17 June 2016
JAMES FROST

There's a saying in stockbroking that goes back decades: "You'll never get fired for buying IBM."

It implies that brokers who consistently recommend blue‑chip stocks – companies with strong brand names and long track records – will never give clients a good enough reason to take their business elsewhere.

Unless, of course, their portfolios start going backwards, and unfortunately, that's exactly what's been happening. Exclusive analysis undertaken by Credit Suisse for Financial Review Smart Investor shows that the returns from Aussie blue chips haven't even kept pace with inflation.

Over the past 18 months, the total return from the 20 largest stocks on the ASX – the banks, miners, Telstra and the rest of the usual suspects – has been a measly 1.9 per cent.

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Meanwhile, the total return from the next 180 largest stocks has been a whopping 19.9 per cent.

Credit Suisse's Hasan Tevfik says that Australian blue chips have proved to be a heavy weight on the portfolios of investors.

"The 20 largest stocks by market cap have proved to be a yield trap. SMSFs need to look beyond them for stronger growth and better total returns," he says.

It's an observation that will resonate with readers who rely on the yield from a portfolio that's taken a lifetime to assemble.

Sure, the dividends keep rolling in, but share prices are rolling off and the net value of your holdings is slowly being eroded.

It's even more important for those readers in the earlier stages of wealth creation, a warning that sticking with large-cap household names could end in capital destruction on a grand scale.

The answer is to cast a wider net; to look beyond the IBMs of the ASX 200 and search out stocks with quality earnings and a growing dividend yield.

To help you, we've assembled 12 stock picks from experts at finding value – Chris Batchelor from Skaffold and Jason Yin from Lincoln Indicators.

Using their proprietary valuation models, they have each selected six stocks that exhibit the qualities investors should seek for long‑term outperformance – or as we like to call them, the blue chips of the future.

Where to start looking

George Boubouras, chief investment officer at Contango Asset Management, says that investors should stick to a small number of sectors when looking for the star portfolio performers of tomorrow.

"If you are looking for a good-quality company with a consistent growth profile, I'd suggest you look to infrastructure or services or listed property," Boubouras says.

What's equally important, however, is that investors review their portfolio frequently for signs that a company is at risk of being disrupted. Boubouras says investors should ask themselves where the next set of downgrades is coming from.

"Cast your mind back to the year 2000 and ask yourself, 'What was the Australian company with the biggest market cap?' Most people think it was a resources company, Telstra or a bank, but it wasn't. It was News Corp," Boubouras says.

While News Corp isn't exactly on the ropes, it's no market darling either.

Following the demerger of its print and entertainment arms in 2011, both vehicles have been treading water. The print business remains structurally challenged and its entertainment arm is under threat from newcomers such as Netflix.

Mind the disruption

Apart from being a political buzzword, disruption is accelerating the irrelevance of many of former blue chips. According to projections from Koda Capital, the rate of disruption to the incumbents is gathering pace.

Over the past 10 years, about half the companies in the benchmark US S&P 500 have left the index, replaced by bigger companies with brighter prospects.

Koda's chief investment officer Brigette Leckie says that she expects the speed at which companies are booted from the index to double; that it will take only five years for the index to turn over the next 250 companies.

That has in turn affected the personal wealth of millions, not least the company founders and others at the top of the wealth tree. A joint report from UBS and PricewaterhouseCoopers from December 2015 found that only half the billionaires of 20 years ago could still be defined as billionaires today.

The lesson is that even if you aren't a billionaire, you still need to carefully consider threats to your portfolio. There's simply no such thing as a safe set‑and-forget strategy.

Blue chip or red herring?

Roger Montgomery, chief investment officer at Montgomery Investment Management, says that contrary to making money for shareholders, the so-called blue chips are more likely to destroy your capital.

"Take a look at BHP Billiton. It has tripled the equity entrusted to the company and tripled its debt, and its earnings are no higher than they were a decade ago. You would be better off with a bank account," he says.

Montgomery uses the example of two companies from the telecommunications sector, Telstra and M2 Group, to prove his point. Between 2005 and 2015, if you ploughed $100,000 into a blue chip such as Telstra you would have seen the value of your shareholding rise to $117,000 and the annual yield rise from $5870 to $6500.

But if you had invested the same amount of money in the upstart telco M2 Group – which has since been acquired by Vocus – the value of your shareholding would have risen to $3 million and the annual dividend would be $99,800. That's right, a yield of about $200 less than your original investment. Every year.

"Telstra's share price is still lower than where it was 17 years ago. Its earnings per share is not a cent higher [than] a decade ago. Investors need to understand that the majority of the blue chips are being disrupted, challenged or have matured," Montgomery says.

Allan Gray chief investment officer Simon Mawhinney also believes that the concept of a blue-chip stock is flawed.

"It's not a phrase we ever use at Allan Gray. Obsessing about blue chips is a complete waste of time because there is no element of valuation in the concept," he says.

Mawhinney, a respected contrarian investor, is more focused on a stock's value than its reputation or strength of brand.

"Valuation needs to be first and foremost. What's important is how much do I pay for a company and what returns will that give me over the next five to 10 years," he says.

Mawhinney's brand of value investing, however, is at the extreme end of the spectrum. It is not unusual for Allan Gray to hold significant positions in some of the most distressed companies on the ASX, such as Arrium or Paperlinx.

Allan Gray often engages with the company at board level on issues such as strategy or asset sales in an effort to release hidden value. It is no surprise, then, that Mawhinney has little time for those who do the equivalent of buying IBM for their Australian clients.

"There is so much career risk when it comes to being a fund manager. The greater risk is not owning something that everyone else owns," he says.

"So sure, you don't get fired, but you don't have a business in the long term. The easiest thing for a fund manager to do is to buy those top stocks, clip the ticket and sail off into the sunset. But it also cements mediocrity in your business or portfolio."


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