How to pick stocks in a lack­lus­tre mar­ket

Bear mar­kets and re­ces­sion­ary times in fact of­fer great buy op­por­tu­ni­ties for in­vestors. But it is im­por­tant to pick stocks that will with­stand the bad times. Trader Petri Redel­inghuys ex­plains his method­ol­ogy to find lo­cal win­ners.

Finweek English Edition - - Contents - By Petri Redel­inghuys

it is no se­cret that the South African econ­omy is in trou­ble. Af­ter a brief bout of Ramapho­ria, mar­kets once again re­alised that we had had ten years of Zuma – and now four years of side­ways mar­ket ac­tion with no real re­turn.

This could no longer be ig­nored as SA has de­cay­ing eco­nomic con­di­tions and wilt­ing con­fi­dence, both do­mes­ti­cally and from the in­ter­na­tional in­vest­ment com­mu­nity.

SA has a mon­u­men­tal task be­fore it and the changes needed within gov­ern­men­tal struc­tures and in the broader so­cio-eco­nomic land­scape will take a lot of ef­fort and a lot of time to af­fect. It may feel like time passes quickly, but the re­al­ity is that things change slowly.

Op­ti­mism is not ill-founded. But we must stay cog­nisant of the cur­rent state of our econ­omy and how the cur­rent eco­nomic back­drop can ei­ther per­pet­u­ate cur­rent mar­ket themes or per­haps ig­nite new ones.

THEME 1: Times of un­cer­tainty

The theme dom­i­nat­ing the SA in­vest­ment land­scape at present is prob­a­bly that of un­cer­tainty. No doubt some­thing that many are tired of hear­ing about by now, as fi­nan­cial me­dia has made countless ref­er­ences to un­cer­tainty be­ing the driver be­hind the poor mar­ket per­for­mance lo­cally.

But to con­tex­tu­alise: In­vestors base their de­ci­sions to ei­ther in­vest di­rectly into an econ­omy or via fi­nan­cial mar­kets on a set of long-term ob­jec­tives unique to them. They have an al­most in­fi­nite num­ber of in­vest­ment op­tions from which they can choose and there­fore en­deav­our to choose the in­vest­ment that they be­lieve will best bal­ance their ap­petite for risk with their ex­pec­ta­tion for re­turn.

Go­ing through five fi­nance min­is­ters in six years does not ex­actly com­mu­ni­cate a mes­sage of sta­bil­ity and low risk.

When things like the lead­er­ship of ar­guably one of the most im­por­tant min­istries in a coun­try can change so abruptly, it be­comes dif­fi­cult to fore­cast what con­di­tions are go­ing to be five or ten years from now. There­fore, in­vestors are re­liant on the re­cent past as a frame of ref­er­ence. Thus far that frame of ref­er­ence in­di­cates that the lead­er­ship struc­tures in our gov­ern­ment are un­sta­ble and un­pre­dictable. Even though we now have a very strong and cred­i­ble fi­nance min­is­ter in the form of Tito Mboweni, given the re­cent track record we can­not at all be cer­tain that he is go­ing to still be around in a few years from now.

Add to that the rhetoric around land ex­pro­pri­a­tion with­out com­pen­sa­tion; fail­ing state-owned en­ter­prises in con­stant need of tax­payer-funded bail-outs; grow­ing dis­con­tent to­wards gov­ern­ment from the pub­lic; our ail­ing econ­omy; ex­ces­sively high un­em­ploy­ment; and all the var­i­ous ex­ter­nal fears and shocks caused by the pull-back in in­ter­na­tional mar­kets… Ladies and gentle­men, we have a recipe for un­cer­tainty about the fu­ture. Put more sim­ply, we have a lot of risk and no way of know­ing whether that risk will re­ward in­vestors in ac­cor­dance with their ex­pec­ta­tions for re­turns.

This theme has had a ma­jor in­flu­ence on our econ­omy over the last two years. This is best re­flected in the de­cline in for­eign di­rect in­vest­ment in SA since 2016.

THEME 2: Re­ces­sion time

The next ma­jor theme is that of de­cel­er­at­ing GDP growth. SA’s GDP growth fore­cast has been cut from 1.5% for 2018 to 0.7%, with the econ­omy shrink­ing a sea­son­ally ad­justed an­nu­alised 0.7% in the sec­ond quar­ter, fol­low­ing a 2.6% con­trac­tion in the first quar­ter. Ac­cord­ing to econ­o­mist Mike Schüssler, and the BankservAfrica Eco­nomic Trans­ac­tion In­dex (BETI) Septem­ber re­port, GDP could well have picked up some­what in Au­gust – maybe even enough to have put an end to the tech­ni­cal re­ces­sion.

But he warns that the uptick in the BETI was mainly due to back­dated “salary in­creases for civil ser­vants in July and Au­gust, and the late salary ad­just­ments of Eskom em­ploy­ees and some mu­nic­i­pal work­ers. We may still see de­layed back­dated pay­ments oc­cur

in Septem­ber, which will add to eco­nomic trans­ac­tion im­prove­ments.”

He warns that “one or even two months of data are hardly ever an in­di­ca­tion of a change in trend. The de­layed salary in­creases have cer­tainly played a pos­i­tive role but, once these are out of the sys­tem, the un­der­ly­ing down­ward trend may con­tinue.”

The BETI mea­sures eco­nomic trans­ac­tions among bank ac­counts in SA and is a very re­li­able in­di­ca­tor for the level of eco­nomic ac­tiv­ity with a very high cor­re­la­tion to GDP.

Schüssler’s re­port might there­fore in­di­cate a short-term re­prieve from the con­tract­ing GDP, but the mes­sage is clear: Don’t hold your breath.

THEME 3: Gov­ern­ment debt

Over the last decade, SA’s bud­get deficit has av­er­aged 4.3% of GDP and came in at 4.6% of GDP last year. This year it is fore­cast to be 4% (re­vised from 3.6%) and is ex­pected to rise to 4.2% in 2019/20, af­ter which it should sta­bilise at 4% in the years that fol­low.

This bud­get short­fall needs to be funded some­how, which means that gov­ern­ment needs to bor­row money from cap­i­tal mar­kets. Over the last decade, gov­ern­ment debtto-GDP has nearly dou­bled to 53.1% of GDP last year, with the ex­pec­ta­tion that it will sta­bilise at 59.6% by 2023/24.

There­fore, debt pay­ments are be­com­ing a larger por­tion of gov­ern­ment spend­ing (it’s the third­fastest grow­ing ex­pense the SA gov­ern­ment has).

Fur­ther, the ris­ing yields of 10-year gov­ern­ment bonds is a sign that in­vestors are be­com­ing less con­fi­dent in SA’s abil­ity to re­pay its long-term debt obli­ga­tions and are thus sell­ing their bonds. It fol­lows that if this trend con­tin­ues, the cost of fi­nance could in­crease to an un­af­ford­able level over the same pe­riod that the gov­ern­ment debt-to-GDP ra­tio is ex­pected to reach nearly 60%.

Our new fi­nance min­is­ter has warned that if gov­ern­ment debt-to-GDP ex­ceeds 60%, SA would po­ten­tially have to ap­proach the In­ter­na­tional Monetary Fund (IMF) in search of fund­ing the coun­try. The IMF is likely to im­pose all sorts of aus­ter­ity mea­sures as a con­di­tion to ex­tend­ing fi­nance, which would pretty much guar­an­tee lower lev­els of gov­ern­ment spend­ing. That would prob­a­bly cost our econ­omy many gov­ern­ment jobs, as well as even lower lev­els of over­all ser­vice de­liv­ery.

Thank­fully, Ramaphosa is be­ing very proac­tive about bring­ing re­forms to gov­ern­ment and at­tract­ing di­rect in­vest­ment into our econ­omy. Also, our new fi­nance min­is­ter seems to be com­mit­ted to not in­creas­ing gov­ern­ment’s spend­ing limit. This could help SA fight back against the forces of a slow­ing econ­omy and an ever-in­creas­ing bud­get deficit.

THEME 4: In­vestor con­fi­dence

The con­fi­dence that rat­ings agen­cies have in SA’s abil­ity to turn the ship around has had a ma­jor in­flu­ence on our econ­omy and con­trib­utes to the theme of un­cer­tainty. Both Stan­dard & Poor’s and Fitch rat­ings agen­cies have down­graded SA gov­ern­ment debt to sub-in­vest­ment grade, or junk sta­tus.

For now, Moody’s In­vestors Ser­vice has been SA’s sav­ing grace as they still rate our gov­ern­ment debt one notch above junk. This means that our gov­ern­ment bonds are still in­cluded in ma­jor global bond in­dices and are there­fore still be­ing held in ma­jor global bond funds.

Al­though Moody’s has ex­pressed that it con­sid­ered the medium-term bud­get pol­icy state­ment, de­liv­ered by Mboweni in Oc­to­ber, as credit neg­a­tive, it has not made any ad­just­ments to SA’s credit rat­ing and is prob­a­bly un­likely to do so un­til af­ter the gen­eral elec­tion next year.

Politi­cians tend to beat all sorts of drums to get elected into of­fice, but once there, their – and hu­mour me here – “prom­ise to de­liv­ery ra­tio” is rather low. There­fore, we are un­likely to have a clear plan on how land ex­pro­pri­a­tion with­out com­pen­sa­tion will be im­ple­mented, for ex­am­ple, un­til af­ter the elec­tion. On that ba­sis, it is equally un­likely that we will see rat­ing agen­cies make any changes to their out­look on the econ­omy un­til “the pud­ding is served”.

THEME 5: A bear phase in de­vel­oped mar­kets

Tight­en­ing monetary pol­icy in de­vel­oped economies like the US and EU is not only re­mov­ing liq­uid­ity from global mar­kets and driv­ing the flow of in­vest­ment away from emerg­ing mar­kets into de­vel­oped mar­kets, but is also prob­a­bly the main an­tag­o­nist be­hind the global mar­ket cor­rec­tion. The im­pact a larger-scale global cor­rec­tion could have on al­ready un­der­per­form­ing emerg­ing mar­ket economies should

Even though we now have a very strong and cred­i­ble fi­nance min­is­ter in the form of Tito Mboweni, given the re­cent track record we can­not at all be cer­tain that he is go­ing to still be around in a few years from now.

not be un­der­es­ti­mated.

It would not be sur­pris­ing to see de­vel­oped mar­kets en­ter a bear mar­ket, or even a re­ces­sion, over the next 6 to 18 months. If that does in fact hap­pen, the like­li­hood that our econ­omy and mar­ket fol­lows a fur­ther down­ward trend is ex­tremely high.

The in­vest­ment the­sis

Each of us must sit down and con­sider whether these themes are more likely to per­sist or dis­si­pate over the medium term. If you are of the view that they will dis­si­pate, then you’d prob­a­bly look to buy the shares you want now as they are cur­rently avail­able at a dis­count. If, how­ever, you be­lieve that these themes will per­sist, then you have two choices: In­vest in non-cycli­cal de­fen­sive stocks, or in­vest in long-term value stocks.

As a gen­eral warn­ing: Even though there is value to be found on the JSE now, share prices could come down more if these themes per­sist. The like­li­hood of buy­ing at the bot­tom is rather low and you might need to ex­er­cise pa­tience be­fore you can reap your re­ward.

Non-cycli­cal, de­fen­sive stocks

Non-cycli­cal stocks, or de­fense stocks, are stocks that are in eco­nomic sec­tors that are gen­er­ally not af­fected by the cycli­cal na­ture of mar­kets. In other words, these com­pa­nies are in sec­tors that are gen­er­ally not too af­fected by changes in con­sumers’ dis­pos­able in­come. The pri­mary sec­tors con­sid­ered to be de­fen­sive are: con­sumer sta­ples such as food re­tail­ers and pro­duc­ers; “sin stocks” such as al­co­hol and tobacco com­pa­nies; health­care and phar­ma­ceu­ti­cal com­pa­nies; util­i­ties such as elec­tric­ity and telecom­mu­ni­ca­tion providers; and then, of course, “safe haven” com­modi­ties such as gold, cop­per, tim­ber and maize.

When look­ing for shares in de­fen­sive sec­tors, we must be pru­dent to only buy those that have a solid in­vest­ment case. It is a bit of a process to find these stocks, but luck­ily tech­nol­ogy has made it some­what eas­ier.

You could start by mak­ing use of the stock screener avail­able for free on­vest­ to scan for stocks that are in the con­sumer/non-cycli­cal sec­tor, or any of the other tra­di­tion­ally de­fen­sive sec­tors.

Once you have a list of shares, you are then able to fil­ter them fur­ther so that you can iso­late those shares that match what­ever fun­da­men­tal or tech­ni­cal cri­te­ria you might spec­ify. From there, you are able to study each of the stocks on the list and de­cide whether to in­vest or not.

A good start is to scan for com­pa­nies that have a pos­i­tive div­i­dend growth rate, a price-to-earn­ings ra­tio (P/E) of less than 16, and a to­tal debt-to-eq­uity ra­tio of less than 51%. From there, fur­ther fil­ter­ing for liq­uid­ity, and do­ing some re­search on the com­pa­nies them­selves, could help to com­pile a list of po­ten­tially in­vestable stocks.


1. As­tral Foods

P/E: 5.57 Div­i­dend yield: 9.45% Div­i­dend growth rate: 33.84% Debt-to-eq­uity: 1.03%

As­tral Foods is a ma­jor chicken and agri­cul­tural feeds pro­ducer. Dur­ing the last fi­nan­cial year, it sold more than 230 000 tonnes of chicken and over 703 000 tonnes of maize. Fifty-nine per­cent of that maize was sold in­ter­nally to the com­pany’s chicken pro­duc­ing di­vi­sion. Thus, it is ver­ti­cally in­te­grated and ca­pa­ble of sus­tain­ing its chicken pro­duc­tion from its own agri­cul­tural feed pro­duc­tion.

Chicken also hap­pens to be the pri­mary source of meat pro­tein for most South Africans and is also by far the cheap­est. A strong rec­om­men­da­tion has been made to zero-rate VAT on chicken and if that were to hap­pen, it would no doubt have a tremen­dously pos­i­tive im­pact for chicken pro­duc­ers.

The share price has been un­der a lot of pres­sure in re­cent times, al­though the lat­est trad­ing state­ment in­di­cates that full-year head­line earn­ings per share (HEPS) will re­flect an in­crease of be­tween 90% and 100%.

As­tral is not only a de­fen­sive stock, but a value stock as well.

2. Tiger Brands

P/E: 13.23 Div­i­dend yield: 4.2% Div­i­dend growth rate: 4.7% Debt-to-eq­uity: 7.8%

Tiger Brands oper­ates in the con­sumer sta­ples space, with brands such as Oros, Koo, Tas­tic, Al­bany, King Korn, Pu­rity, En­ter­prise, Jelly Tots, All Gold, Bea­con, Black Cat and more.

The share price was re­cently hit hard, as the com­pany was re­spon­si­ble for an out­break of lis­te­rio­sis. It ap­pears that the fall­out from that out­break has now been con­tained as Tiger Brands re­opened the fac­tory in Ger­mis­ton that was re­spon­si­ble, af­ter rig­or­ous as­sess­ments by the depart­ment of health.

3. Telkom

P/E: 9.3 Div­i­dend yield: 6.5% Div­i­dend growth rate: 18.2% Debt-to-eq­uity: 34.9%

Telkom has pulled off a re­mark­able turn­around over the last five years. It has re­struc­tured it­self by ac­quir­ing BCX (an ICT ser­vices com­pany), availed its in­fra­struc­ture via Open Serve and out­sourced main­te­nance and man­age­ment of its as­sets through a wholly-owned en­tity called Gyro.

The next step forTelkom would be to start un­lock­ing value from its new data prod­ucts and grow­ing its mo­bile mar­ket share. Over the last five years, the com­pany has proven it­self able to adapt and im­prove on a con­sis­tent ba­sis.

4. Vo­da­com

P/E: 13.5 Div­i­dend yield: 6.6% Div­i­dend growth rate: 1.7% Debt-to-eq­uity: 50.1%

Vo­da­com has op­er­a­tions through­out South­ern Africa, with its largest mar­ket be­ing SA it­self. Dur­ing the 2018 fi­nan­cial year, it added 7m new cus­tomers and grew its rev­enue by 6.3% to R86.4bn. Sixty-three per­cent of Vo­da­com’s rev­enue is earned in SA, while the re­main­ing 36% is earned from other coun­tries in the South­ern African re­gion.

Like other wire­less telecom­mu­ni­ca­tions com­pa­nies, rev­enue from tra­di­tional voice call­ing is de­creas­ing, while rev­enue earned from data ser­vices (in­clud­ing fi­bre in­ter­net, etc.) is in­creas­ing.

An ex­cit­ing add-on to Vo­da­com is M-Pesa, which last year helped 11.7m cus­tomers (an in­crease of 30.4%) process trans­ac­tions worth R1.3tr, re­sult­ing in over R1.9bn worth of rev­enue for Vo­da­com.

Vo­da­com only just barely makes the cut from a value per­spec­tive, al­though it does look like a well-po­si­tioned de­fen­sive share.

As in­vestors, we must re­mem­ber that bear mar­kets and re­ces­sions are huge op­por­tu­ni­ties for us to buy into great com­pa­nies at great prices and at­tain great re­turns over the long term.


When search­ing for shares that can be classed as value stocks, you can use the same fun­da­men­tal and/or tech­ni­cal cri­te­ria you used to fil­ter out the bet­ter stocks in the non-cycli­cal/de­fen­sive sec­tors. Ex­pand­ing on those cri­te­ria could also be done if re­quired. This time, though, the search is done across the whole mar­ket and not just the non-cycli­cal/ de­fen­sive sec­tors.

1. Stan­dard Bank

Nor­mal share:

P/E: 10 Div­i­dend yield: 5.7% Div­i­dend growth rate: 15% Debt-to-eq­uity: 14.1%

Banks in gen­eral have been un­der a huge amount of pres­sure re­cently, and if the themes above con­tinue to play out, banks will likely re­main un­der pres­sure for some time to come. Al­though, at present, bank­ing stocks come with a clear warn­ing la­bel, some of them are start­ing to show some value.

The Stan­dard Bank pref­er­ence share, how­ever, of­fers an op­por­tu­nity to get into a much lower risk ver­sion of the share with sim­i­lar fun­da­men­tal val­ues. The dif­fer­ence is that you are guar­an­teed a 6.5c/ share div­i­dend, twice a year. With the pref­er­ence share trad­ing be­low R1 a share, this rep­re­sents more than 13% div­i­dend yield (15.29% D/Y at R0.85 per share). If in­vest­ing for div­i­dends is your goal, this is great value.

2. SA Cor­po­rate Real Es­tate

P/E: 9.19 Div­i­dend yield: 11.3% Div­i­dend growth rate: 8.1% Debt-to-eq­uity: 45.7%

Of the prop­erty stocks that make the list, SA Cor­po­rate Real Es­tate of­fers the high­est div­i­dend yield at 11.34%, mak­ing it very at­trac­tive.

Be­tween 2012 and 2017, the com­pany suc­cess­fully af­fected a turn­around strat­egy and con­verted it­self into a cor­po­rate real es­tate in­vest­ment trust. It has also suc­cess­fully di­ver­si­fied its prop­erty port­fo­lio, as it now owns prop­er­ties in the in­dus­trial, re­tail, com­mer­cial, res­i­den­tial and stor­age sec­tors in SA and boasted a va­cancy rate of only 4.5% dur­ing the pre­vi­ous fi­nan­cial year.

Find­ing your own win­ners

The stocks dis­cussed above are only a hand­ful of shares that match a very nar­row set of cri­te­ria. There are many more com­pa­nies out there that are of­fer­ing dif­fer­ent forms of value for in­vestors who have a long-term in­vest­ment hori­zon.

In­vestors will need to do some work to look for them, which will take ef­fort and time, but if the themes dis­cussed above per­sist, the work done to find the longterm value or de­fen­sive stocks should pay off in a few years. It is not easy to pre­dict what is go­ing to hap­pen, but search­ing for value has never been to any­one’s detri­ment. Things are volatile and frag­ile out there. Tak­ing the time to find qual­ity shares might not pay off im­me­di­ately, but over time, hold­ing qual­ity will stand you in good stead.

As in­vestors, we must re­mem­ber that bear mar­kets and re­ces­sions are huge op­por­tu­ni­ties for us to buy into great com­pa­nies at great prices and at­tain great re­turns over the long term. The trick is to find com­pa­nies that are likely to still be around in 20 or 50 years from now, and that are trad­ing at prices that are at­trac­tive enough to buy, even in the bad times.

Tito Mboweni Fi­nance min­is­ter

Mike Schüssler Econ­o­mist

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