After a long period where cash was good, stocks are now offering some of the best returns in five years, writes John Collett.
The rally on the Australian sharemarket holds the promise of being long-lived. Though share prices never go up in a straight line, and there will be plenty of setbacks, investors who wait on the sidelines in cash risk missing out on the best returns from shares in five years.
So far this year, the market is up about 10 per cent and the recently concluded profit-reporting season has exceeded expectations, says a senior client adviser and economist at Lonsec sharebrokers, Michael Heffernan.
"Confidence is seeping back into the DNA of companies and the momentum of the market is likely to continue," Heffernan says. "The problems that have been besetting the market are now being neutralised," he says.
Sharemarkets around the world have rallied. Share prices on Wall Street and the London Stock Exchange are close to their pre-GFC highs as the US economy picks up and the European debt crisis stabilises.
Analysts are expecting the theme of the past year, of the market being led by the big stocks that pay good dividends, to continue, albeit with setbacks along the way.
"The good performances have come from the defensive stocks, which is what you would expect given that the economy is not roaring," Peter Warnes, head of equities research at Morningstar, says.
Many of the best results from the reporting season came from companies with defensive earnings. Woolworths' underlying net profit was up 5.5 per cent for the half-year to December 31, 2012. The result was driven by its supermarkets and helped by poker machines.
Wesfarmers reported a rise in underlying net profit of almost 7 per centfor the half-year, with its Coles and Bunnings businesses performing well.
Heffernan's share picks include Woolworths and Wesfarmers. He expects them to maintain their good performances. "They are standout performers and I think there is a lot more gas in the tank for both of them," he says.
Heffernan likes Woolworths' rollout of the Masters home improvements chain that is competing against Wesfarmers' Bunnings. Wesfarmers is also a well-managed business, Heffernan says. He also nominates Telstra as one of his stalwart stocks.
"People used to say to me that Telstra was 'tired' when it was $3.90," he says. "I know that Telstra is boring but it could get to $5 from $4.60 now, and still pay a fully franked dividend of 5.6 per cent," he says.
Heffernan likes Ramsay Health Care, which is the only listed hospital owner and is expanding overseas. Ramsay Health Care was established by Paul Ramsay in Sydney in 1964. It operates more than 100 hospitals and day-surgery facilities across Australia, Britain, France and Indonesia.
Chief executive of Lincoln Indicators, Elio D'Amato, also likes Ramsay. He is expecting revenue to grow strongly as it continues to expand overseas.
Blood-products maker CSL Limited is another of D'Amato's picks. It reported a good rise in profits and has improved the efficiency of blood-plasma collection - and that has gone straight to its bottom line, D'Amato says. The company is a major global player in the blood-products market.
"It is a great Australian story," he says. "It was the Commonwealth Serum Laboratories and it has grown into an amazing company with sales of about $1 billion around the world."
Insurance Australia Group (IAG), the general insurer, is putting in a good performance. It has established brands in its home markets of Australia and New Zealand and a growing presence in Asia.
"It has a very strict reinsurance plan, which means that in a year of natural disasters, its bottom line would not be affected too much," D'Amato says.
IAG has a return on equity of close to 40 per cent, strong earnings-per-share growth and revenue growth.
"There is a lot of good news there," D'Amato says.
He likes iiNet, the telecoms provider, as a more speculative pick. The company is Australia's second-largest DSL (standard telephone lines) internet provider. It has significant infrastructure and networks, and a growing number of customers using its services.
Over the past year, iiNet has acquired two businesses that have been integrated "perfectly", D'Amato says.
"It is a bit of a riskier play than Telstra; however, we are confident that in an economic slowdown its revenues would be insulated because of the growing demand for internet services," he says.
Warnes says the upward trend in share prices is likely to continue, though the market has probably gone ahead a little too quickly.
"That is what happens in the early stages of a bull market," he says.
"[They] overshoot and then they consolidate, earnings catch up or confidence catches up, and then off you go again for the second leg.
"We are comfortable that we are into a bull market that could go on for another couple of years and over that period we are going to be in a rising trend with volatility."
Warnes thinks the defensive theme will continue. "Your 'necessity' retailers and healthcare, communications and banks are going to continue to do reasonably well given the [subdued economic] environment in which they are operating," he says.
He likes NAB because of its strong franchise in Australia and its yield, which is the highest of the four major banks.
Editor of the FNArena financial news and analysis service, Rudi Filapek-Vandyck, says NAB is his pick from among the big banks.
"Banks have done well and still look reasonable value on a three-year horizon, and the best call among them is NAB," he says.
Warnes also likes QBE Insurance Group, which has a relatively new chief executive who has made some big changes after the problems of the past two years with elevated catastrophe claims.
John Neal, who became chief executive in August last year, has cut dividends and laid out his plan for turning the global business around, which includes job cuts. The cut to dividends will strengthen the company' s balance sheet. His tasks are to fully integrate the acquisitions made under his predecessor and manage costs, Warnes says.
A senior resources analyst at Morningstar, Mark Taylor, says Woodside, which is one of the world's biggest producers of liquefied natural gas (LNG), has been operating for more than 20 years in LNG and has a head start on the competition.
"It has solid infrastructure on the North West Shelf [off the north-west coast of Western Australia]," Taylor says.
Woodside is expanding other gas and LNG projects off the Australian coast.
The company has taken a 30 per cent interest in Leviathan, a huge natural-gas find off Israel's Mediterranean coast.
Among the smaller companies, Warnes likes SMS Management and Technology, an IT service company with clients that include government and the banking, telecommunications and airline industries. With a market capitalisation of less than $400 million, it is a small cap with the associated risk of smaller companies, Warnes says.
Among the larger companies, Filapek-Vandyck picks Amcor.
The packaging company is one of his long-term favourites. It has gone from being a market darling to hard times to recovery, but many investors have their view of the company coloured by those experiences, he says.
Since 2009, Amcor has been one of the best performers on the sharemarket and has done so without its shares becoming expensive. He likes its global reach and the fact that packaging of food and drink is a resilient business. Filapek-Vandyck says one of the reasons that many investors ignore Amcor is that its dividends have no franking credits.
"Some investors are so focused on the franking that they miss out on a good investment," he says.
Filapek-Vandyck also likes Coca-Cola Amatil. The market regards the company's boss, Terry Davis, highly. He has done a good job in lifting profit margins. Filapek-Vandyck says, though, that Coca-Cola shares are fully priced and he would be buying its shares on price weakness.
He also likes Mayne Pharma Group, the specialty drug maker. The company's first interim profit result since the acquisition of US company Metrics came in at the top of analysts' expectations. Though the company posted a loss, the underlying performance of the business is sound.
"The company should have annual profit growth of more than 20 per cent over the coming years, but that is not reflected in the share price," Filapek-Vandyck says.
Analysts’ top tips
Michael Heffernan, Lonsec sharebrokers
Peter Warnes, Morningstar
QBE Insurance Group
SMS Management and Technology
Rudi Filapek-Vandyck, FNArena financial news
Mayne Pharma Group
Elio D'Amato, Lincoln Indicators
Insurance Australia Group (IAG)
Ramsay Health Care