sharemarket.

The trouble for investors is that those companies that have reported rises in earnings and upbeat outlooks usually have the positives already factored into the share prices, says the editor of the FNArena financial news and analysis service, Rudi Filapek-Vandyck. "Most of the outperformers over the past 16 or 18 months have gone really well in the reporting season," he says.

"The problem is that the market has already anticipated that, so the expensive stocks have become more expensive."

Yield still king

The chief investment officer at Insync Funds Management, Monik Kotecha, says banks and resources companies are "going to be more challenged". Many small investors have these companies in their portfolios but they should seriously consider reducing their exposures to these companies, he says.

He likes good-quality companies with a predictability and consistency of earnings and sustainable dividends.

While the outlook for most of the market's giants was subdued and their prices not expected to grow much over the next year, there was a silver lining to the reporting season. Oliver says 63 per cent of companies have raised their dividends. Most were able to increase dividends through cutting costs and redirecting cash flow to dividends, rather than growing earnings. Kotecha says that as the first baby boomers enter retirement seeking income from their investments, there will be continuing support for the share prices of companies with sustainable dividends.

Some people think chasing yield may be a trap for investors because when consumer confidence returns, high-yielding shares will be dumped in favour of shares with better prospects for share-price growth. High-yielding shares have been favoured by investors during the past year. Kotecha says capital growth will eventually come through, but it could still be some time off.

He says over the long term higher dividend-paying shares tend to have better share price growth.

Oliver says we would need to have more interest rates cuts and more confidence regarding the global economy to get the "cyclicals" companies that depend on the economic cycle to do well. "But that may take a while and in the meantime high-yielding defensives might have further to run," he says.

Top tips for the new world order

THE editor of the FNArena financial news and analysis service, Rudi Filapek-Vandyck, likes McMillan Shakespeare, the salary-packaging and vehicle-leasing company.

He also likes Monadelphous, which provides engineering construction, maintenance and industrial services to the resources, energy and infrastructure sectors, and Coca-Cola, which recently reported a steep rise in earnings.

Filapek-Vandyck says he would be happy to have these companies in his portfolio, on any price dips, but would be reluctant to buy them now.

The chief investment officer at Insync Funds Management, Monik Kotecha, likes Transurban, the toll road operator. He also likes Spark Infrastructure, which invests in regulated utility infrastructure both within Australia and overseas, and Woolworths, with its attractive price-to-earnings multiple and its yield of more than 5 per cent, or between 6.5 per cent and 7 per cent after franking.

Head of equities at Morningstar, Andrew Doherty, says the market is overly pessimistic on some of the household names.

He says BHP Billiton is his preferred resources pick. It's a well-diversified, relatively low-cost producer with high-quality assets.

But he warns investors in resources need to have a long-term focus because commodities prices could fall further.

Doherty's preferred big bank is Commonwealth, which has the largest market share in housing loans and retail deposits.

He also likes Wesfarmers, which owns Coles and Bunnings.