4 ASX-listed stocks Plato is shorting in 2023 (and the team's top picks for the long term)

Growing up, my parents consistently badgered me to look out for red flags. No Chinese people in a "Chinese" restaurant? Red flag. A guy is late to your first date? Abort. A stranger invites you to check out the puppy in the back of their blacked-out van? Run! 

Unfortunately, when it comes to investing, it seems many of us don't see the red flags until it's too late. 

In 2022 alone, the ACCC found that Australians lost a record $1.5 billion to investment scams. That's just investment scams - how much more has been lost on the landmines, scandals and failures that litter the world's listed indices? 

This year alone, we've seen the collapse of three US banks, as well as the downfall and subsequent acquisition of a global investment powerhouse. 

In Australia, we have witnessed several major examples of businesses that have taken down investors' savings with them - Blue Sky Alternative Investments, Quintis, Dick Smith, Slater & Gordon, Babcock & Brown, One.Tel, AMP, and Openpay just to name a few. 

Often, we are bewitched by a charming CEO, missing the red flags in a company's balance sheet. Sometimes, the downfall is trusting the regulators to do the job for us. 

But Plato Investment Management's latest fund has a unique process to help investors spot the mountains hiding beneath the molehills. Having analysed every historical corporate scandal and failure, Plato's Dr David Allen built up a list of 126 red flags to avoid landmines on the long side and identify opportunities for the portfolio's shorts. 

Unlike Plato's other income-focused funds, the Plato Global Alpha Fund is a long/short strategy dedicated to generating alpha throughout the cycle. The team isn't mandated to stick to a particular style - like value, growth or quality. Instead, the Fund is focused on generating consistent returns so those in the accumulation phase can grow their assets over time. 

Note: This interview was recorded on Thursday 4 May 2023. You can watch the video or read an editorialised summary below. 

About the Fund 

• Name of the fund: Plato Global Alpha Fund
• Asset Class: Global equities
• Year listed: 1^st September 2021
• Size: $22 million
• Description of strategy: Long/short global equities
• Investment objective: The Fund aims to outperform the MSCI World Net Returns Unhedged Index by 4% p.a. (after fees) over the medium-long term. The Fund uses an all-weather investment style that seeks to deliver consistent alpha over the cycle.
• What role does the fund play in a portfolio: For investors seeking capital growth, used as a small allocation within a portfolio where the investor has a minimum investment timeframe of 5 years and a high risk/return profile.

Managed Fund

Plato Global Alpha Fund

Global Shares

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Today's market is a shorter's paradise 

Since launching in September 2021, Allen reveals the majority of the Fund's alpha has been generated through its short book. He describes the recent cooling-off period from a decade of "cheap and easy money" as a "once-in-a-lifetime opportunity" for short sellers. 

As mentioned in the intro, Plato utilises a unique system to identify opportunities - red flags. Just like in life, and dating, Plato uses these red flags as warning signals for long positions (and possible opportunities for shorts). 

This could be anything from remuneration structures, ownership structures, forensic accounting, as well as governance, social and environmental factors.

"If a company just has one red flag - maybe the CEO is selling all their stock, or maybe they use a very unusual auditor - it doesn't actually mean that much for future returns," Allen explains. 

"But if a company has six or more, then those companies almost invariably perform very poorly - they're going to be landmines on the long side of your portfolio, and potentially great short ideas." 

There are a lot of red flags on the ASX right now

Allen and his team have recently identified a higher average number of red flags per stock in Australia compared with other countries around the world. He's steadfast that he's not bearish on Australia, in general, but recommends investors avoid a "blind index approach". 

Of the 10,000 companies in the Fund's investment universe, one Australian company has 22 red flags - Brainchip Holdings (ASX: BRN).  

"That's the second highest out of the 10,000 companies that we look at," Allen says. 

"And this is a company that just a few months ago had a market cap of over $3.5 billion and has less revenue than some cafes." 

He also points to Weebit Nano (ASX: WBT) as another Australian-listed short in the portfolio - which he notes, has a valuation of more than $1 billion but makes "zero revenue". 

Other names on Plato's blacklist include Austal (ASX: ASB), the ship-building company which has had a number of governance issues (read: accounting fraud) surface recently, as well as construction and real estate company Lendlease Group (ASX: LLC). 

Why Lendlease? Well, Allen is betting that the next great sector short is commercial real estate. 

"COVID has changed the game. And no matter how much CEOs stamp their feet and try and get everyone back in the office, they're struggling to get people back in more than two or three days a week," he explains. 

While the last three years have been tough for Lendlease, Allen argues that conditions for commercial real estate players have been favourable for some time. 

"Interest rates have been low, house prices and property prices, in general, have been appreciating at very, very high levels. And yet, they haven't made any free cash flow on an accumulative basis since 2009," he says.  

"So if you can't make money in that favourable environment, what does the future hold for you in an environment where people aren't coming into the office, in an environment with higher interest rates and less property appreciation?" 

Thankfully, there is one business Allen is backing in Australia - JB Hi-Fi (ASX: JBH). 

"They trade at a pretty decent multiple, 8.5 times," he says. "And they've doubled or tripled free cash flow over a relatively short space of time, with 40% return on equity." 

Global growth has made a major recovery in 2023... But you need to be selective going forward

Despite the rerating we have witnessed in global growth stocks this year, Allen believes investors need to focus selectively on quality names that are less influenced by interest rates. Two names, in particular, come to mind.

"ASML (NASDAQ: ASML) has 88% market share, so a virtual monopoly in the deep ultraviolet lithography machines that are required to build the chips that are used in all of the technology around us, but specifically all of AI," he says. 

"If you ask who is going to be the eventual winner of the AI race, it's very hard to say. But what you can say is that this picks and shovels approach of investing in the companies that are producing the machines that are producing the chips are going to win." 

ASML is currently Allen's highest conviction long position. 

"If you look at the backlog they have, their annual revenue is a little bit over €20 billion, they have a backlog of €40 billion. So there's this pent-up demand, they've got a virtual monopoly, and the valuation's not particularly demanding. I think that's a name that should be on everyone's radar," he says. 

He also notes that it is "extraordinarily well-run", has doubled its revenue and EBIT over the last few years, and boasts a return on equity of 60-70%. 

"Another great name that I've been invested with for many years is Novo Nordisk (NYSE: NVO) ... They're the third-biggest pharma company in the world," Allen says. 

"I think in the next 10 years, the really exciting story is anti-obesity drugs and Novo Nordisk has an 88% market share in that space, and they've got a number of drugs in Phase 3 as well with the FDA." 

While he doesn't have a short bet against Tesla (NASDAQ: TSLA), Allen names it as a stock that he would currently avoid. 

"It has a relatively large number of red flags, eight to 10, but ... if sentiment is really, really strong, we'll never go short a name because in the meantime it can double or triple," he explains.

In comparison, a stock like BMW (ETR: BMW) looks comparatively exciting. 

"They trade at a forward PE of six and a half times ... Tesla trades at 50 times," Allen says. 

"And if you look at how fast each of those two companies is growing in the EV space, it's both 35%. So they've got the same growth rate in that space, but one, I think, is a super high quality, storied brand that's going to stand the test of time, and give you a much smoother return journey." 

Learn more

The Plato Global Alpha Fund uses an all-weather investment style that seeks to deliver consistent alpha over the cycle.

Managed Fund

Plato Global Alpha Fund

Global Shares

View