Reporting season has come and gone… where to from here?

Reporting season is the most important time of year for self-directed investors. For those that have the time, perseverance and know-how, it presents a unique opportunity twice a year to take a deep dive into the financials of the more than 2000 listed companies on the ASX.

For everyone else there’s Stock Doctor. You can assess the health of your portfolio against Lincoln’s renowned 9 Golden Rules right now with a free 14-day Stock Doctor trial.

As we do every reporting season our team of analysts have been busy examining the flurry of corporate results, providing updates in near real time, and empowering our members to make informed investment decisions based on reported fundamentals.

Discussion around the many headwinds facing investors today – rising inflation, increasing interest rates, supply chain issues and geopolitical tension – takes up a lot of the headlines. However, our unwavering belief is that while macroeconomic factors may impact short term performance, long-term investors need to be persistently focused on making stock selection decisions based on the underlying fundamentals of the businesses they are investing in.

When we overlay our proprietary Financial Health model – which considers 12 key accounting ratios – across the results of all 2000 ASX listed companies, shockingly we see that 75 per cent of all ASX listed companies are in either Early Warning, Marginal or Distress Financial Health and are therefore at risk of failure.

This only further reinforces our point, that regardless of macroeconomic headwinds or short-term market disruptions, understanding the underlying fundamentals, to avoid the three quarters of companies in poor financial health, and identify the quality companies, is critical.

The Lincoln 9 Golden Rules provide an investment framework that uniquely help Stock Doctor members to identify exceptional investment opportunities while avoiding high risk or financially unhealthy businesses.

There is never a better time to analyse financial health than at reporting season. Now it has wrapped up, with some pretty strong results shining through, you may want to reposition your portfolio to ensure it is invested in those businesses with proven strong fundamentals.

What do those fundamentals look like? Here are a couple of examples to show how Stock Doctor, and the 9 Golden Rules, help investors identify the metrics that matter in practice.

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Stock Doctor Star Stocks.  Exclusive to members, our Star Stocks are those identified by our exclusive methodology to be financially superior stocks on the Australian Stock Exchange (ASX) for income and growth.

Star Growth Stocks

For Growth investors – that is, those focused on capital gains – Altium (ALU) and Wisetech (WTC) are two shining examples of companies that reported strong underlying fundamentals this reporting season.

Altium Limited’s (ALU) core product is its printed circuit board design tool, allowing electronic product designers to progress from concept to final design.

• It features strong financial health with net cash position of $200m with operating cashflow up 17.4% (Golden Rule 1).
• Return on Equity increased to 22% from 15% on year (Golden Rule 2).
• Net profit margins improved to 25% from 19% (Golden Rule 2).
• Earnings revisions were up 15% and there remains a strong positive outlook with double digit earnings and revenue growth forecast to be driven by strong demand for electronics on the back of 5G communication, electric vehicles, and increasing use of data science (Golden Rule 3).

Wisetech (WTC) is a cloud-based logistics software-as-a-service business. Their software solutions help freight and third-party logistics companies optimise and manage their supply-chain deliveries.

• It reported strong financial health with no debt and 45% rise in operating cashflows (Golden Rule 1).
• Return on Equity and net profit margins increased to 15% (vs 11% on pcp) and 29% (vs 22% on pcp) respectively (Golden Rule 2).
• Earnings revisions up were 24% on the back of an earnings upgrade in July and better than expected outlook statement (Golden Rule 3).

Star Income Stocks

For Income investors, who are more concerned about generating income and recurring dividend streams, Deterra Royalties (DRR) and Telstra (TLS) are two companies that demonstrate the fundamentals that you should be looking at.

Deterra Royalties (DRR) is Australia’s largest ASX listed mining royalties business, providing exposure to both specific mining projects and the strength in the underlying commodity, but with little costs relating to the operations such as maintenance, labour and capital requirements.

• The stock is on a forward gross dividend yield of 11% with free cashflow expected to be 36.5cps, well above dividend payments of 32cps (Golden Rule 3).
• There is no net debt which strongly supports its financial health (Golden Rule 1).
• It’s market cap of $2.1bn allows for sufficient liquidity (Golden Rule 6).
• Investors do need to be mindful of the risks: although DRR does not bear mining costs, it is not a traditional defensive income stock because earnings are tied to the commodities cycle.

Telstra (TLS). Bluechip telecommunications leader TLS has a forward gross dividend yield of 6% with free cashflow, though declining to 25cps from 35cps, remains well above forecast dividends of 17cps (Golden Rule 3) and is in strong financial health with debt in decline (Golden Rule 1).

• Performance was supported by strong growth in mobile due to its rollout of 5G and cost T22 cost simplification strategy.
• Telstra has also divested its Towers business and formulated an attractive leasing arrangement with TPG Telecom.
• These decisions should help sustain free cashflow as NBN receipts cease (Golden Rule 2).

Reporting season let-downs

As noted above, three quarters of all companies listed on the ASX are financially unhealthy. These include many well-known names that attract many investors looking for the next big thing. Here we look at two – EML Payments (EML) and Kogan (KGN) – that performed poorly during the reporting season and represent examples of what to avoid when constructing your portfolio.

EML Payments Limited (EML) provides payment solutions such as gift cards, rewards and supplier payment terms.

• The immediate red flag indicating it is in distressed financial health is its negative operating cashflow (Golden Rule 1).
• The stock has experienced significant downward earnings revisions (Golden Rule 3).
• It’s share price is down close to 80% over the year (Golden Rule 4).
• Could represent a value trap due to it trading at significant discount to valuation (Golden Rule 5).

Kogan (KGN) is a celebrated online retailer providing a wide variety of services including mobile plans, insurance and travel.

• This is another company in distressed financial health due to negative earnings and significant increase in lease liabilities (Golden Rule 1).
• It has a negative share price return of 69% over the year and a high short interest at 7% (Golden Rule 4).
• It is trading at a discount to valuation but could also be considered a value trap (Golden Rule 5).

Where to from here?

In volatile and uncertain environments like we are in now, investors can’t afford to set and forget. Risk is increasing and active portfolio management is critical.

What we know from experience is the cream always rises to the top, regardless of the broader macroeconomic environment, quality companies will outperform across market cycles over the long-term.

Continuing to monitor the financial health of your investments to ensure you remain invested in only quality companies, while minimising exposure to poor quality stocks, is the key to long-term financial success.

Stock Doctor, through our best-in-class tools and market leading research, is built to empower self-directed investors to make informed investment decisions. Test the financial health of your portfolio by taking advantage of our free 14-day trial and discover the power of Stock Doctor in helping to set you up for long-term investing success.

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