Ben Clark: 7 stocks for when the market comes "roaring back"

Companies with tailwinds to ride the reopening, continued capacity to keep growing earnings - those that were overlooked during reporting season – are the stocks you should be considering now, says Ben Clark, portfolio manager at TMS Capital.

“When growth starts to run, the businesses that reported really strongly in February, and that were completely ignored, will be the first businesses to roar back,” Clark said in his latest interview. 

The seven Australian companies he’s currently buying span a range of industries. They include “platform companies” in real estate and job listings; a healthcare firm, a financial company; and a home-grown NZ software firm. Words like “resilient,” “mature growth,” and “profitable” are used in his descriptions of each of these companies.

“Don’t hold onto things thinking, ‘Oh, they’ll come back." Some things won’t come back. There was a lot of froth and excess, particularly in the second half of 2021, which is being really washed out of the market at the moment."

"Some businesses will go to God during this period and for others, this is a period where the mettle’s being tested, but I’m confident they’ll bounce back.”

In the following interview, Clark details the seven stocks he’s been buying, two calls he got wrong from reporting season, his macro view, and why it will pay investors to switch off slightly during the current volatility.

Edited transcript

James Marlay:

Hi, there Livewire readers and viewers. I’m James Marlay and today I'm joined by special guest Ben Clark from TMS Capital. Many of you will be familiar with Ben, a regular on Livewire's Buy Hold Sell. He was on the Rules of Investing podcast at the end of last year, but he's a financial adviser and wealth manager, and I've brought him in today because I think he brings a unique perspective to running portfolios. He deals with many clients that are just like many of you among our readership. And with the volatility and all of the big news items hitting the market at the moment, I thought it'd be a great opportunity to get his perspective, talk through some of the good stuff that's happening. Talk through some of the things that haven't been going so well and get a few of his tips. So Ben, great to have you in. Thanks for coming along.

Ben Clark:

Thanks for having me, Jimmy.

James Marlay:

What do you think are the most important changes taking place in the market today and in particular, the ones that are weighing down equity markets?

Ben Clark:

In December, when the markets were hitting all-time highs, it was almost the last trading day of the year. It feels like a distant memory, doesn't it? But there's one issue from last year that has continued on: inflation. Especially in the US, there was a feeling that would start to have topped out this year, and maybe we're through the worst of it.

Clearly, that's continued and the Fed, with time, has grown more concerned about its persistence and strength. I think we're seeing some early signs of a wage-price spiral in the US, not so much here, but on top of that. The funny thing is, there are three real issues at the moment, but they're all completely interlinked, which is quite unusual. You've got COVID, now of course, that awoke the sleeping beast in inflation and the Omicron strain that ripped through the world in December and into January. That's probably one of the things that has prompted the Fed to change its stance. And it's also China now, which has locked down 50 million people in the last two days and we've seen what's happened in Hong Kong. The question is, how long does China pursue, what I think most people would say, is a fruitless exercise of trying to get zero COVID? And how much pain is it willing to take, for the economy and for its people?

And then you've got Russia as the other big, current issue. I don't think markets saw the invasion coming. They didn't see either the fightback that the Ukrainians have put on or the united front with which the west has faced the invasion. And all of these issues are effectively asking the question: Does this heighten the inflation issues that we saw last year? Russia produces a lot of soft and raw commodities and that spikes prices. And then China has just announced that the largest port in the country, Shenzhen, has been locked down. So this is going to create further supply chain issues. How does the world deal with that? And what implications does that have for bond yields, which is flowing into equity markets?

James Marlay:

It's interesting. Transitory seems to be the word of 2021, but I haven't heard it so much in 2022.

Ben Clark:

Looking back, when Jerome Powell, towards the end of December, said, "Transitory is just that." In hindsight, the phrase itself was transitory. That's really when bond markets kicked off again, and that's what's led to the volatility that we're seeing in the share market. And I think with these issues, none of us has been through a global pandemic. We don't know how this tale ends. We don't know how long the war in Ukraine drags on or how intense it gets. We don't know how long China persists. So, the market's trying to price something in, which I think is virtually impossible to know the answers to. And that's why you're seeing these big swings day-to-day.

James Marlay:

Of those things you've touched on, which are significant enough to have a bearing on the portfolios that you manage and what are some of the changes that might flow on from those considerations, given we have no control over things like war and the pandemic?

Ben Clark:

The thing that's probably changed, in my thinking, is the inflation line. It clearly is going to persist for longer. I saw a good statistic yesterday, actually in 2019, I think about 38 million people entered America with an intention to look for work. Last year it was like 2 million. That's not going to go back to 38 in 2022, it's going to take time. And I suspect that inflation is going to take longer than we thought to top out and to pass through. A slight tack that we've taken in our investing, and we haven't made wholesale changes on the back of any of this, is a shift toward more mature growth businesses on the market, slightly at the expense of the longer duration growth businesses.

With all this uncertainty, that feels like a bit of an insurance policy against the "unknowable" things. So, businesses that might be growing sustainably at 15% or 20% and are trading on 35 times earnings maybe, as opposed to the "hyper-scale" growth businesses, which are on much higher PEs. Also, for private clients, we've been making sure that we maintain what we call "the ballast stocks," those that smooth out the volatility that we're going through. Two of those got taken over Spark and Sydney, and we've been looking for replacements for those, but making sure that we stick to that philosophy. The temptation is to think, "Oh, well this is in a really oversold area. So we'll move that money into there." But you want to stick to what you're doing in your approach.

James Marlay:

Now I know you're a stock picker and not a macroeconomist or forecaster, but I'd like a temperature check on how worried you are that central banks might be "behind the curve" and that we're going to get a really aggressive rate hiking cycle. And how are you viewing the difference between what's happening in the U.S. and Australia?

Ben Clark:

I'm not worried, but I think the Fed definitely has been caught behind the curve, in hindsight – and hindsight's a beautiful thing. They probably should have bought a bit of protection against the uncertainty that was out there. Jerome Powell was the first to say we don't know how the end of this pandemic plays out. But in hindsight, they probably should have lifted rates a few times last year and signalled to the markets. This isn't a rate rising cycle. This is just a bit of normalisation. And then we look at the data and see what goes from there, but always be wary of people that tell you what they think the Fed or the RBA should be doing. All that matters is what they are going to do. And they're about to start the hiking cycle.

Ben Clark:

It will be an aggressive hiking cycle, but you've got to remember the bond market has already priced that in. So, the markets are not going to wake up in December and think, "Oh, wow, they've raised seven, eight times this year." The market's already expecting that. You could get further volatility from here if the market believes that is still too conservative and that the Fed's going to have to go even more aggressive than that aggressive stance. And I think that's really going to be determined by the things we were speaking about at the start of the interview, which is that you've just got to see how these things play out. But honestly, if you take a step back, for all the talk of high and rising bond yields, it's not so much where bond yields are priced at now. It's the speed at which that pricing has changed. That's what's unsettled the markets. A repricing might take six to 12 months of this kind of magnitude, and it's probably taken two or three, and that's been a pretty violent move in the bond market. And that's seen the volatility created in the share market.

James Marlay:

As I was preparing for this interview, I was listening to a podcast you did with Patrick Poke towards the end of last year, which was a very different time. And you were talking about growth stocks and what it takes to invest in them, how to hold the line. And if anything, it's more topical now, because I think a lot of people are having their conviction tested. How has your conviction been tested, and that of investors out there in the growth part of the market?

Ben Clark:

Investing is as much about managing your emotions and taking a step back and trying to look at it from an arm's length point of view. It's a good reminder that periods like this will occur, and when you're in the depths of those periods and it feels like everything's hitting you in the face and things are against you, it's easy to lose your stance, to lose your mentality, to lose faith in what you believe in. But this is really a time when you've got to continue to remind yourself what you're trying to achieve. Yes, you've got to keep going back and checking the businesses that you own, because everyone says growth businesses, but there are unprofitable growth businesses that won't be profitable for years.

The revenue growth might be exploding. But to me, that's become an area of the market I would increasingly not go near at the moment. I think that has changed, but growth businesses are doing what they do. If you look at Afterpay as one of the big examples, it used to have a 30% to 40% pullback two or three times a year, from the moment it was listed on the ASX. And it would constantly test your mettle. So, I think you've got to keep making sure that what you own is what you want to own. And the good thing is, we've just been through February and we've heard most of these companies' reports so we know how they're travelling.

So that is one thing that you've got in your favour at the moment. It's not like we've had no news for three or four months. So maybe the market's telling you something that might make you a little bit warier, but for the moment, hopefully, it's good advice. And the other thing is, you don't want all of your portfolio in growth stocks. Having those safe ballast stocks hopefully irons out some of this volatility.

James Marlay:

As you alluded to there, we've had reporting season, but before I get you to crow about a couple of cracking results, let's do a mea culpa and talk through some of those that fell short of your expectations.

Ben Clark:

I thought the result season was remarkably good. Earnings are growing at around twice the historical trends. And even though a lot of businesses are facing a lot of cost issues, for us, it was actually two serial offenders Appen (ASX: APX) and Tyro (ASX: TYR) as two businesses that disappointed. Appen's result itself was a very narrow miss versus what they guided, but still, it was a miss. And it highlights a vulnerability of that business, which is a lack of earnings visibility. The thing that more unnerved the market, I think, is when they said they would stop giving year on year guidance. I think it's actually the right approach, but the wrong time to employ it.

Everyone was already quite sketchy at that time. So, you saw a much bigger share price drawdown than I think you would've, they gave five-year numbers and this is the confusing thing, which just looked too good to be true. They're so far above every analyst's expectation of where they'll be in five years. I would also say there was a reaction like, "Oh they're going to take weaker margins to try and grow the revenue line harder on the core. The CEO was actually adamant that wasn't going to happen. So, there's sort of a bit of confusion there. We're sticking with it. It's a business that we skim some time ago, a few years ago, and that we've added to in more recent years, it's a fairly small holding, but I still think that there's a good business there.

Tyro was harder. And that's really because when you look back at their last six months, for half of that, most of their merchants were in lockdown. And I think the area that the market I think was disappointed on was that they're not seeing the operating leverage come through the business. So, the margins weren't as strong as the market thought. I'm more willing to give them the benefit of the doubt because they did things like waive all of the terminal hire fees to merchants that weren't allowed to open. There is a bit of confusion around this Bendigo joint venture partnership and what impact that's having on margins. But when you walk past restaurants and cafes and bars, they're very busy again, so hopefully, we start to see the operating leverage come through the business. Those one-off costs that we saw, they hired around 58 people in the last six months, to spend 10 million on an office fit-out, that had some impacts.

The other thing I'd just say with Tyro is that it's potentially a good inflation hedge because if cafe A is selling a coffee for $4 and that goes to $4.40, they take a percentage clip of that. So, potentially this is a business like Visa and MasterCard in the U.S. that could do really well in an inflationary environment, because they take a clip at the nominal dollar purchase, not of the profit that the merchant's making.

James Marlay:

So two sinners, both still in the portfolio. Is your conviction still strong? 

Ben Clark:

Our conviction has been particularly tested with Appen. I haven't added to them because I do think that you want to probably build positions, my view is being affirmed by the numbers. And at the moment my view is being tested by the numbers. And I think also position size is important. You don't want to go too hard at things where the market's telling you're wrong and that's what's happening at the moment.

James Marlay:

One of the interesting comments you made the other day, when we spoke ahead of this interview, is the fact that switching costs from lower quality into higher quality businesses is low right now. Because it's been a bit of a damp market. What are some of the examples of the opportunities that you are seeing present themselves amongst this selling? And maybe explain that concept to people.

Ben Clark:

What are switching opportunities? I'm sure everyone watching this has one or two stocks that they look at in their portfolio and think, "Why the hell did I buy that?" Maybe it was a tip on a golf course. One thing I would say is that it's really important to have a business in your portfolio that is either profitable or it's on the cusp of becoming profitable. The concept stocks, the stocks that we're trading on sales multiples, revenue multiples, subscriber multiples. To me, that is done in a rapidly changing interest rate environment. I think to me you got to accept that. The good thing is that you can still move across into businesses that meet that first criterion that is heavily off where they were trading on the 1 January, there might be some cost in doing that.

Don't hold onto things thinking, "Oh, they'll come back." Some things won't come back. There was a lot of froth and excess, particularly in the second half of 2021, which is being really washed out of the market at the moment. And some businesses will go to God during this period and others this is a period where the mettle's being tested, but I'm confident they'll bounce back. To me, I look to reporting season and I look at potentially the more mature growth stocks that I was talking about earlier. Feel like a place to be while we are sort of assessing inflation and these things.

So companies like REA (ASX: REA) grew their earnings 37% last half. Every newspaper I pick up on Monday, a record number of auctions on Saturday. That's great for REA. Companies like Seek (ASX: SEK), the job market is as tight as I've ever seen it. Every head hunter that you speak to says, "Change this pricing dynamic model. We're paying them more than we ever have. And we just got to do it." ResMed (ASX: RMD) has still got the tailwind of the competitors. Macquarie (ASX: MQG) had its best quarter on record. These are still 20, 30% off their January one, two-month prices. The businesses are continuing to trade extremely well. I suspect the opportunities at the moment if you take a longer-term view are in those long duration, growth stocks, so we've been looking at Pro Medicus (ASX: PME), very high PE feels like the thing you shouldn't be buying at the moment, but I suspect that's the time you want to be getting really interested. IDP (ASX: IEL) is another one that I listened to the result and I thought was excellent.

They've got a big tailwind as the world reopens, colleges try to get people back and Xero (ASX: XRO), which is one that we own and has been one of our largest holdings, didn't report in the reporting season. It's such a resilient, consistent business. I don't think you're going to get any bad news from it. It's dropped 40% from its January one high. So don't put the blinkers on and think, "Oh, I've just got to hold tight." You still do have to think, is this a business that's going to come back when the market comes back? The market will come back. When growth starts to run, the businesses that reported really strongly in February, and it was just completely ignored, will be the first businesses to roar back.

James Marlay:

What are the best questions you're being asked now? What are your responses?

Ben Clark:

Should I be worrying? That's probably the number one question. And when I say to clients, I'm not worrying, hopefully, that gives them some peace of mind because you've got to remember for a year and a half, the markets were almost lobotomized. There was so much money that was pumped into them to get us through COVID, either into the economy or into the markets. For a year and a half, we barely had a 3% correction. It wasn't volatile, despite everyone saying it's going to be volatile. And to me, the longer the periods you get of that, you get excess building up, you get froth building up.

And inevitably when you do get the correction that you need, which is why you want regular nice corrections in a rising market, sounds counterintuitive, but they're actually healthy. They're just regularly taking the froth out. Otherwise, when you get one, it can turn into a bigger one. So I think clients can ask things like, they can get set on Russia, these big macro things. But to me, this is just a healthy part of markets and there will always be a reason that you look back and say, "That was the catalyst for it." But it's probably more likely that the markets just needed a good flushing out. And a reminder I sort of try and give people is we own quality businesses that are continuing to grow despite all of the worries that we have out there in the world. And it's just inevitable to me that the market will come back to them and the rise will continue. I just don't know how long it's going to be.

And that will be based on how all of these things play out. So, I think if you feel like you own the right businesses and everyone I think in the back of their minds looks at their portfolio and thinks their quality businesses and they're a bit more debatable. If you've got quality, if you stuck to your knitting, if you're trying to achieve your goals and objectives, make sure your asset allocation's where it should be. You're not losing sleep, be patient, just try and look away. Don't stare at a screen every day, try and sort of take your attention off it. It will come back.

James Marlay:

Well, ladies and gentlemen, I hope you enjoyed that interview as much as I did remember the hit subscribe on the Livewire YouTube channel. We've got lots of videos coming fresh to you every week.

Macro

Ray Dalio and Henry Kissinger on the US and China, and why we should worry

View

Never miss an insight

If you're not an existing Livewire subscriber you can sign up to get free access to investment ideas and strategies from Australia's leading investors.

And you can follow my profile to stay up to date with other wires as they're published – don't forget to give them a “like”.