The ASX 100 Made Simple
Let me make the Australian stock market simple for you. There are over 2000 stocks most of which don’t make a profit.
But you don’t need to worry about most of the Australian listed stocks and if you are like most investors one of your best ‘quality’ filters, as brainless as it might be, is size of company or market capitalisation (number of shares times share price).
The All Ordinaries Index is an obvious place to start. The All Ordinaries excludes most of the loss making companies and slims the market down to 500 companies. But 500 is still a heck of a lot of stocks to filter for the average stock picking investor. So lets cut it down again.
The ASX 200 includes (obviously) includes 200 of the largest and most liquid companies and nif you add up the size of all the biggest 200 companies it accounts for 92.5% of the All Ordinaries Index. In other words if you drop off 300 stocks you only lose 7.5% of the market. You can probably afford to lose those. But you could make life even simpler. What if you cut it down to 100 stocks, still a lot of stocks to choose from.
The ASX 100 Index includes the 100 largest and most liquid listed companies and accounts for 82.73% of the All Ordinaries Index. Losing 400 stocks has only lost 17.27% of the market. 100 stocks should offer enough opportunities to make money, surely, and they do. Here’s the proof:
- In the last year the average ASX 100 stock returned 22.6% before dividends
- The ten best performers in the ASX 100 in the last year returns an average 88.1% before dividends
- The worst ten performers in the ASX 100 in the last year averaged a minus 20.0% return before dividends
There is plenty of opportunity – if you can pick the top ten performing stocks in the ASX 100 next year you could potentially make many multiples of the average annual return of 5.7%. 100 stocks are enough, and if you want a simple, less volatile, more predictable, more researchable, less surprising investment experience there are good arguments for restricting yourself to just the top 100.
In our portfolios, the MT Growth Portfolio and the Marcus Today Growth SMA we sort of do this, we have an 80-20 rule which says 80% of the fund will be invested in ASX 100 stocks and the other 20% will focus on a few ‘conviction’ stocks that may be outside the ASX 100. In so doing we contain risk for the fund investors but at the same time allow ourselves to chase a few high growth stocks in the mid-cap space.
For most investors, especially retiree investors looking for an easy life, ducking and weaving in the small end of the market is not something they want to do, its too hard, risky and a gamble and with 82.73% of the market capitalisation of the whole market contained in 100 stocks, for the not very very engaged investor, 100 is enough. Most investors really don’t need to go beyond the top 100 stocks – there is enough variety, choice, growth and income available from the largest 100 stocks to suit any sleep at night long term investor.
THE ASX 100 MADE SIMPLE
So lets have a look at the ASX 100. Here are some numbers – this table shows the breakdown by sector, sector size (biggest first) then the average PE, ROE, earnings growth and dividend growth as well as the average gross yield:
The table tells a story sector by sector:
BANKS – Low but steady ROE, earnings and dividend growth has disappeared for the moment, big mature companies with limited growth options so they pay most of their profits back as dividends. As we all know, with 22% of the ASX 100 represented by banks with an average gross yield (gross means including franking) of 7.8%, this is where most self-directed equity investors come for income. Macquarie employs some of the best brains in Australia with one purpose in mind – make money – its a great investment in a bull market (falls over in a bear market). CBA more expensive than the rest of the big banks but there’s a reason for that – “Quality”. All fairly low risk (not terribly volatile).
OTHER FINANCIALS – A smorgasbord of stocks here….not really a ‘sector’. Different drivers, have to be assessed separately on their own merits not invested in as a sector theme. Most of them are what I call “stock market” stocks – they need healthy financial markets to thrive. JHG and VUK are UK stocks listed here (benefits if the British pound goes up). MFG needs international stocks going up (and the A$ going down).
INSURANCE – Most long term investors avoid the insurance sector, it is prone to “accidents” and don’t have the quality of earnings of the banks. AMP is under a Royal Commission sentiment cloud that has scarred it. MPL follows the trend in private health as does NHF (not in ASX 100).
GROWTH STOCKS – This is not really a sector it is a list of growth stocks in the ASX 100. You need to assess them on their individual merits. If there is one theme that they all share it is that they all need a very positive stock market sentiment – most are high PE stocks with low yields. When the market turns down they have weak fundamental foundations and are often illiquid and can get sold down quickly and hard. So these are fair weather stocks to be assessed on their own merits. You can see that most have high ROE and are overvalued in the current bear market.
TELECOMS – Telstra another traditional income stock that has cut its dividend with only a 6.0% gross yield now. TPG is the up and comer. All overvalued. Poor earnings growth. Not an essential sector. Many retiree investors are wedded to Telstra – others do long duration trade Telstra on charts.
VARIOUS INDUSTRIALS – This is not a sector either, its a group of individual stocks. Take your pick on their individual merits. These industrials didn’t quite fit into the ‘hot’ growth stock description. A variety of industries represented her from gambling (ALL, TAH, CWN) to retail (HVN, JBH) to travel (FLT, QAN) and others.
CONSUMER STAPLES – The two big food retailers (COL and WOW – should probably have WES in here too but its more diversified) and A2M which should maybe be in the growth stocks box. WOW is on the highest PE its ever been on. Overvalued. But steady ROE.
HEALTHCARE – A sector that has been knocking the lights out – all expensive, all overvalued, all high ROE, most with solid earnings growth and low yield. They are loving a bull market. Broker think they are mostly expensive as well. Don’t sell until the bull market ends. If it does, make sure you buy them back at the bottom. We all want an opportunity to buy the sector cheap….because they’re not.
UTILITIES AND INFRASTRUCTURE – Low ROE low growth stocks that have all become overvalued because the share prices have done incredibly well as interest rates have fallen over the last year. Most have high debt levels (natural for these companies are they build and maintain huge long term infrastructure assets) so falling interest rates are as good as an earnings upgrade as they pay less interest. They peaked out as interest rates bottomed late last year. If interest rates go down further you can safely hold them. Rising interest rates are their Achilles heel. Rising interest rates are also a sign that the global economy is picking up and if that’s the case everyone looks to growth companies and dumps these boring old regulated stocks with limited growth options. Good in a low interest rate environment and defensive usually when the market falls, but not from these prices, all expensive and overvalued for the moment.
REITS – Similar to infrastructure and utility stocks. Love low interest rates. Need bouyant economies. There are a few sectors they invest in including residential property (houses), commercial property (offices), industrial property (factories) and shopping centres (retail). All those sectors have their own drivers and come and go themes. You need to know which REIT is exposed to what and play their themes. For the big institutional investors REITs are where they get their “Property” asset allocation and they are always playing in the space. REITs are mostly trusts which means they have to distribute all their profits each year and have no money to reinvest, so they come to the market regularly (some have annual share issues) or when they have a new project or acquisition. They have to, because they have no retained profit. Low volatility stocks, low ROE, middle of the road yields with generally no franking. Love low interest rates and will fall over if rates rise. Most looking overvalued after recent sector rallies as rates fell last year.
RESOURCES – They follow commodity prices around. BHP, RIO, FMG for instance are all trading stocks that follow the iron ore and commodity price trend depending on what they are exposed to. I say trading stocks because sometimes the commodity price trend changes and the stocks have very high correlations with commodity prices. Not “Set & Forget” stocks, but can be traded for long-duration trends. BHP and RIO are low volatility stocks. You just have to spot the “Big” pivot points that come once every few years when the whole sector trend changes. Chinese GDP growth the main threat to the sector. Trade (long duration trends) don’t blindly hold all the time.
ENERGY – Most of these stocks have high correlations with the oil price (which follows the other energy prices). Correlations are so close to the oil price for stocks like WPL, OSH and BPT that there really is no other game in town other than “guess the oil price” and if you get it right these stocks will give you a much better bang for your buck than trading oil or gas prices. WOR is an oil services company and a great illiquid trading stock if you can pick the eyes out of the oil price. SOL and WHC follow the coal price around. CTX has been bid for – a refiner – hard to get right.
GOLD – Obvious – get the gold price right. Gold goes up when the market gets fearful. In the October 2018 correction in the equity market (ASX 200 down 15%) the gold sector went up 20%. Hate the market? Buy gold. A good trading sector. NST and EVEN much more sensitive than NCM to the gold price.
And thats it, the ASX 100 in a nutshell. It may be all you need to invest. I hope that was useful. There is obviously more complexity to the individual stocks than I have let on but this overview should allow you to decide which sectors to focus on depending on your risk profile and which stocks to play for which themes.
FINALLY – some of the growth stocks not in the ASX 100 – ASX 200 growth stocks….where the fun is supposed to be:
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