Warren Buffett’s annual shareholder letter was published over the weekend as part of Berkshire Hathaway’s 2017 annual report.
And in the wake of the latest dose of investing wisdom from the Oracle of Omaha, Credit Suisse equity strategists Hasan Tevfik and Peter Liu have highlighted how Buffett’s lessons can be applied to the ASX200.
Among his various market observations in the letter, Buffett said that while stocks have more daily volatility than bonds, over-exposure to bonds is likely to be “a terrible mistake” over the longer term.
He added that Berkshire is currently sitting on more than $US100 billion in cash, but didn’t pull the trigger on a big deal in 2017 because everything looked too expensive.
To start with, Credit Suissse equity analysts Hasan Tevfik and Peter Liu considered how Buffett’s anti-bond stance is relevant to Aussie stocks.
They noted that Buffett was referring to the low returns on a bond investment made in 2007, as interest rates stayed low in an era of unprecedented monetary stimulus.
In such an environment, bond investments can be more risky than stocks. And on the flip side, companies have been able to issue bonds at low rates to secure a cheap source of finance.
But Tevfik and Liu said to watch out for Australian stocks which are highly leveraged, now that interest rates are rising on the back of steady global economic growth.
They cited the example of oil & gas company the APA Group, one of the most leveraged companies on the ASX200, which had to ask shareholders for an extra $500 million in a surprise capital raising.
“Debt markets have been kind to APA through its entire existence, but now they have turned risky and it could be time to use less debt and more equity,” Tevfik and Liu said.
“Shareholders are set to suffer. We think this is a lesson for all of our highly leveraged companies.” APA shares are down more than 5% in afternoon trade.
While on the subject of bonds, the two analysts also advised investors to steer clear of their “Bondcano” stocks — the Aussie companies whose valuations are looking stretched in an environment of rising bond yields.
Here’s a summary of the Bondcano stocks, from the duo’s research last year:
“The reporting season has been a dismal one for the stocks at the top of our Bondcano,” the pair said.
“The infrastructure stocks are all there and it is telling that these companies struggled during the reporting period,” they said, noting that Transurban and Sydney Airport both missed earnings estimates.
When it comes to buying stocks at a sensible price, the two analysts said it still pays to be positioned towards stocks with a low price to earnings (PE) ratio, which increases as a company’s price rises faster than projected earnings.
While the PE ratio has its share of critics, Tevfik and Liu said companies that came into the February reporting season with the lowest PE ratios had outperformed the market.
“Our positioning continues to be towards low P/E stocks. They are less sensitive to rising bond yields and also many of the cyclicals should continue to perform well as the rising tide of an earnings expansion provides important support,” the pair said.
Lastly, Tevfik and Liu heeded Buffett’s advice that “betting on people can be more certain than betting on physical assets”.
In other words, invest in companies that have the best management. The analyst’s highlighted Alan Joyce’s stewardship of Qantas as a clear example of how an effective CEO can add value.
While Buffett’s exposure to the ASX200 is small — aside from a stake in insurer IAG — it probably pays to apply his investing insights where possible.
Berkshire Hathaway’s 2017 results show the company has achieved a cumulative gain in market value per share of 2,404,748% since 1965.