The brutal selloff in shares between May 1 and May 18 has been very instructive for traders.
During this period the benchmark All Ordinaries index fell 9.7 per cent before bouncing about 1.7 per cent over the next two trading sessions. Some stocks though moved much more aggressively.
If this type of volatility continues there is a far greater chance of making money out of high beta stocks than low beta stocks. Beta is a measurement used by traders to gauge if individual stocks move greater or less than the overall market.
Following the aggressive selloff we can assume volatility has returned in the near term and to simply sit it out will probably end up in losses.
While it is not for everyone to get the greatest bang for your buck, traders need to identify what are the highest beta stocks. The key will be to avoid them on the way down and dive in on the way up.
From May 1 to May 18 commodity drilling player Boart Longyear tumbled 31.5 per cent, before rebounding 9.5 per cent in just two trading sessions. In the same timeframe, OneSteel fell 36 per cent and then popped 12.5 per cent higher. Rounding out a nice troika is Fortescue Metals, which fell 26.3 per cent before recovering 9.2 per cent.
It is critical that when you are trading a quick bounce in stocks you stick with highly liquid names. To climb into a stock that hardly trades is normally easy to get in but hard to get out of. These stocks are commonly referred to as lobster pots. The three stocks mentioned above all trade millions of shares a day.
BANK ON IT
For those long-term investors who don't have the stomach for rapid trading, some opportunities seem to be emerging at the small end of the banking sector.
These companies have been relentlessly sold down by investors in recent months despite appetising yields. Bendigo and Adelaide Bank is trading on a price-to-earnings multiple of less than eight times 2013 earnings with a yield of about 8.5 per cent, fully franked. The stock is friendless, falling almost 20 per cent in the past few months. Bank of Queensland has faired slightly better, trading on a PE of about 10 times and a yield of 8 per cent. Drop another notch and we find Wide Bay Australia yielding about 8 per cent and Tasmanian minnow MyState pushing up towards 9 per cent.
These companies are all under pressure, and earnings expectations may have to be wound back, but there is no suggestion profits are going to collapse and dividends slashed. The plight of Europe and the prospects of a banking crisis have kept people at bay, but for longer-term players it could be worth starting to look at what represents great value.
IT'S A LOTTERY
In contrast, there have been some companies that have hardly trembled in the May selloff. They can be divided into two distinct categories - defensive and high yield.
Qualifying in both of these categories is the wagering and lotteries outfit Tatts Group. The stock has powered higher by 14 per cent and paid a dividend of 11? a share over the past six months. In comparison, the overall market has been flat.
Investors were impressed by the half-year result and are looking to a strong June half on the back of some large lotteries.
Investors though should keep in mind a few factors about Tatts before getting too excited. As is well documented, the company will lose its poker machine licence in Victoria at the end of this financial year. Earnings will adjust down, putting the company on a price-to-earnings ratio of about 14.5 times 2013 earnings, a healthy premium to the industrial market average of 12 times.
The decline in earnings will result in a lower dividend given the company already pays out about 90 per cent of its profits.
Tatts's board has also announced it will look to replace the long-standing chief executive, Dick McIlwain, towards the end of this year. The new CEO will have big shoes to fill. At the top of the list will be the question: has the company underspent on systems in recent years? Capital expenditure has been running significantly below depreciation for some time and there may need to be a rapid acceleration in spend.
Wagering competitor Tabcorp spends about $30 million on its systems each year compared with $10 million by Tatts.
Tabcorp introduced an iPad and iPhone application well before Tatts and now it is a case of catch-up. A sudden bulge in capex would not be welcomed by shareholders.
Finally, we should remember Tatts is not a listed bond and, while defensive, faces problems just like any other company.
Frequently Asked Questions about this Article…
What is beta and why do traders focus on high beta stocks in a volatile market?
Beta measures whether an individual stock tends to move more or less than the overall market. In a volatile market — like the May 1 to May 18 selloff when the All Ordinaries fell 9.7% — high beta stocks tend to move more aggressively, so traders see a greater chance to make bigger gains (or losses) from sharp rebounds.
Which Australian stocks showed high-beta behaviour during the May selloff and rebound?
During the May 1–18 selloff the article highlights several high-beta moves: Boart Longyear tumbled 31.5% then rebounded about 9.5% in two sessions, OneSteel fell 36% then popped 12.5%, and Fortescue Metals dropped 26.3% before recovering about 9.2%.
How should everyday investors trade quick rebounds and volatile stocks?
If you trade quick bounces in volatile stocks, stick to highly liquid names that trade millions of shares a day. The article advises avoiding high-beta stocks on the way down and considering them on the way up, but only if liquidity is strong so you can get in and out easily.
What are “lobster pots” in the market and why are they risky for rebound trades?
“Lobster pots” are stocks that hardly trade — they can be easy to buy but hard to sell. The article warns that these illiquid names can trap traders during volatile rebounds, so choose liquid stocks when aiming to trade short-term moves.
Are small Australian bank stocks good value after the recent selloff?
The article suggests some small banks look attractively priced for longer-term investors. Examples: Bendigo and Adelaide Bank was trading under 8 times 2013 earnings with a yield around 8.5% fully franked and has fallen nearly 20% recently; Bank of Queensland was about 10 times earnings with an ~8% yield; Wide Bay and MyState were yielding around 8%–9%.
What risks should investors consider when looking at high-yield small bank stocks?
While yields look appealing, these banks are under pressure and earnings expectations may need to be wound back. The article notes broader concerns — such as the plight of Europe and the prospect of a banking crisis — have kept investors cautious, so long-term players should weigh potential earnings downward revisions before buying.
Why has Tatts Group been relatively resilient, and what issues should investors watch?
Tatts has been both defensive and high-yield: it rose about 14% and paid dividends over the past six months, helped by a strong half-year result and big lotteries in the June half. But investors should note it will lose its poker machine licence in Victoria at the end of the financial year, faces an expected earnings adjustment, pays out roughly 90% of profits, and trades on a premium P/E (around 14.5 times 2013 earnings).
How could management changes and capital expenditure affect Tatts’ dividend and outlook?
Tatts’ board said it will seek a new CEO toward the end of the year, and one key issue will be whether the company has underspent on systems. Capital expenditure has been significantly below depreciation and may need to accelerate. A sudden increase in capex would pressure cash flow and could lead to lower dividends, which shareholders may not welcome.
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