When Market Volatility Is Irrelevant

By Greg Tolpigin | More Articles by Greg Tolpigin

I believe that there are two broad ways to invest, either the wider index approach or the stock-picking strategy. The wider index approach, as you may have already guessed, either invests in an index related ETF or collection of large-cap stocks that by and large renders your returns to be similar (and hostage to) the broader market. This strategy also tends to be more passive as the main underlying driver to capital appreciation is economic and thus earnings growth to drive values higher and that take time.

There are advantages of this strategy as it achieves diversification and removes the necessity to ongoing in-depth research and understanding if these are your goals. While I generally do not follow this strategy there are times when it can be the best approach:

  • When shorting in a bear market. You don’t run the risk of being exposed to one specific company that is the target of corporate action.
  • At the end of a market crash or period of heightened volatility. When you think the market is going to rebound strongly after a crash, the best thing to do is buy the index. Different stocks recover at different speeds so to ensure that you benefit from a sharp rebound, just buy the index.

I do by and large focus primarily on stock or sector picking and in my book “Creating Wealth From Explosive Stocks” I detail the process to finding them. It takes more effort and time, but as with anything in life that requires more input, the output is far more rewarding. Furthermore, if done correctly can reduce exposure to market volatility.

A good example of two stocks that I highlighted in my video last week reflects how the combination of strong fundamentals and share price momentum can override short term market volatility. The underlying principle is effectively the same as Warren Buffett’s school of investing, however with a more active and cutting edge ethos to it. We are investing in a business as Buffet famously built his riches on, but we are doing so only when the market is willing to reflect those great fundamentals.

The two stocks I noted in my last video that were identified using my process were Select Harvest (SHV) and Integrated Research (IRI). These two managed to make new highs while the index dumped three hundred points giving up three months worth of gains. Frustrating. SHV gained 8% this week and IRI 3%. Not a bad showing.

SHV released its results the week before and reflects that solid earnings, visibility and momentum can outweigh broader market sentiment. SHV produced a NPAT of $53 million or EPS of 55.5c bringing its trailing P/E multiple down from 23x to 14.4x. A dividend of 20c was declared (following an interim dividend of 15c). Almond production also beat upgraded guidance, water costs were managed well and existing bank debt was paid down. An all-round great result.

What makes SHV a great proposition here is the trailing p/e dropped from 23x to 14.4x. If the share price now moves to a 23x multiple again this will equate to a $4.44 or over 50% appreciation to around $12.50. Sounds unrealistic? Look at the run in early 2015 when the stock last broke through $8.00. Interestingly this was also the last time dividend payments were on the increase, so it’s clear that the market does reward improving earnings and dividends quite aggressively. The move through $8.00 this time is leaving behind a nice multi-year base – one of my favourite setups – which often leads to these re-rating phases. During this phase, the broader market volatility becomes irrelevant as the focus continues to be on the company-specific growth and uplift in valuation.

Integrated Research provides systems and applications for communications networks and payment platforms and has been on a consistent growth path for several years. At the recent AGM it was highlighted that the Company had produced a record be profit of $21.9 million, a 14% increase. Revenue was up 11% to just over $100 million. Margins were strong too – 40% (for the last three years) and profit margins of 22%. Other companies take note, this is what consistency looks like and comes from having global tier one clients with a 95% retention rate.

Unfortunately it seems the market has been rewarding other tech-related companies first, with the likes of Dicker Data (DDR), Data 3 (DTL) and even Technology One (TNE) on runaway appreciations over the past nine months. The first two have more than doubled. And yet IRI sits here with record revenue and record profits without a fresh record high share price attached. Why? I think it’s coming and coming soon.

Share price momentum is building with a nice downtrend below breaking and the ability of the share price to be up in a heavily volatile week is a reflection that there is an underlying bid tone and revaluation underway. Like DDR and DTL, the huge runs in the share price first started with small gains and limited weakness. Eventually, resistance levels break and momentum begins to build with a crescendo of heavy buying as institutions and traders stampede in. I think we are at the resistance level breaking stage and new record highs are still some 33% away.

It shows that a strategy focused on actual businesses with momentum can repel market volatility. Importantly it can help you ride out any volatility because you understand that a “tweet” doesn’t translate to any effect on profits.

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Greg Tolpigin

About Greg Tolpigin

Greg Tolpigin has over 20 years of experience as a proprietary trader and high-level strategist for the major investment banks including Citigroup, Bankers Trust and Macquarie Bank.

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