Head of research at Australian boutique fund manager PM Capital, Ashley Pittard, believes a significant discrepancy in the valuation of blue chip stocks in Australia compared with the US market offer contrarian investors significant opportunities over the coming decade.
Pittard says Australian blue chips have out-performed the US counterparts over the past decade but warns this run may be coming to an end.
The investment process built up by Pittard is around the simple principle that the best way to preserve and enhance wealth over the longer term is to “buy a good business at a good price.
"These businesses don’t have to be based in Australia We look at the wider investment universe and believe investors limit their opportunities by not looking overseas,” he said.
Pittard says intensive research and peer group review have revealed significant anomalies in the valuation of good business in the US compared to Australia, with the low US dollar also currently providing strong buying power for Australian investors.
“The US is struggling with 10 per cent unemployment and uncertainty so investors are bidding good assets lower.
“In Australia we have relatively low unemployment and a relatively strong economy. Assets have been bid up above fair value. Just look at property.
“We seek to invest our clients money wherever the greatest opportunities exist and the risk reward ratio on good solid US stocks with global businesses that have been beaten down and flat for a decade offer potentially greater significant upside than their Australian comparables”, he adds.
Pittard backs up his theory comparing the stock prices over the past decade of several leading US blue chip stocks like Coke, Wells Fargo, Merck, Wal Mart and Johnson & Johnson and compares them to their Australian equivalents Coca Cola Amatil, CBA, Woolworths and Cochlear, all of which have enjoyed a significant run.
Example one: Coke Parent vs. Coke Amatil
Pittard says “We think it would be better to own shares in the US company that owns this global brand over the local Australian company that owns all the heavy manufacturing plants to bottle the product.
“Australian-based Coca Cola Amatil’s principal activities are manufacturing, distributing and marketing of finished bottles and cans of a range of beverages.
Its US parent, Coke produces the ingredients and guides the marketing.
“The US parent has grown its earnings per share at 8% pa over the last five years whilst Coca Cola Amatil has grown earnings per share at 8.6% pa.
“They are easily compared when the bottler just packages up the parent’s product.
The parent trades at 14x PE for current 2010 earnings whilst their Australian bottler trades at 17.5x.
Pittard says CCL faces a host of new players entering the Australian soft drink market with Japan’s Asahi starting to aggressively acquire companies.
Example Two: Wells Fargo Bank Vs CBA
Two well run and well capitalized banks with the same business and same long term return metrics.
Earnings growth over time has generally been very similar between them.
However in the US, the housing market is down 50%, while prices in Australia are very high.
Wells Fargo has taken significant loan losses while CBA has loan losses at near record lows.
The 2011 PE valuation for CBA is 12x compared to Wells Fargo which is 8x
“As contrarian investors we look to protect our downside and the upside will take care of itself.
The risk reward on a stock that has been flat for a decade over one that is up significantly is easy to see”, he concludes.
Footnote: Watch the currency and remember that if you chase income from US shares, the currency can play an important part because many big American companies take months to pay dividend.
For example, Microsoft this week upped its quarterly dividend to 16c a share (which was up 3c). But it won’t be paid until December. The value of the Australian and US dollars can vary a lot between now and then.
