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VIDEO: Is the stock market overvalued?

Richard Hemming

Our editor Richard Hemming last spoke with subscribers in March when we were in the teeth of a market that was plummeting, eventually falling by about a third. Under the Radar Report urged small cap investors to buy small parcels of shares and not to chase share prices. This has proved to be the right advice for our stock report subscribers. Hear what our advice is now that the market has bounced hard.

Click below for this week's stock market update 

Quality Small Cap stocks at affordable prices

Under the Radar Report has been in regular contact with our small cap investor subscribers via our weekly stock Market Updates. But at that time, we published our 10 Best Buys and then the next week, we followed with another 10 stocks to buy because there were so many quality stocks at affordable prices.

Big returns for Small Cap investors 

It was a brave call, indicating that if small cap investors looked through the crisis, you would see big money making returns over 3 to 5 years. What’s happened since has been a rebound that has been astounding. Since late March, S&P/ASX All Ords has climbed 21%, while the S&P500 Index has done slightly better, climbing 22%.

What we’re seeing is a liquidity injection like we’ve never seen before. The US Federal Reserve and to a lesser extent other central banks, have stepped in and been buying in unprecedented levels, securities, including high yielding corporate bonds.

This is unparalleled in history and has a crowding out effect. Because of near zero interest rates, small cap investors are forced into buying risk assets, primarily stocks, because there is nowhere else to generate an adequate return. Under the Radar Report has spoken a great deal about this in our Blue Chip Value stock reports and in our weekly market updates.

What does this mean for Small Cap investors?

All Ords is 23% off its record high, while S&P500 13% off those levels. You could take that to mean that the market thinks economies will rebound to the levels they were at before. This is obviously not going to happen. Just look at unemployment, which is heading towards 20% once they get rid of govt assistance like JobKeeper. The real economy around the world is going to be in pain for quite some time and this will be reflected in many company results.

Are stocks now overvalued?

This is interesting in itself, because while you can see that big companies like Google owned Alphabet, Facebook, Amazon and other FAANGS are huge beneficiaries, it’s not so obvious in Australia which ones will be the great survivors from this health induced economic earthquake.
 
What we are seeing is a big dispersion between the companies.
 
We’re now firmly in a stock picking environment where some companies will sink and others will dog paddle. Some might even do freestyle. Investing in index linked ETFs won’t cut it.

Has there been a unique trend in Australia regarding stock to buy?

In one word: capital raisings.  In April Australia companies raised $14bn in equity capital. This was within shooting distance of American companies, even though that market is almost 30 times bigger.
 
The primary cause of this is dividends, which are encouraged by Australia’s franking credit policy. The average payout is 70%, which means there isn’t enough reinvestment of profits and Australian companies were left high and dry when the tide went out.
 
Exacerbating the problem was that balance sheets were kept too slim as management have been too focused on their bonuses in their efforts for short-term returns.

What advice has Under the Radar been giving to small cap investors?

First, up we’ve been advocating to take part in some raisings when they’ve been for growth. When they haven’t, we’ve steadfastly avoided them. Examples include NAB at the big end of town, where we’re holders but advised not to take up the entitlements; versus Infomedia (IFM) where we advised to take profits on the entitlements.
 
Over and above this, however, we’ve been taking profits into this rally. Moreover, this is a good discipline to have: build up your cash reserves to take advantage of opportunities when they arise.

This week’s Small Cap Portfolio update is a must read

The Idle Speculator talks about our focus on quality and about building up fire power for the next bout of selling. Our focus right now is on raising money. You do this by taking profits where you can and selling those positions where you haven’t got high conviction.
 
Under the Radar takes you through this process in a simple way. First we have our Best Buys list; Second we get on the front foot to buy and sell

What is quality?

This is easily summarised by customers, balance sheet and competitive advantage. We go into much more detail in previous issues, which we’ll highlight in our news section.
 
One of the keys for a small cap that often differs from its bigger counterparts is the importance of a blue chip customer base, which gives it a competitive advantage. As a minority small cap investor you’re getting the benefit of much more due diligence from these customers on the company and its products than you’re ever going to be able to do.

Are there other buying opportunities?

We’ve been quick to buy and sell companies that are much more leveraged to market conditions.
 
Classic examples are Kogan (KGN) and The Reject Shop (TRS) which we’ve been buying and taking profits on, but you can also include Buy Now Pay Later operators in this equation, Afterpay, Zip Co and Splitit.
 
This is where it’s good to read Under the Radar Report for trading opportunities. I would add that it’s very difficult, if not impossible to get the timing exactly right. What we’re looking for is whether on a relative basis, these companies look cheap or expensive. Shareholder sentiment is the key for these stocks.

What’s Under the Radar Report's advice now?

Our advice now it to take profits on stocks that you’ve done well so you have cash. In this changing market small cap investors need clear Buy, Hold and Sell recommendations as the market is constantly changing and you need updates regularly.  
 
 

About the Author

Richard Hemming

Richard Hemming (r.hemming@undertheradarreport.com.au) is an independent analyst who edits www.undertheradarreport.com.au, which provides investment opportunities in Small Caps that you won’t get anywhere else.

Under the Radar Report is licensed to give general financial advice only (AFSL: 409518). The author does not own shares in any of the stocks mentioned.

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