Share market sentiment appears to be entering the third phase of a bull market. Traditionally investors look for growth related stocks in this phase, and the recent rallies in resource and industrial stocks are also pointers to this shift in market thinking. Aggressive investors may look for leveraged exposures to growth, and we highlight two companies with profit profiles that are likely to outperform in an environment of increasing business confidence.
Sir John Templeton said one hundred years ago, “Bull markets are born in despair, rise on scepticism, mature on optimism and die on euphoria”. A clear recovery in US housing markets and data showing slowing growth rates in China are stabilising appear to be pushing sentiment from scepticism to optimism, despite ongoing European concerns.
Markets price the future. Normally, a recovery in consumer activity leads to a pick-up in business confidence. Staying ahead of the market means anticipating the next phase, not the current one. To this end, investors and traders could be considering companies leveraged to the business cycle that don’t yet reflect a more positive outlook.
IT companies are highly leveraged to revenue increases. Costs are substantially fixed, and the incremental cost of adding a new customer or contract can be low compared to the revenue increase, meaning more revenue drops straight to the profit line.
This combination of factors (IT exposure to more positive business cycle) is found in a number of companies. Two on the radar at the moment are Seek Ltd (SEK), and SMS Management and Technology Ltd (SMX).
Seek Ltd – Weekly
Seek Ltd is an online business with three key units – job ads, training courses and investments in offshore job ad businesses, giving it clear leverage to the business cycle in Australia as well as Asia and South America.
It’s trading on a forward Price to Earnings (P/E) multiple of around 15 times, with long term growth (G) prospects estimated between 16% and 20%. This gives a PE/G ratio less than one – usually considered undemanding in growth stocks. While some investors will consider buying immediately, other more chart oriented traders may wait for a break of resistance at $7.15 (illustrated on the chart).
SMS Management and Technology Ltd – Weekly
SMS Management and Technology Ltd is an IT company offering consulting and integration services to business. Australian based, it has operations across the Asian region.
Earnings Per Share (EPS) are currently growing at an annual rate around 6.5%. Its forward P/E is around 13 times, a relatively low multiple (the Australia 200 Index P/E is around 17). If a better business cycle does emerge, this stock is likely to be substantially re-rated.
Some investors may wait for a breach of this year’s high at $6.74 before taking exposure. However, for investors still sitting on the sidelines waiting for a pullback that is looking less and less likely, these stocks may answer the question “what to buy now?”