Honing the stock picking skills

Johannesburg - The recent rally in equities will force value seekers to sharpen their stock-picking skills.

Alwyn van der Merwe, director of investments at Sanlam Private Investments (SPI), said on Tuesday the stock markets rally will only be sustainable if rising company shares are backed up by better reported earning.

He pointed out that after most stock market slumps where shares are heavily sold down, the valuations typically tend to recover in two stages. The first stage is courtesy of a broader re-rating of stocks, and the second when the earnings of companies actually start to impress.

Van der Merwe said the present rally reflected the end of the first phase, but earnings have not yet come through; this is where much attention will be focused for analysts and investors going forward.

Cause for caution

Since March 2009, the JSE Top40 index has rallied nearly 40% in Rand terms and over 100% in US dollar terms. This, coupled with the dramatic recovery in the S&P500 index - which has recovered 51% in dollar terms - marks one of the quickest equity market recoveries in history.

This, says Van der Merwe, is cause to exercise some caution.

Van der Merwe said aggressive fiscal and monetary policies of the world's major central banks have injected money in the form of stimulus packages into the global economy, but a recovery in the underlying economies is likely to be far slower than what is being reflected in the market.

"In short, we think that the quantitative easing will work, but the recovery will be at a much slower pace," he said.

This means investors will now have to look at the underlying fundamentals and investment merits of companies, rather than broadly buying into the market rally.

One of the key metrics that SPI uses when assessing a potential share is the return on equity (ROE) that the business is able to generate. Van der Merwe said this technique has been used very successfully by Kokkie Kooyman, manager of the Sanlam Global Fund, to pick shares - particularly in the financial services and banking sector.

Kooyman has received kudos for being one of the few managers to begin aggressively buying shares during March 2009, when other managers were ducking for cover and moving into cash - a decision which has paid off handsomely for him.

"The important thing to remember when using ROE is that you need to compare shares in the same sector," cautioned Van der Merwe.

SPI Stock picks

The five stocks which remain the cornerstones of the SPI portfolio are media group Naspers, telecommunications firm MTN, British American Tobacco, resource giant BHP Billiton and banking group Standard Bank.

Van der Merwe said the strong dividend yield of tobacco giant British American Tobacco was a key factor, pointing out that since 2000 the share has seen its dividend yield grow 14% per annum.

Despite the recent run-up in commodity stocks, Van der Merwe said he was also quite upbeat on the prospects of mining heavyweight Anglo American, but added that SPI would be a buyer of the stock at around R220 to R225 a share, rather than its current level of R250 a share.

- Fin24.com