Three key factors to consider when choosing companies next year.
It’s December 2019, and you’re tasked with providing an outlook for Australian shares for the next 12 months.
Somehow, you manage to predict with perfect foresight the events of 2020: bushfires, a global pandemic that would claim more than 1.2 million lives, a total ban in Australia on international travel, state borders to slam shut, the second-most populous city in the country to enforce a lockdown for 112 days. You see 1 million Australians unemployed as the country enters its first recession in 29 years.
As the year draws to a close, you predict the president of the United States will refuse to concede the 2020 election outcome.
Given this outlook, what prediction are you likely to make for Australian equities?
With perfect foresight, you’d have been more likely to stick your money under the mattress than in the market – I think few people would’ve guessed that the market would be pretty much flat over the 12 months from December 2019.
This thought-experiment highlights the core issue with forecasting: it’s hard to predict the big events that move sharemarkets, and it’s even harder to predict how markets will react to them.
So rather than vague prognostications on what next year might hold, when assessing the top three things that matter for investing in 2021, we assess the same three things that always matter for any investment, at any time.
1. Balance sheets
Corporate debt levels hadn’t seemed to matter to the market much over the last few years, and some companies had been lured by cheap debt to fund share buybacks or increase dividend pay-outs.
The economic impacts of the COVID-19 health crisis quickly changed the market view on the importance of financial strength, with over $30 billion of equity capital raised on the ASX in 2020 to repair balance sheets.
(Editor’s note: Almost $56 billion was raised in secondary capital on ASX in the calendar-year to October 2020, including emergency capital raisings).
However, it’s not just during global crises that financial strength matters. Over the long term, companies able to fund their operations, including growth, from internally generated cashflows tend to outperform those that repeatedly need to come to the market to raise equity.
This collection of companies that repeatedly require new equity capital, or “equitisers”, has underperformed by 9% per annum relative to low equitisers on the ASX over the past 20 years, according to Airlie analysis.
Figure 1: Long Term Outperformance of Companies with Low Levels of “Equitisation”