Medium to longer investors can focus in triple plays to generate alpha on a sustainable basis – DNH

DNH Financial is urging investors who are medium to long-term in outlook to focus on what it described as “triple play” to generate returns on a sustainable basis. It defined triple play as stocks with sustainable top line growth, firm earnings momentum and healthy market liquidity. Here are excerpts from DNH Financial’s weekly review of and outlook for the stock market:

Short and sticky trading week

In what was a shortened trading week characterised by sticky trading, the bellwether ASPI closed 1.2% lower to end the week at 6332 while the MPI also lost 0.8% to close at 5652.

Reflecting lackadaisical investor activity, average daily turnover for the week declined by 73.8% to Rs. 1.7 b with the only significant trades recorded by John Keells Holdings, Chevron Lubricant and Sampath Bank which collectively accounted for 29% of the week’s total.

Losers outpaced gainers with Hotel Developers, SMB Leasing (W0015) and Mercantile Shipping declining by 27.1%, 18.2% and 14% offsetting gains in Lanka Ashok, Huejay and Miramar which rose by 23.3%, 19.7% and 17.2% respectively.

Global markets

Global markets meanwhile traded in mixed territory, albeit with a downward bias see sawing between Italian Prime Minister Silvio Berlusconi’s offer to resign and Greece’s new Prime Minister Lucas Papademos’ pledge to implement the bailout package.

While we do contend that the Sri Lanka bourse has not delivered in the recent past as a result of a multitude of factors, we view the current consolidation as a strong opportunity to accumulate quality liquid stocks that will outperform in the medium to longer term.

Consequently, we advise investors to pro-actively seek counters that are likely to record healthy and sustainable top line growth, firm margins, are cash generative and are sufficiently liquid; attributes which we believe will lead to above average gains and outperformance.

In this respect, we re-iterate the need for investors to take a directional call, make an informed investment decision, build a robust portfolio and maintain a strict investment discipline over a medium to longer term investment horizon in order to benefit fully from our expectation of a moderately secular bull market that will take shape going forward.

Go for triple plays

While the market as a whole may not be in a rising tide, we advise investors to select triple play stocks that we believe have the potential to be lifted. Companies with sustainable top line growth, firm earnings momentum and healthy market liquidity being our criteria for triple plays are likely to increasingly re-rate to higher multiples over the medium to longer term. While all stocks go through cycles of undervaluation and overvaluation, investor returns can be maximised by taking advantage of these cycles, buying triple plays when they are undervalued and subsequently selling them when they are overvalued.

Sustainable top line growth

With the 3Q2011 corporate results season coming to an almost end, it is time to go cherry picking once again. Given the fact that most investors would now agree that the potential for short term trading opportunities are markedly limited, selecting medium to longer term investments would depend on a number of parameters, most importantly the strength of the top line and its sustainability. Although 3Q2011 consolidated top line revenues have grown by 18%, obviously not all companies have reported equal growth. While the ongoing rise in domestic consumption levels and growth in corporate revenues are definitely encouraging against the backdrop of the global slowdown, the majority of companies in the Motor, Diversified, Land & Property and Trading sectors have posted significantly higher revenue growth ahead of others.

Strong earnings are just not enough

While we do not rule out the importance of earnings as a strong indicator of growth, it is highly important to determine the source of profits, whether a result of top line growth or an increase in other income or a dramatic cut in costs that could have a negative impact on future productivity. Of perhaps even more significance is the sustainability of such earnings.

In this respect, while we advise investors to seek quality, both in terms of the top line and the bottomline, we accentuate the need to select stocks that may not only pass the quality test in terms of fundamentals but are also sufficiently liquid with a healthy bid/offer spread.

Range bound momentum may continue in the short termWe are admittedly in a range bound market where the reversal of market moves appear to be generally the order of the day. If investors do not recognise the idiosyncrasies of a range bound bourse, they may find themselves burnt in the reversal process while merely tossing funds at market indices – a strategy that did wonders in the past but is unlikely to prove successful in the present.  Considering the current market conditions, we advise investors to be focused, select stocks carefully and maintain a healthy investment horizon in order to emerge a winner in the medium to longer term.

Sit in cash if you are still seeking short term gains

As investors, if you still desire speculative short term gains, we believe it is may be far more prudent to sit in cash as an asset class rather than invest in the bourse in anticipation of overnight gains which could prove to be potentially loss making and subject to high volatility.

While cash assets may generate negative or mildly positive real returns, they can still be far less risky than speculative trading activities whose downside risks can be significant given the current low market liquidity.

However for those investors who seek a medium to longer investor horizon investing in triple plays should generate alpha on a sustainable basis.