Elio D’Amato, chief executive of shares researcher Lincoln Indicators, has a warning to investors such as those buying shares for their self-managed superannuation funds. And that is not to buy shares in companies because they are cheap without regard to a company’s financial health. D’Amato has been around long enough to have seen several of the greed and fear cycles of Australian shares. It has confirmed to him that companies in sound financial health are much better to withstand shocks like credit squeezes and changes in government policies than those in poor health.
“Focusing on fundamentals can also help investors block out the noise and avoid being seduced by the latest investing theme or fad,” D’Amato says.
Lincoln’s financial health model assesses accounting ratios such as profitability, cash-flow, liabilities and assets. It gives a score to each company and highlights those in financial distress. If a company’s fundamentals are sound, investors should be rewarded with good long-term performance almost regardless of the industry sector it is in, he says.
A company with good fundamentals can still perform well in a struggling industry sector. He says investors should let the sector allocation be determined by the companies that have been selected on fundamentals.
Diversification is still important, as it is about the only free lunch in investing. But it “should be a diversified portfolio of the best companies on the market”, D’Amato says.
Of course, the prices paid for the shares are also very important. Most of the companies in the best financial health have shares that are fully priced. But that does not mean that such companies should be bypassed. The company may be paying very good, fully franked dividends. There may be well-founded expectations of continuing profit growth, such as with the big banks, for example.
In D’Amato’s opinion, companies with a “strong” or “satisfactory” score have acceptable levels of risk for investors and should, therefore, make up the bulk of an investment portfolio.
Companies with an “early warning”, “marginal” or “distress” score carry escalating degrees of risk and should be avoided by risk-averse investors, he says.
According to Lincoln’s analysis, only a quarter of the 2000 companies listed on the Australian sharemarket are in good financial health. The percentage of companies in good financial health rises greatly among the biggest companies. Eighteen of the 20 biggest companies by market capitalisation score a “strong” rating.
Of the top 20, only Macquarie Group has an “early warning” rating and oil and gas explorer and producer Santos has a “satisfactory” rating. An early warning rating is where a company may suffer financial stress unless measures are taken to rectify its financial health standing. In the case of Macquarie, the company is in a “transition period” after Macquarie split off a number of its investment trusts, D’Amato says. Santos has been marked-down because of its heavy capital expenditure.
So what are D’Amato’s top tips? He likes three stocks in particular – blood products maker CSL, Amcom Telecommunications and electronics retailer JB Hi-Fi. Each has a “strong” financial health rating.
This story Administrator ready to work first appeared on Nanjing Night Net.