Bad news on bourse offers good chance for some rich pickings- BUYER BEWARE ::

Author: Bina Brown
Date: 04/08/2007
Publication: The Australian

The challenge is finding good, undervalued stocks that are out of favour

WITH the stock market off its highs and the annual profit season just starting, investors prepared to embrace negativity could end up ahead in the medium to long term.

Buying stocks that are out of favour is counter-intuitive to the natural instincts of an investor, but it can easily add an additional 20 per cent or so to returns.

Market observers are expecting directors to raise all sorts of possibly negative issues -- including the strength of the Australian dollar, higher interest rates and global market uncertainty -- as they unveil the outlook for their companies.

As markets generally overreact to bad news, much of the negativity could present attractive buying opportunities.

Take Macquarie Bank, which this week fell 11 per cent in one day, despite having no exposure to the dreaded US sub-prime mortgage market as was originally thought.

The challenge is finding good, undervalued businesses that can deal with the issues making them or their sector out of favour.

Steve Johnson, of Intelligent Investor, expects the strength of the Australian dollar to be a big theme of a generally positive reporting season.

Australian companies with overseas businesses -- that is, most of the big ones -- will be particularly sensitive to the appreciating dollar.

But, if like Johnson, you think there is no reason for the currency to remain where it is, then some of the companies that have been sold off because of it will be good buying opportunities.

Westfield Holdings, currently trading at its lowest level in six months, and Brambles -- 20 per cent down on where it was six months ago -- are among the industrials that have taken a hit since the start of the year but show no long-term signs of slowing down.

Investors who would benefit from having either major industrial company in their share portfolio can take the plunge now and pick up a potential bargain or wait until the potential negatives -- in these cases the strong currency will continue to be a potential issue -- have passed. Waiting might cost 20 per cent but then it may be worth it for the added certainty.

Timber growers such as Great Southern Plantations and Timbercorp have also been oversold, according to Johnson.

Shares in both companies slumped after the Australian Tax Office decided to disallow upfront tax deductions on non-timber managed investment schemes after July 1 next year.

While some of the sell-off may have been justified because of the difficulties they face in continuing to sell horticultural products, both Great Southern and Timbercorp have locked in future revenue increases, which Johnson believes will offset losses elsewhere.

Ron Bewley, general manager quantitative research and investment strategy at CommSec, says the biggest opportunities are in the healthcare and utilities sectors. Based on the consensus forecasts of several stockbrokers, he says the expected returns in the year ahead for health-related stocks is 10 per cent above the overall market index, or about 25per cent.

He expects the utilities sector to return 16.9 per cent this year, with far less expected volatility than some of the other sectors.

As for picking individual stocks, Bewley suggests investors choose a research house they trust and go with their stock picks.

"An investor could choose a larger stock from the healthcare sector which has a `hold' or better (recommendation) or choose any company with a `buy' on it, depending on what is in the rest of their portfolio," he says.

Angus Geddes, a director of tip sheet Fat Prophets, specialises in picking undervalued stocks.

His aim is to pick established businesses that make real money at a time when the industry is on its knees and the company is trading in its darkest hour.

While the market has focused on booming commodities such as zinc, Geddes remained a fan of gold -- a classic contrarian investment. Gold hit $US255 an ounce in 2001 and has slowly climbed to $US650 an ounce.

Geddes predicts it will test $US1000 an ounce within 12 months.

The stock to watch is Lihir Gold, which he says offers ``good leveraged exposure to the gold sector, has a large reserve base to 2027, is unhedged and has low cash-operating costs". Having backed the stock since it traded at 55c, he expects it to continue on from current levels at about $3 a share to $4.50 within 12 months.

For Geddes, the other standout opportunity is Foster's.

With the private equity premium all but gone and the wine industry still out of favour, the stock price is below $6 for the first time in 12 months.

"It may take another year or two, but the wine industry will recover," he says.

"Most industries have cycles and with the contraction of supply and weaker producers going out of business, there will eventually be a sustained rise in the price of wine in the future."

Roger Montgomery, value investor and chairman of Clime Asset Management, says that within a week the number of ``great" companies trading below their intrinsic value has risen from six to 25 and now include ANZ, Flexigroup, Westfield, Aristocrat, HGL and Bunnings Warehouse Property Group.

"People react with less than perfect information, making the stock market offer wonderful opportunities to those that are patient and long-term in their outlook," says Montgomery. Patience is a key to contrarian investing.

It is one thing to get the price and direction of a stock right and another to have the patience to wait for the positive returns.

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