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Wednesday 16

January, 201911:19 PM



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WAAAX Stocks -- Buy or Stay Away

WAAAX Stocks -- Buy or Stay Away

By Bob Kohut 17.12.2018


Not to be outdone by the Yanks, the Australian investment community adopted its own acronym for the hottest of our hot tech stocks, WAAAX, composed of:

• Wisetech Global (WTC);
• Afterpay Touch Group (APT)
• Altium Limited (ALU);
• Appen Limited (APX);
• Xero Limited (XRO).

Since the US stock markets have a strong influence on world markets, it seems only natural to coin our own version of the fabled FAANG US stocks, composed of:

• Facebook (FB)
• Amazon (AMZN)
• Apple (AAPL)
• Netflix (NFLX)
• Google parent Alphabet (GOOG)

The red-hot rise of the FAANG stocks came to an abrupt halt in October of this year, with the group seeing a collective 20% drop, the worst decline since the onset of the GFC in November of 2008.

With US stocks setting the pace, the high-flying Aussie WAAX stocks also fell.  Since 13 October the average decline is 14.6% with Afterpay Touch Group investors suffering the most, down 24%, and Appen shareholders suffering the least, down 6%.

All booming sectors suffer from “irrational exuberance”, a phrase popularised by former chairman of the US Federal Reserve, Alan Greenspan, where analyst and experts alike line up to scream “overvalued.”

Buried within that phrase is something all retail investors would do well to remember – share prices do not reflect the fundamental value of the company.  The price is determined by supply and demand; not for whatever it is the company sells, but for the shares of the stock itself.  Perception is tainted by future expectations, in many cases ignoring present and historical performance.  Once anointed as a market darling, demand for a stock can reach and exceed the point of irrational exuberance.

Once upon a time the share price reflected how the investing community felt about the company’s long-term prospects.  The digital age has radically and forever changed the share market trading environment.  Algorithmic machine trading now dominates trend-setting US markets.  The instant availability of financial information undreamed of by investors of old enables short-term trading on a grand scale, with momentum investors jumping on a hot trend and dumping once the trend cools.  Some investors shorten the investing time frame to a single day.

Amid what many see as the chaos of the modern investing world stands the lonely, average, ordinary retail investor.  Given the restraints of time and expertise, many retail investors shy away from investing approaches requiring extensive research and constant monitoring of macroeconomic, market, and business sector trends.  Finding stocks to hold for a reasonable time frame is the preferred approach for many.

What stocks to buy can be confusing, with contradictory analyst and expert advice to buy low and sell high versus buying high and selling higher.  Perhaps the scariest advice of all is the “overpriced” tag.  Hot sectors like technology over the past year or so see rapid rise in share prices, leading to analyst claims of lofty valuationsout of touch with reality.

A frequent statistic used to support the “overpriced claim” is the earnings multiple, or Price to Earnings ratio (P/E), calculated by dividing the stock price by the earnings per share (EPS).  Thus, Stock A is said to be trading at 20 or 40 or more times its earnings.  Unfortunately, not all financial websites posting P/E ratios state what earnings figure is used in the denominator.  Although the P/E or earnings multiple is the most frequently used measure of valuation, there are problems with this ratio.

The first is the share price itself, which as noted reflects market perception.  The second is the EPS does not capture future growth.

Earnings multiple based on estimated EPS are better measures but are found only in the commentary of selected analysts.  The more available measure is the P/EG ratio, or price to earnings growth ratio, where the current share price is divided by estimated future earnings.

It is predictable when a drop happens in “overpriced” stocks financial websites begin posting articles speculating whether buying on the dips is something to consider.  

Despite nearly unanimous claims the WAAAX stocks were overpriced going into the recent decline only Wisetech Global lacks a consensus analyst rating of OUTPERFORM, with a HOLD recommendation.  The following table lists the five by market cap with relevant measures for an investment decision.


The Afterpay Touch Group P/E and P/EG could well be described as irrational, but the stock had the highest share price appreciation year over year and for a two-year time frame as well, besting its closest competitor, Appen Limited.


Afterpay also has the most impressive growth estimates, but since its 2017 listing on the ASX the company has yet to turn a profit while revenues have jumped substantially.  The company offers its retail merchant clients a platform allowing customers to “buy now, pay later.”  The company is expanding in both the US and the UK but there is a cloud on the horizon, stemming from high-level government inquiries into various financial companies.  The Haynes Commission into financial institution practices did not include pay-day lenders and buy now pay later firms but a new Senate inquiry could threaten Afterpay’s future growth.

With the exception of Xero all the other WAAX stocks have solid growth prospects, which might lead retail investors to wonder how they could be overpriced.  The answer may lay in the conventional market wisdom that says expected future performance in high-growth stocks is “baked in” to the current share price, leading to severe declines if expectations are unmet and less than spectacular movement without substantially exceeding expectations, signaling more growth on the horizon.

With only negative earnings to report for the past three fiscal years, Xero has no reported P/E or P/EG.  The company provides cloud-based accounting services to small and medium sized businesses (SMEs) and has been in business in New Zealand since 2006.  The company now trades solely on the ASX.

The company operates globally and the market for cloud-based accounting among SMEs is growing.  Some analysts favor Xero over the other WAAX stocks, perhaps due to its international expansion and revenue growth, with positive earnings not far away.

According to the Reuters financial website, 2019 EPS estimates for XRO have dropped from +$0.0535 per share to - $0.085 within the last month, with a strong rebound to $0.2578 in 2020.  However, the 2020 EPS estimate also dropped over the last two months, down from $0.3745.

Investors who buy the “overpriced” narrative might be attracted to Appen Limited of all the WAAX stocks.  The company has the lowest P/E and a mouth-watering P/EG, where anything under 1.0 is considered a bargain.

The company listed on the ASX in 2015 and has grown revenues and profit by double digits in each of the last three fiscal years.  Appen operates in a sector expected to grow dramatically in the coming decade -- machine learning and artificial intelligence. 

The share price since listing bests that of market darling Afterpay and has kept pace in total shareholder appreciation with APT since that company listed a little more than a year ago.


Appen operates internationally, with centres here in Australia, the US and the UK, the Philippines, and China.  Language recognition spans more than 180 languages and data analytics powered by artificial intelligence and a host of other software solutions meets the needs of organizations in government, finance, retail, healthcare, automotive, and technology.

On 11 November following the October rout Appen upgraded its Full Year 2018 guidance by 12.4%, welcome news for harried investors.  
 
One of the concerns leveled at companies like Afterpay and other stocks that come roaring out of the box on fire is they have little or no operating history to judge. 

Altium has been a leader in circuit board design since the late 1990’s, now operating largely as a SaaS provider (Software as a Service).  Altium Designer is an electronic design solution, with the added benefit for customers of AltiumLive, an online forum for designers from around the world as well as design resources.  The company also offers a data management system – Altium Vault – and a tasking system for industry standard operating systems and software program management.

Here are some of the company’s performance highlights:

• 5 Year average earnings growth rate of 57.1%

• 10 Year average earnings growth rate of 44.4%

• Average Dividend growth rates of 19.5% over 5 years and 33.9% over ten

• Average annual rates of Total Shareholder Return -- 72.2% over three years; 61.9% over five; and 50.6% over ten years.

• 5 Year Average Return on Equity of 40.54%

• 5 Year Average Return on Assets of 50.1%

While some will still scoff at the WAAAX stocks until their share prices drop further, note that all five have already begun to recover from the October onslaught.
 
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