The Key to Successful Investing in the Share Market

The Key to Successful Investing in the Share Market

Blog - 14112013In the short term, the share market is an irrational place. Prices jump all over the place and in a lot of cases, there is no evidence or fact to explain such large swings in share values. Instead, most of the time such price volatility is a result of investors who make decisions based on emotion rather than fact. The faintest whiff of bad (or good) news can ignite greed (or fear) among investors and this can lead to panic selling (or buying) in very large numbers. This sort of behaviour, more often than not, explains why share prices move up and down so erratically in the short term.

Medium-to-long term however, the market typically values companies properly, that is, according to their fundamental valuations which is typically centred around assets, cashflow and earnings growth.

Therefore, the key to successful share market investing is buying quality businesses when they are undervalued by investors and then waiting for share prices to reflect what the businesses are actually worth. It’s that simple.

To illustrate these principles in practice, let’s consider a current example.

Webjet Limited’s (ASX code: WEB) share price has declined around 40% since the company announced their results for FY13 back in August. Here is a summary of the key results;

• 15% increase to normalised net profit over FY12 (in line with the company’s guidance issued in Feb 13).
• Margins increased by 12% over FY12.
• Lots of Hotels business (a new business initiative in Dubai) launched in March 2013 and expected to be profitable in September quarter 2013.
• Zuji acquisition complete (a Hong Kong-based travel business) and expected to be profitable from July 2013.
• Dividend consistent with FY12 despite Zuji acquisition and Lots of Hotels rollout.
• No debt on the balance sheet (note that the acquisition of Zuji and start-up of Lots of Hotels were funded with cash).
• Reported profit was diluted by around $8m due to one-off costs associated with Zuji & Lots of Hotels.
• Continued investment in infrastructure and systems to further improve margins and efficiencies was promised.
• Full year guidance would be announced after the AGM on 13 November 2013.

Since results were announced, the following developments have occurred;

• CFO Rob Turner resigned in August (was a big part of the Zuji acquisition).
• Concerns developed about Flight Centre taking business away from Webjet (these turned out to be unfounded and WEB later announced it had actually increased its market share, this didn’t stop WEB’s share price from declining further however).
• Lots of Hotels business was profitable after September quarter as predicted and is running ahead of plan (rolled out in 12 countries to 30 September 2013 with another 8 countries anticipated by 30 June 2014).
• Zuji profitable in July as predicted and is continuing to develop in line with expectations.

In addition, some analysts predict that short term, the main theme for the travel sector is an increase to international travel. Domestic travel is predicted to remain flat. To put some context around this, 85% of Webjet’s bookings relate to domestic travel and 15% relate to international.

International travel is expected to increase in 2014 due to;

1) An expected improvement in household consumption driven by a recovery in consumer confidence (new government etc).
2) An expected improvement in corporate travel driven by a recovery in business confidence.
3) The fact that the airline capacity war between Qantas & Virgin appears to be over which is expected to improve the operating conditions for both airlines.

Whilst there is some logic to these points, an imminent decrease to the stubbornly-high $AUD to assist export-driven companies is also a consideration. A lower $AUD would actually make overseas holidays more expensive which could benefit domestic travel. (The point here is that an increase to international travel in 2014 is not a certainty).

After this week’s AGM, WEB announced that they expect profit for FY14 to be flat (i.e. same dollar amount as for FY13). There were 2 primary reasons given for this guidance; 1) an expectation that the Australian travel market will remain flat for the next 12 months, and 2) significant investment for the future in the areas of advertising and marketing (particularly with respect to the Zuji brand in Australia) and continuing technology and systems improvements.

In summary, Webjet has been sold off heavily over the last few months simply because the majority of investors are short-term focussed and don’t consider the big picture. For them, the overriding factors are flat profit guidance for FY14 and predicted industry themes not suited to WEB’s business in the short-term. Facts such as WEB meeting its own short-term guidance, the expectation of strong growth from Zuji & Lots of Hotels in the medium term aided by a commitment to invest in technology and marketing for the future, and maintaining their dividend despite setup costs for Zuji & Lots of Hotels have all been ignored. Investors have also glossed over the strength of WEB’s management team given their ability to make a strategic acquisition in Zuji and rollout a new hotel business without the use of debt and making both profitable in such a short space of time.

The example of WEB illustrates that the share market is a popularity contest in the short term. Most investors jump on companies that are the flavour of the month with scant regard given to long-term fundamental valuations. This can result in quality businesses becoming out-of-favour and undervalued and it’s during these times you should invest to maximise the likelihood of profits down the track.

Please note we have used Webjet for illustrative purposes only and you should obtain professional advice to suit your own objectives before making investment decisions.

This advice may not be suitable to you because it contains general advice that has not been tailored to your personal circumstances. Please seek personal financial and tax advice prior to acting on this information. Opinions constitute our judgement at the time of issue and are subject to change. Financial Planning Expert Pty Ltd does not give any warranty of accuracy, nor accept any responsibility for errors or omissions in this document.
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