Learn To Invest
Stocks Special Reports LICs Credit Funds ETFs Tools SMSFs
Video Archive Article Archive
News Stocks Special Reports Funds ETFs Features SMSFs Learn
About

News

WAAAX: Fundies warn Aussie tech darlings ‘too difficult to value’

Emma Rapaport  |  05 Jun 2019Text size  Decrease  Increase  |  
Email to Friend

Australian buy now, pay later juggernaut Afterpay may be forging new ground in the US and UK but some fund managers are avoiding it because they fear it is too hard to value and is at risk of being swallowed up by credit card giants Visa and Mastercard.

Sean Martin, chief investment officer with Solaris Investment Management and Brad Potter, head of Australian equities with Nikko Asset Management Australia, have been monitoring the stellar run of the WAAAX stocks – WiseTech (ASX: WTC), Altium (ASX: ALU), Appen (ASX: APX), Afterpay (ASX: APT) and Xero (ASX: XRO) – with a cautious eye.

But speaking at the Morningstar Investment Conference in Sydney last week, they both agreed the stocks had upset the normal rules of valuation.

Afterpay came in for close scrutiny, particularly because of the 246 per cent rise in its share price in the 12 months to 30 June 2018.

Potter and Martin, however, said they were reluctant to hold it because it’s too difficult to value.

"You have to throw out the valuation textbook to value it," Martin said.

"There's a bull mindset they could take on the world and they would argue that the US market is an audience that's going to grow with incredible speed – but that's too hard for us."

Potter believes if Afterpay manages to "get it right" in their bid for the US and UK markets, that a larger payments platform like PayPal, Visa or Mastercard will come it and "take it out".

Potter and Martin’s comments came in response from Morningstar moderator and analyst Michael Malseed, who wanted to know why Australian investors pay more for growth stocks.

Malseed’s question referenced new research from Goldman Sachs Australia, which showed high growth stocks in Australia appear much more expensive than other markets.

Goldman defines high growth stocks as companies with a market cap greater than $500 million, which are expected to deliver more than 20 per cent earnings per share growth over the next two forecast years.

This universe includes the WAAAX stocks as well as implant company Cochlear, investment and superannuation platform HUB 24, and biotechnology company CSL.

High valuations

Lead researcher Matthew Ross found the premium for growth in Australia is 25 per cent above the second most expensive market for growth stocks, the US (31.5x).

"'High growth firms listed in Australia now trade on a forward price-to-earnings of 38.9x (median) after an average share price return of 62 per cent over the past 12 months,” Ross said.

"The valuation premium of Australian growth stocks is the highest when compared to both the global average for growth stocks (65 per cent above the 23.5x global average) and the broader average of the local market (135 per cent above the 16.3x P/E for ASX stocks).”

12 month forward P/E of stocks forecast to grow EPS by >20pc p.a. over FY1 to FY3

High growth stocks Australia

Source: Goldman Saches Global Investment Research, Bloomberg

On the opposite end of Ross's high growth list is Altium, with only one mark against it owing to its premium to the market. Founded in 1985, Altium is an Australian-owned company headquartered in California, which provides software for engineers who design printed circuit boards.

While Martin says he can't justify the company's valuation, he admits that it is the only WAAAX stock they're willing to own.

"When we're talking about valuations, we're the first to admit that the Altium price is hard to justify – and accordingly we've sold two thirds of our position in it," he said.

"However, we think we think they have something that's very hard to replicate. I actually bought it in 1998 when I worked for Schroders and the company was called Protel.

"Altium have not missed a number for five years, the chief executive owns a material amount in his own name and has this great market share and a captive audience. [This in contrast to] WiseTech that has acquired most of its growth over that period."

Scarcity, low interest rates blamed

So why are Australian investors paying a premium for these stocks? Martin and Potter argue it’s a matter of scarcity.

"I don't think there's enough in the market," Martin said. "I think the answer is scarcity – it's all new to Australia – we didn't have a sector like this three to four years ago."

Potter echoed this, saying: "The cohort of Australian high growth companies is so small compared to the incredible breadth companies you can buy in the US."

Goldman’s Ross, however, disagrees. He says while the scarcity of growth companies in Australia is "certainly a factor" – making up 11 per cent of the Australian market by number of stocks, and 3 per cent by market cap – high growth stocks are just as rare in other markets where the growth premium is more modest. 

Ross leaves open the question of why Australians are paying a premium for growth stocks. 

“We continue to recommend investors be underweight this cohort stocks, and increasingly this view seems to be shared by a number of domestic fund managers,” he said.

"While these figures are among the lowest levels globally, they are broadly in line with a few other developed markets where the growth premium is significantly lower.

Afterpay touch

Potter believes if Afterpay manages to 'get it right' in their bid for the US and UK markets, that a larger payments platform like PayPal, Visa or Mastercard will come it and 'take it out'

"Further, it does not appear to be a case of the Australian firms trading on higher multiples because of higher growth rates. The average price/earnings to growth ratio across the Australian firms (1.0x) is significantly above the global average (0.76x)."

Ross also says a common view that the fall in long-term interest rates has contributed to a large expansion in P/E multiples for Australia's long-duration growth stocks is limited.

"The fall in long-term interest rates has contributed to a large expansion in P/E multiples for Australia’s long-duration growth stocks," he said.

"That said, it is hard to reconcile these moves globally. Despite falling to all-time record lows, Australia’s 10-year bond yields are still relatively high when compared globally (below only China and the US).

"Even in countries where long-term interest rates are negative, the valuation premium attached to structural growth stocks is significantly lower than it is in Australia."

Warning signs

Ross says that while “growth firms” have outperformed the ASX 200 by 2.1 per cent over the past 20 years, identifying stocks with certain characteristics that have historically been linked to underperformance can help investors recognise the warning signs of future poor returns.

These include large share issuance, low profitability, large goodwill balance (as a percentage of market cap), and high gearing. Companies that score worst under Ross's framework have underperformed by an average of -15 per cent a year.

Companies that score worst under Ross's framework include telco Vocus, health supplement company Blackmores, logistics and infrastructure company Qube, and multinational media giant News Corporation. Real estate classifies business Domain, infant formula producer Bellamys and Afterpay.

is a reporter for Morningstar.com.au

© 2019 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

Email To Friend