The past 12 months have been a story of two halves for investors in Australian equities. In the first six months to December 2021, the market saw a slow rise, up +4%, reflecting steady gains since mid-2020.
Conversely, the past six months have been very stormy, starting with a sell-off in January on concerns about global banks raising interest rates and then a recovery in March and April. The year ended with a big drop in June, when the US Federal Reserve and RBA aggressively raised interest rates to fight inflation.
In the past financial year, the ASX 200, including dividends, has fallen by -6.5%.
Market volatility and rising interest rates so far in 2022 have had the most impact on the high price-to-earnings-ratio (PE) companies, with many of these former market darlings and the pillars of growth manager portfolios appearing in the bargain bin for the first time.
In this piece we will look at the “Dogs of the ASXin 2022, like the black bear in the photo rummaging through the market’s trash in search of treasure, see how the 2021 Dogs performed and see how accurately Atlas’ predictions were in July 2021 for the coming year†
Dogs of the Dow/ASX 100
Michael O’Higgins, in his 1991 book, popularized a systematic investment strategy for investing in underperforming companies called “Dogs of the Dow”. Beating the Dow† This approach aims to invest in the same way that deep value and contrarian investors do.
O’Higgins advocated buying the top 10 worst-performing stocks of the past 12 months from the Dow Jones Industrial Average (DJIA) at the start of the year, but limiting the selected stocks to stocks still paying dividends.
Limiting the investment universe to a large-capitalization index, such as the DJIA or ASX 100, increases the chances of the unloved company recovering in the following year.
Larger companies are likely to have more financial strength – or insight into capital providers (such as existing shareholders and banks) – who can provide additional capital to facilitate recovery from corporate missteps or unfriendly economic conditions.
Conversely, smaller companies in the Dogs of the ASX 200 for 2022, such as ZIP Money (-94%), appear to be fighting for their business lives and will likely face a much greater challenge to still be there in 2023.
Retail investors have an advantage
One reason this strategy persists is that institutional fund managers often report the contents of their portfolios to wealth advisers as part of their annual reviews. This process incentivizes fund managers to sell the “dogs” in their portfolio by the end of the year as part of their portfolio “window dressing” before being evaluated.
For example, in July 2021, fund managers would have seen some pretty stern questions from asset advisors about why they owned an energy company with production issues that had reduced the size of its reserves (Beach Energy +41%). Likewise, many fund managers would have found it difficult to justify a utility company in their portfolio that reported a $2 billion loss (AGL Energy +7%)!
Here, retail investors can have an advantage over institutional investors, as they attract companies whose share prices have come under pressure around the end of the fiscal year due to the sale of tax losses.
In addition, retail investors can afford to take a long-term view of the investment earnings of any company that may have hit a speed bump, as retail investors will not be swayed by wealth advisers who have doubts about its short-term underperformance.
Dogs of the ASX in 2021
Over the past year, the 2021 Dogs were down -2%, significantly outperforming the ASX 200 index’s return of -6.5%.
This makes this the seventh time in the past decade that the Dogs of the ASX 100 strategy has outperformed the index.
From the table below, five of the 10 “dogs” of 2021 outperformed the ASX 200, with Beach energy (ASX: BPT), origin energy (ASX: ORG) and Orica (ASX: ORI) directing the load.
Beach Energy surpassed pessimistic market expectations after solving operational problems in the Western Flank oil field and enjoying the benefits of a 53% increase in oil prices.
Over the past year, Origin Energy has benefited from significant increases in liquefied natural gas (LNG) prices as supplies from Russia have been curtailed.
The share price of explosives manufacturer Orica has recovered from higher profits from high ammonium nitrate prices and the sale of the troubled Minova subsidiary.
Conversely, the pain in FY22 remained for gold miners Evolution (ASX: EVN) after lowering production estimates in April and then again at the end of June, which was poorly received by the market.
Likewise, the stock price of the former market favorite A2 Milk (ASX: A2M) continued its downward trend after reporting declining profit margins and a slump in sales to China amid regulatory issues and Chinese consumers preferring domestic baby food brands.
Our picks for July 2021??
In deciding over 12 months which of the dogs from FY 2021 would recover in the coming year, Atlas’ success rate was better than in previous years.
We predicted that correctly AMP Groups (ASX: AMP) the misery would continue if the vertically integrated financial services company kept breaking itself into smaller pieces.
Similarly, we saw that China’s attitude towards certain imported foods from Australia and New Zealand would not soften and that? A2 Milk would continue to struggle.
Our pessimism towards AGL Energy and Origin Energy was less successful based on the assumption of low wholesale electricity prices and continued government interference in the national energy market, with both companies seeing their stock prices recover. Much of Origin’s outperformance, however, can be traced to rising natural gas prices.
Atlas chose that correctly Beach Energy (the ASX’s best-performing FY21 Dog) was set to recover the following year on the back of an improvement in production and an ongoing recovery in energy prices.
Our other choice for the coming year was that Newcrest (ASX: NCM) would outperform the other gold stocks on the list due to its cheap operations, growth potential and conservative balance sheet. While it’s technically correct, given Newcrest was the best-performing prospector in the past 12 months, given that the company’s stock price fell -15% and underperformed the ASX 200, it’s hard to categorize that as a victory for Atlas.
What will the class of 2022 look like?
Looking at the list of the underperformers of 2022, there are many new faces, with Virgin Money UK (ASX: VUK) the only company to have been on this list of ASX 100 Dogs for the past 10 years before.
Indeed, most of this list would have been the backbone of any top performing growth style fund as of 2020!
Also unusual about the list below is the preponderance of high-quality companies whose stock prices have fallen, not because of self-inflicted injuries, but because they have fallen out of favor with the market.
The three main themes in the Dogs of FY 2022 list are:
- COVID-19 winners come back to Earth after two years of abnormal growth – like Ansell (ASX: ANN)† Dominoes (ASX: DMP) and Fisher & Paykel Health (ASX: FPH)†
- highly valued technology companies have been written down as rising interest rates reduce the present value of profits in the distant future – such as: Xero (ASX: XRO)† Search (ASX: SEK) and Block (ASX: SQ2)and
- companies affected by a slowing economy – such as Virgin UK† Reece (ASX: REH) and Nine Entertainment Co (ASX: NEC)†
Our choices for 2022
Every year, three or four companies in the Dogs of the ASX may seem like a bad addition to an investor’s portfolio on July 1, but the following year they will significantly outperform the market.
When selecting a stock price recovery candidate for the following year, we generally look at companies whose current problems are company-specific rather than caused by factors beyond the control of their management team.
Based on this, Atlas sees that: virgin money and Block They are unlikely to outperform significantly over the next year, with both companies burdened by news of rising bad debts.
Likewise, companies with a high P/E ratio, such as: xero and To search Given the rising interest rate trajectory, it is unlikely that the rating will be revised upwards.
Plumbing & Plumbing & Bathroom Products Company Reece is a high quality building materials company that consistently enjoys higher margins than brick and tile manufacturers. In the coming year, however, many of Reece’s customers will experience significant increases in mortgage payments, which will reduce the demand for bathroom remodeling from $30 to $50 thousand.
Although they are not a fan of their pizzas, does Atlas see that? Domino’s Pizzasat is the most likely candidate in the above Doghouse to recover in the next 12 months.
As rising mortgage payments limit discretionary spending, Dominos should see higher-than-expected sales from budget-conscious consumers who replace a night out at a local restaurant with three large pizzas, garlic bread, and chocolate lava cake, delivered for $29.95!
With less confidence, Atlas also proposes gold prospector Evolution as a recovery candidate, based on the statistic that no company has appeared on the list of dogs for three consecutive years. Evolution’s stock price is at its lowest level in five years, but the company’s manufacturing problems are not permanently insoluble. The prospector’s share price could bounce back in 2023 by improving production, raising the gold price or making a takeover bid.
Hugh Dive’s blue chip strategy to thrive in turbulent markets
Never miss an insight again
If you are not an existing Livewire subscriber, you can: Sign up to get free access to investment ideas and strategies from leading Australian investors.
And you can follow my profile to be notified of other posts when they are published – don’t forget to give them a “like”.
#Dogs #ASX #Fiscal #Year