The recent 5% plunge in the ASX200 led to some great value opportunities for nimble investors. This was particularly so in small caps, which fell even further. In this exclusive video, Ben Rundle from NAOS Asset Management and Shane Fitzgerald from Monash Investors Limited join Jeremy Hook from TMS Capital to discuss their outlook and how they are thinking about the market. Ben tells us: “I think we’ll look back in 6 months time, and see this as a buying opportunity”. The market has already turned back up since filming this interview, so perhaps this window could close quicker than anyone expected. Click below, or read the transcript, to hear three stocks they nominate as worthy of further attention, and which thematic you should avoid in a volatile market.   

Transcript

Jeremy: Welcome to Buy Hold Sell. I'm Jeremy Hook from TMS Capital. With me on the panel today, Shane Fitzgerald from Monash Investors, and Ben Rundle from NAOS Asset Management.

Well, it's been a rocky start to February, down about 4.5% the leaders on the market but the smaller cap stocks doing about 1% worse. What have we learnt from this fallout of the market? Shane, firstly with you. What can a small cap investor take from this sort of volatility? 

Shane: Well, I think the first thing to look at is what's the driver of the pullback? We see this as a pullback, a valuation correction if you will. Yeah, the economy's building on quite nicely in Australia, the U.S. is very strong. There's always concerns over China and Europe, but right at the moment, they're pretty narrow. 

Jeremy: Ben, any big takeaways from this kind of movement? 

Ben: Look, I think the move was initially started from an inflation picture, which looked a lot higher than what people were expecting. Now, if I look to what drives share prices, it's earnings growth. So, inflation should drive earnings growth. GDP growth will drive earnings growth. The two of those put together will drive an increase in commodity prices, and Australia's a commodity country. So, I agree with Shane. I think it's a short-term pullback. It's hard to see it bouncing back very quickly given the aggression of the move downwards. So I think you'll probably see this period of volatility sort of hang around for a little while, but I think we'll look back in six month's time and see it as a buying opportunity. 

Jeremy: Okay, and if we're looking at the market as a whole, some areas more affected than others, which are the more protected areas in the market right now? 

Ben: The more protected ones are probably companies that have a decent level of free cash flow. So, a company we like, for example, is Smartgroup (ASX:SIQ). It's been an incredible performer, they've got a healthy top-line growth rate. And at the moment, you can get it on a free-cash-flow yield of about 7% or 8%. So, if you compare that to the risk-free rate, it's actually pretty attractive. I think, it will still get caught up with the rest of the share price moves, but there is a buffer there because of the free cash they're producing. 

Jeremy: Okay. Shane, do you think it will bounce back quickly, or is it something that'll take a bit of time? And if so, where do you go to first? 

Shane: Well, I think it will take some time to bounce back. We're bullish on the market, we just think the pace that the market rose at last year also has to be put into context as well. We're back to about, I think, where we are back in Christmas. So, it's not the end of the world. The other driver going on here at the moment, is the view about interest rates going up. Well, we all know that. We also know there's a lot of financial leverage in the system. But, they said we will manage via central bankers, the government, and the holders of those obligations. So, we're not overly concerned by that, but we see the trajectory of the market gains from here being a lot flatter than what they've been in the last, say, 12 months. 

Jeremy: Okay, and there have got to be some areas you'll be avoiding with those kinds of impacts. 

Shane: I think when you have a pullback like this, the areas of the market that are going to do worse are the ones where there's no valuation anchor that you can hang your hat on. There's companies which don't have any near-term earnings, so the valuations based off a DCF or a DDM have a lot of subjectivity to that valuation. And also, you know, those stocks would have poor liquidity. You know, when there’s a fright in the market, that poor liquidity will hammer them. So, the stocks in particular, doing it pretty hard at the moment, are any type of concept stock. You know we all love these concept stocks from time to time. But these concept stocks, of course there's no valuation anchor in bedrock on, they're the ones that are the most likely, there're going to be susceptible to a pullback. 

Jeremy: Valuation being an issue, are REITS and infrastructure things to be careful of? 

Ben: I think both actually. I think REITS, for example, will come back with the moves that we're seeing in bond yields. Shane makes a great point, the companies that use the DCF and rely on a terminal growth rate to provide the output of a valuation, that gets adjusted when rates go higher. So all of a sudden, the valuation is lower, analysts pull back their targets, and it affects the share price. But, this sort of volatility does create opportunities. A good example of a stock that's reported, MNF Group (ASX:MNF), they saw an opportunity in their business to spend $3.5 million to get $8 million in pre-tax earnings in two year's time. Now as a fund manager, if we saw that opportunity, we'd jump at it. A listed company that does it gets penalised because they expense those earnings up front, and the near-term outlook looks worse. So, that provides an opportunity going forward. 

Jeremy: Excellent. Shane, the baby often thrown out with the bathwater, can you give us a stock that you find really low and unloved at the moment. 

Shane: Well, we've been chipping away at is Afterpay Touch (ASX:APT). It's had a great run, to be fair, but this business is really firing. We think the product itself is a win-win for both the retailers and the consumer. And during this pullback, or just prior to that, they announced they're moving to America. I don't think we have to wait a long time to hear what they're going to do in that marketplace. And if they even have a modicum of the success that they've had here, you know, there's a lot of upside in that stock. 

Jeremy: Terrific. Market volatility does provide opportunity. There are some great ideas for you. 

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