Growth Beats IncomeI know a lot of you hold big holdings in banks for income, so have we, but it has, in hindsight, been one of the biggest Australian investment mistakes of the last five years. In the last five years, as you know, the banks have been pummelled. It all started with a Commonwealth Bank rights issue in March 2015 which led to $12.4bn worth of bank sector capital raisings by year-end. That first CBA issue marked the peak of the sector. After that initial bout of indigestion came a series of negative waves starting with those unnecessarily prudent APRA led ‘restrictive lending practices’ in 2017, now repealed. They kicked off a slowdown in the bank sector’s lifeblood, the housing market, and as credit lending slowed, and as Shorten threatened measures to pique the investment lending market, we saw the first bank sector earnings downgrades in years. Then came the Royal Commission which started with a discovery process that paralysed department after department, involving thousands of employees who were rendered unproductive and demoralised by millions of wasted hours in front of a photocopier finding, scanning and printing documents. Then came the Royal Commission itself, the loss of reputation, the brand damage, the destruction of their wealth management brands and businesses, asset sales, business restructuring, more employee demoralisation and more earnings downgrades. And then last month, just when the sector was getting back into uptrend, the AUSTRAC revelations cratered Westpac by 14.7% in a month with the ANZ and NAB both down 11% in a month. (The CBA survived, up 0.3% in November, having already been through the AUSTRAC fiasco). Here are charts of the individual big four banks and their performance relative to the bank sector index (red line) - CBA the clear winner, WBC the clear loser: And this is Macquarie just for interest's sake: All in all, since the March 2015 sector peak, when the Commonwealth Bank announced the first of the 2015 rights issues, the sector is down 27.7% against the All Ordinaries up 14.8%. Including dividends the total return from the All Ordinaries Index is up 42.51% since March 2015 with the total return of the CBA, Westpac, NAB and ANZ individually underperforming the All Ordinaries index by 34%, 59.1%, 47.2% and 52.9%. Despite this underperformance, most fund managers, intimidated by the fact that the banks formed 25% of most benchmarks, didn’t sell. The fund managers didn’t sell because they like to hug their benchmark and getting a big sector like the banks wrong is suicide. So they, as we did for a while, sat with neutral holdings. And retirees didn’t sell because no-one ever told them to. Few advisers would, could or will ever advise retirees to sell their banks. They are an Australian institution, an oligopoly and they’ll be alright in the end. Won’t they? On top of that, the advice industry sees it as a value add to collect franking credits for clients, and that’s what the banks are used for, to collect franking credits. Getting a refund is clever isn't it? Taking money off the ATO an astute strategy, surely? But for the last four years, chasing a franking credit refund through banks has been a mistake. The credit still arrived, but the loss of capital more than matched it. And trying to strip the bank dividends over results has been in most cases disastrous, we have been swimming against the tide. To make money you needed impeccable timing which is only possible in hindsight. And there are other reasons income hungry (mostly retiree) investors have not sold.
- Because understandably, for someone who wants a stress free investment life, they have adopted a long term “buy and hold forever” approach.
- Because they would rather lose two dollars than pay the government a dollar of capital gains tax.
- Because they don’t care what the share price is - they intend to pass their assets on - “its my kid’s problem”.
- Because they cannot find investments with high yields. Even now, after the underperformance and some dividends cuts, the banks are still offering some of the highest yields in the Australian market.
I refer you to our recent article - THE ULTIMATE GROWTH PORTFOLIO - it included this list - a good place to start: RELIABLE GROWTH STOCKS WITH HIGH ROE - this is a list of stocks with an unblemished 5 year earnings growth outlook (one year of history four years of forecasts). THese are what rthe market considers to be growth stocks. This list shows growth stocks with a return on equity of 20%. They are in ROE order - you might pay attention to the market cap column...I don't want you filtering out of banks into small caps. ROE or return on equity is effectively what a company earns each year if you give them a dollar. This is the number that value investors are obsessed with. Some of these ROE numbers can get pretty “dirty” (they need to be cleaned up for one-off items and accounting sleights of hand) but at the headline ROE is still a pretty good filter. Why for instance would you want LOV or NWL, who are earning 66.9% and 63.4% returns each year on every dollar you give them, to pay a dividend at all. It is clearly better to let them invest the money at a 66.9% and a 63.4% annual return than it is to have it returned to you now. There are some interesting stocks on this list, stocks you already intuitively know, some of the best stocks in the market, stocks like COH, CSL, RMD.