The bear's roar brings opportunity

The market is a perpetual tussle between the two extremes of fear and greed. Right now, fear is winning.

The All Ordinaries Accumulation Index fell 5% in the past week and is now down over 15% from the post-GFC high struck in April 2011. We’re now back at the lows of August last year, when we last upgraded a swag of stocks (see Opportunities amid the falls and Chaos amid the storm: The upgrades from 5 Aug 11).

Fears have re-emerged about the US’s nascent recovery and the fact that a solution to Europe’s woes seems increasingly distant. Add to that acute concerns about the sustainability of the resources boom and you can appreciate why markets are falling. Intelligent Investor members would be more than familiar with the arguments, a fact a quick recap of recent Director’s Cuts would soon make clear.

In an admission that resources demand is slowing, even BHP Billiton, the world’s largest miner and founding member of the ‘stronger-for-longer’ club, is considering winding back its $80bn capital expenditure program. Slowly, our well-flagged fears about China (see The coming China crash) appear to be coming to fruition.

So what should you do?

First, take a deep breath. Tune out from the market chatter and instead focus on businesses. Swift falls in stocks prices are galling to watch but create enticing opportunities. Adding carefully selected businesses to your portfolio at these times can seriously boost your investment returns.

Buy and sell strategy

Cast your mind back to August 2011. Those members that bought Macquarie Group, Woolworths or Sonic Healthcare at the time have been handsomely rewarded, enjoying respective returns of 13%, 12% and 10% plus dividends.

This at a time when the market overall is in the red. These three stocks especially, and the gains we’ve made on them, emphasise the sense of the buy and sell strategy, outlined in the Director’s Cut of 10 Oct 11.

In contrast QBE Insurance has performed poorly, but we still believe it is materially undervalued. We would prefer to wait for the interim results before upgrading to Strong Buy to ensure there are no surprises, but we may upgrade if the stock price remains significantly below $13. The share price has been fluctuating with US Treasury yields, which have turned down again as investors seek percevied havens. Eventually value reveals itself, but it can take many years. In a world suffering from extreme shortsightedness, patience remains your greatest advantage over professional investors.

Today, we’re advising the same, sensible course of action. The problems facing the world’s economies are extensive—no one should dispute that—but acting now is not about predicting what may happen; it’s a question of comparing price to value. High quality businesses will prosper come what may. Right now, we’re getting the chance to buy top quality blue chips cheaply.

What to buy

Now’s the time to put to work some of the cash we’ve been encouraging you to accumulate. Table 1, which lists what we consider to be the best buys on offer now, is a pointer to where you should focus your capital.

Start with high quality, blue chip businesses. These should form the bedrock of your portfolio. The table lists nine attractive options.

Macquarie Group, for example, was sold off heavily last week, prompting an upgrade (see 18 May 12 (Long Term Buy – $25.66)). QBE Insurance also suffered large share price falls as lower interest rates caused investors to panic. At less than $13 a share, the market is giving the company no credit for its remarkable underwriting performance over a long period. In all probability, this very well run business will perform far better than the market price implies over time.

Similar fears are weighing on Computershare. But with part of the business very stable and the other, more market exposed, segments priced on temporarily depressed earnings, the current valuation is attractive.

Other first rate businesses such as grocery wholesaler Metcash and Woolworths offer fully franked dividend yields of 7.0% and 4.7% respectively. Woolworths is clearly the higher quality business but with recent share price rises the opportunity to buy this stock at a reasonable price is closing.

Excessive fear has also punished the share prices of Santos and Origin Energy. Each offers exposure to energy prices without being wholly beholden to Chinese growth (see A peaceful gas boom? from 19 Apr 12).

Soul Pattinson and Brickworks should also be on your prospective shopping list. Due to complex cross shareholdings (see Cross shareholding riddle revealed) these businesses are related but distinctly different.

Brickworks is cheaper right now due to its namesake building products division suffering from a downturn in residential developments while Souls is benefiting from its 60% holding in coal miner New Hope. Revisiting past reviews will help you better understand which business is better for you.

Second liners

There are quite a few attractive second liners, too. Accounting firm WHK Group offers a relatively resilient earnings stream and an 8.3% fully franked dividend yield, and Servcorp’s ambitious expansion program is finally showing signs of bearing fruit. Challenger Infrastructure Group and Fisher & Paykel Healthcare are also worthy of your attention, and both will benefit from a lower Aussie dollar. Challenger is a particularly complex business, though, so please read past reviews before acting.

Finally, a smaller portion of a more adventurous portfolio can be allocated to speculative investments such as Silver Lake Resources, Sirtex Medical, Tap Oil and Alumina.

More buys to come

It’s worth keeping some powder dry, however. Why not set up your overseas brokerage account now (see Overseas brokerage – Part 1 and Part 2) in anticipation of our upcoming special report, which will reveal a selection of very attractively priced overseas blue chips. That will protect you from any further falls in the Aussie dollar in the interim.

There are also a swag of stocks just a whisker away from an upgrade. In Table 2 we’ve outlined those businesses that we’re closest to pulling the trigger on, and the prices at which we’ll shoot.

Options for income and growth investors are plentiful. Income focused investors should keep a close eye on the recently reviewed Commonwealth Bank Bonds (see CommBank Retail Bonds get big tick from 13 Apr 12 (Hold – $97.65)) or higher quality operating businesses such as ASX or Sydney Airport (due to be downgraded but now closer to remaining a Long Term Buy).

Growth investors may finally get a chance to purchase either BHP or Rio Tinto at cheap prices and perhaps buy into the turnaround occurring at Aristocrat Leisure. Due to the volatility in the pricing of many smaller stocks, we won’t be officially upgrading Abacus Property Group or Infigen Energy unless both fall a bit further, despite their shares being under their respective upgrade prices.

Other stocks not on the list, including several gold explorers and Iress, are also under internal review, so stay tuned.

Plenty of value

Let’s recap. That’s a list of 19 stocks worth buying now, many of which are high quality blue chips, and a further nine stocks that are very close to an upgrade. They’re excellent places to focus your attention and your capital.

Patience, however, is critical, as is abiding by the guidelines set in the portfolio limits. Remember to allocate no more than 10% of your portfolio to each of insurers, banks or funds management businesses, and 25% to them in total (the 25% figure includes all types of financials). Share prices are likely to jump around so stick to the prices shown in our recommendation guides.

Over the next few weeks, opportunities may well increase. There are two things we recommend you do now in order to prepare. First, reread the article titled Feel the fear and buy anyway from August last year.

It explains how those investors that missed the many buying opportunities amid the GFC were given another chance last year. Once again, opportunity is knocking on your door. If you’re hesitant to answer it—and that’s perfectly understandable—it delivers ‘a dose of psychological fortitude to help you avoid critical mistakes and profit from the opportunities before us.’ Read the full article here.

Second, establish a ‘My Stockwatch’ list on our website. This practical new feature alerts you, via email, as soon as any stock on your watchlist has research published to the website. Within a few seconds, you’ll get the very latest research on those stocks of most interest to you, which means you can act faster to opportunities.

Early harvest

If you have any further questions, please submit them via the Ask the Experts forum or give one of the team a call on 1800 620 414. We’re always happy to hear from members and help you through times like this as best we can.

This is a challenging time but it’s also one laden with opportunity. There’s every chance that further bargains will emerge down the track, so tread carefully, prepare, and act with the courage of your convictions.

Note: The Growth and Income portfolios own a number of the stocks mentioned in this article, refer to the portfolio pages for a full listing.