Top 20 stocks: The good, the bad and the ugly

Transcription

1 Top 20 stocks: The good, the bad and the ugly special report june 2014 Intelligent Investor Share Advisor PO Box Q744 Queen Vic. Bldg NSW 1230 T F info@intelligentinvestor.com.au shares.intelligentinvestor.com.au

2 PO Box Q744 Queen Victoria Bldg. NSW 1230 T F info@intelligentinvestor.com.au shares.intelligentinvestor.com.au DISCLAIMER This publication is general in nature and does not take your personal situation into consideration. You should seek financial advice specific to your situation before making any financial decision. Past performance is not a reliable indicator of future performance. We encourage you to think of investing as a long-term pursuit. DISCLOSURE As at 1 June 2014, in-house staff of Intelligent Investor held the following listed securities or managed investment schemes: ALL, AOG, ARP, ASX, AWC, AWE, AZZ, COH, CPU, CSL, EGG, ICQ, IFM, JIN, KRM, MAU, MIX, MQG, NBL, NST, PTM, QBE, RMD, RNY, SLR, SRV, SWK, SYD, TAP, TEN, USD, UXC, VMS, WDC, WES and WRT. This is not a recommendation. PRICES CORRECT AS AT 30 May 2014 Contents Of diamonds and dogs 3 A review of 2007 s ranking 3 Lessons from 2007 s ranking 4 Australia s Top 20 stocks ranked by investment 5 attractiveness Using Intelligent Investor s value-based ranking 6 Prudence stuck on Blue Chips 8

3 3 Special report Of diamonds and dogs In 2007, we ranked the Top 20 stocks in order of attractiveness. Seven years later, the difference in returns between investing in the top and bottom five was more than 50%. This time, we re again looking for the diamonds and dogs in that auspicious list. We ll also suggest ways you could use this ranking in a very practical sense: to build a core portfolio around Australia s largest stocks. The top 20 stocks are the most widely owned in the country. Who doesn t have a place for at least one of the big four banks, a resources giant or an owner of one of the two dominant supermarket chains? In this report we ll not only draw together our recommendations on Australia s largest stocks in one place but we ll also rank them based on their attractiveness. In other words, you ll see which of the two current Buy recommendations in the Top 20 we like the best and which of the three stocks bearing negative recommendations we like least. Just as importantly, you ll also see how we rank the 15 Holds in between. That all begins on page 5. We ll also suggest ways you could use this ranking in a very practical sense: to build a core portfolio around Australia s largest stocks. That s on on page 6. Table 1 shows very effectively that Hold recommendations are far from boring. There s actually great value in understanding which of the Top 20 stocks Table 1: Prudence (profitably) stuck on blue chips - results reviewed offer better opportunities than others, even if most of them sport this bland-looking tag. To show how, let s start with the returns from the 2007 data. A review of 2007 s ranking June 2007 was a heady time. Harry Potter and the Deathly Hallows was about to become the fastest selling book in history and the All Ordinaries Index was a few months away from its boom-time peak. No one had heard of the GFC, although there were rumblings and worries about banking practices and derivative products. Market observers were intently discussing three Top 20 Aussie stocks that were hovering around the financially irrelevant but aesthetically interesting $100 mark: Macquarie Group, Rio Tinto and CSL (before its subsequent 3-for-1 share split). Seems like another world now doesn t it? In this climate we ranked the market s Top 20 stocks, not by common yardsticks like market capitalisation or Perf Rank Stock 2007 price price/ Dividends Total rank (2007) (29 June) ($) recommendation adjustments ($) adjustments ($) Return (%) 15 1 Westfield Long Term Buy Westpac Hold Woolworths Hold Comm. Bank Hold ANZ Hold Telstra 4.59 Hold Rio Tinto Hold Mac. Bank Hold Woodside Hold PBL Hold NAB Hold CSL Hold Brambles Hold Coles Hold Wesfarmers Hold QBE Insurance Better Value Elsewhere St George Take Part Profits BHP Billiton Take Part Profits AMP Avoid Suncorp Sell Average 29.2 II Top II Bottom 5 2.8

4 Share advisor 4 The nature of CSL s business also means it has more optionality With an annual research and development spend approaching half a billion dollars, there s always the chance of discovering another blockbuster drug. revenue but by another, more useful, measure. [To see the full article, turn to page 8 and read Prudence stuck on Blue Chips Ed] We placed them in order of attractiveness from a long term investor s perspective, comparing the value on offer with the price paid to secure it. At the time, Intelligent Investor had only one positive recommendation on a Top 20 stock (Westfield), five negative recommendations and 14 Holds. But the gradation of these recommendation types into a clear ranking from most to least attractive was incredibly valuable, as the results summarised in Table 1 (on page 3) show. The average return from an evenly-weighted portfolio of the Top 20 stocks was 29.2%, about 3.8% a year. By comparison, our top five picks based on value returned an average of 56.5% 6.7% a year. And that figure was achieved without the inclusion of the Top 20 s best performer, CSL. How did we deliver almost double the performance of the average returns from the Top 20? By identifying those stocks that turned out to be underperformers. Five stocks from 2007 s Top 20 list delivered negative overall returns. We successfully identified three of those in the five stocks at the bottom of our 2007 ranking. They were QBE Insurance (which ranked 16th), AMP and Suncorp (which ranked 19th and 20th, respectively). Members did well simply by avoiding the losers. We were also able to separate the better-performing big four banks from their lower-performing siblings. In fact, we almost got them in the exact order, except that we preferred Westpac (which delivered a 76% return) to Commonwealth Bank (87%). The third-rated of the four ANZ returned 50% while NAB, which was the only big four bank to miss out on a top 10 ranking, was clearly the worst performer with a paltry 11% return. Readers may note that several of our recommendations changed subsequently. As QBE Insurance fell from being horrendously overpriced in 2007, we shifted to a more favourable view in In hindsight and after so many years of studiously avoiding it at much higher prices, we were too keen to add this impressive long-term performer to our recommended list. Woolworths, Commonwealth Bank and Westpac also earned positive recommendations in 2010 and Macquarie Group became a Strong Buy in These cases speak to the cycles of the stock market and reflect the nature of value investing. At the market s peak in 2007 only one of the Top 20 stocks boasted a positive recommendation from Intelligent Investor. A few years later when prices were more attractive, that number had shot up to six. Today, following a strong rebound, it s back to two. We re pleased with the results of our previous ranking and hope that they underscore the way that your portfolio might benefit from the process of casting a value investing eye over the nation s largest stocks. You ll find our latest ranking on page 5. But first, a few observations from the results of the past seven years. Lessons from 2007 s ranking What lessons can we learn from the results of our previous Top 20 ranking? Firstly, it s noteworthy that we missed the best-performing stock in our top five selections, but doing so didn t do us any harm. CSL has returned a stellar 159% over the past seven years. It s a strong player in a global market which means it had, and continues to have, more growth potential compared to the likes of a big bank or a large retailer like Woolworths, all of which face a tough choice between a mature domestic market or international expansion into countries where they don t possess an obvious competitive advantage. The nature of CSL s business also means it has more optionality. For instance, it has the potential to develop tremendously valuable products like its HPV vaccine, Gardasil. With an annual research and development spend approaching half a billion dollars, there s always the chance of discovering another blockbuster drug. Takeovers were another theme driving performance. Both Coles and St George were in the second half of our value-based ranking but ended up being top-half performers thanks to takeovers by Wesfarmers and Westpac, respectively. At the time Coles was playing second-fiddle to Woolworths, to the point where some analysts were questioning whether an unassailable gap was opening up between the two groups. And St George, like its regional peers, was finding it an uphill battle against the majors. We have to be careful about the lessons we draw from these stocks, though. Suncorp was a poor performer which might have been rescued by a St George-type deal but wasn t. In short, we d never recommend an investment on takeover potential alone. It would have to come as icing on an already attractive cake. The results also highlight the dangers of acquisitions, which played a role in all three of the worst performing stocks. QBE Insurance had been acquisitive, and successfully so, for many years. But a combination of a couple of lessthan-spectacular acquisitions, a turn in industry conditions and record low interest rates conspired against it. In 2007, investors were paying more than four times book value for a company that had just posted a return on equity of 26.1%. In 2014, after two consecutive years of 7% returns on equity, investors are now paying less than 1.2 times book value. The true long-term value and returns on equity likely lay somewhere between those figures. If QBE was partly savaged by a string of acquisitions, Rio Tinto and AMP were felled by single, large transactions. Both demonstrate the reason we ve always been sceptical of such moves. Depending on your view, Rio Tinto s Alcan acquisition was either ill-timed, ill-conceived, or both. Long the custodian of a counter-cyclical culture, the company s board performed a volte-face and authored this signature

5 5 Special report Not a single member of the big four banks has made our Top five this time around. top-of-the-cycle deal. It was an ugly ride down the far side of the commodities super-cycle boom-time slope. AMP s acquisition of arch-rival AXA was driven by a combination of hubris and over-optimism. The price paid demanded ambitious assumptions that conservative investors shouldn t have swallowed. Throw in a challenged business model involving skimming fat fees from less sophisticated clients who are gradually waking up to their alternatives and you can see why it was in a close race for last place. Those are essentially the same reasons which drive the company s rating in this year s ranking. The business challenges remain and the dilution caused by issuing so many shares to former AXA shareholders will weigh heavily for many years. Australia s Top 20 stocks ranked by investment attractiveness While we currently only have a couple of Buy recommendations, a few Sells and a preponderance of Holds among the Top 20 stocks, the 2007 exercise shows the value in identifying which companies are more attractive from a valuation standpoint, beyond the gradations of a simple recommendation. Two years ago we also had Macquarie Group, QBE Insurance and Origin Energy on the list of Top 20 stocks sporting Buy recommendations. But with the All Ordinaries index up 34% since then, value investors should expect slimmer pickings, which is exactly what we find today. Table 2: Top 20 stocks ranked by value Two years ago, a quarter of the Top 20 stocks offered good value for investors. Today, the figure is just 10%. Just two stocks Santos and Woolworths (and we re even pushing things here as the giant retailer is trading a little above our official Buy recommendation price guide) are on our Buy list. At the other end of the scale, we have Sell recommendations on AMP, ANZ Bank and Brambles. AMP has the dubious honour of being at the bottom of the table this time around while also being ranked 19th out of 20 in our previous list. Given it s down 26% over the past seven years, including dividends, it s been an horrendous performer. We don t expect the next seven years to be as bad for AMP shareholders but we simply can t get behind a company that seems mired in a dated business model and bears all of the problems of corporate indigestion that inevitably come from swallowing your largest competitor. You might also note that not a single member of the big four banks has made our Top five this time around. That s in stark contrast with seven years ago when Westpac, Commonwealth and ANZ occupied three of the Top five places. On the other hand, four resources-exposed groups have made our Top five this year, compared with a big fat zero in That was the right call, incidentally, with every one of the resources stocks in the 2007 Top 20 delivering a below average return over the ensuing seven years. We re also mindful that CSL just missed a place in this year s Top 10 and, for the reasons discussed on page 4, could easily be a standout performer again. Rank Stock code Most recent review Reco. & price ($) Current price ($) Sell price ($) Buy price ($) 1 Santos STO 27 Feb 14 Buy Above Below Woolworths WOW 3 Mar 14 Buy Above Below Origin Energy ORG 24 Feb 14 Hold Above Below Rio Tinto RIO 17 Feb 14 Hold Above Below Wesfarmers WES 20 Feb 14 Hold Above Below Telstra TLS 13 Feb 14 Hold Above 6.00 Below QBE Insurance QBE 15 Apr 14 Hold Above Below BHP BHP 21 Feb 14 Hold Above Below Woodside Petroleum* WPL 25 Feb 14 Hold Above Below Commonwealth Bank CBA 19 May 14 Hold Above Below CSL CSL 13 Feb 14 Hold Above Below Macquarie Group MQG 26 May 14 Hold Above Below Westpac WBC 19 May 14 Hold Above Below Westfield Group WDC 21 May 14 Hold Above Below NAB NAB 19 May 14 Hold Above Below Suncorp SUN 27 May 14 Hold Above Below Insurance Australia Grp IAG 10 Jan 14 Hold Above 6.00 Below Brambles BXB 12 Sep 13 Sell Above 8.00 Below ANZ Bank ANZ 19 May 14 Sell Above Below AMP AMP 10 Jul 13 Sell Not provided Not provided *Woodside Petroleum was downgraded to Sell on 2 Jun 2014, subsequent to this rankings finalisation.

6 Share advisor 6 If you re patient, the best approach is to just wait until one of the Top 20 stocks earns a positive recommendation. Using Intelligent Investor s value-based ranking Most investors have a core portfolio built around the Top 20 giants. Let s take a look at different ways that building such a portfolio might be achieved. Imagine you had a $150,000 share portfolio and that you wanted to allocate two thirds of it to the largest 20 stocks, with the other third in a combination of second line and speculative issues. That s $100,000 to be invested in the Top 20. If you were to split your $100,000 along size lines, you d be investing around 65% of your Top 20 allocation across just two industries and six stocks (the two giant miners and the big four banks). Add in Telstra and you re at a 70% allocation in just seven stocks in only three industries. You can see the outcome in Table 3. Simply splitting the $100,000 evenly across all 20 stocks would provide more diversification. The problem with that approach, or the market capitalisation-based one, is that it takes no account of investment attractiveness. Table 3: Portfolio of Top 20 stocks by market capitalisation We would never advocate buying an over-priced stock simply to add diversification to a portfolio. Better to hold cash than pay more than 100 cents for a dollar s worth of value, which brings us back to our rankings and how to use them. If you re patient, the best approach is to just wait until one of the Top 20 stocks earns a positive recommendation. Over the past seven years, that approach would have seen you accumulate a collection of six of the Top 20 stocks at attractive prices. If you wanted to build a portfolio more quickly, you have another option. Rather than invest $5,000 in each of the Top 20 stocks, you could eliminate the bottom five by attractiveness (namely, Suncorp, Insurance Australia Group, Brambles, ANZ Bank and AMP) and double up on the five most attractive options by investing $10,000 in each of Santos, Woolworths, Origin Energy, Rio Tinto and Wesfarmers. Using this approach, you d end up with a 15-stock portfolio skewed towards those investments offering Rank Stock code Shares (m) Current price ($) Market Cap ($m) Investment ($) 1 BHP BHP 5, ,084 18,105 2 Commonwealth Bank CBA 1, ,028 12,037 3 Rio Tinto RIO 1, ,802 10,116 4 Westpac WBC 3, ,323 9,711 5 ANZ Bank ANZ 2, ,558 8,375 6 NAB NAB 2, ,644 7,116 7 Telstra TLS 12, ,943 6,057 8 Wesfarmers WES 1, ,755 4,502 9 Woolworths WOW 1, ,167 4, Woodside Petroleum WPL ,566 3, CSL CSL ,887 3, Westfield Group WDC 2, ,483 2, Macquarie Group MQG ,372 1, Suncorp SUN 1, ,189 1, Origin Energy ORG 1, ,006 1, AMP AMP 2, ,677 1, Brambles BXB 1, ,019 1, Santos STO 1, ,550 1, QBE Insurance QBE 1, ,194 1, Insurance Australia Group IAG 2, ,909 1,259 Total 1,105, ,000

7 7 Special report This portfolio smooths much of the lumpiness that arises from sizebased allocations and tilts your investments towards those stocks offering better value. better value. Table 4 Illustrates what this value-based portfolio might look like based on a $100,000 investment (being two thirds of an overall portfolio of $150,000). This portfolio achieves two worthwhile aims: it smooths much of the lumpiness that arises from size-based allocations and tilts your investments towards those stocks offering better value. Of course, you might come up with other inventive ways to build a portfolio around our value-based ranking. Table 4: Illustrative value-based portfolio Rank Stock code Investment ($) 1 Santos STO 10,000 2 Woolworths WOW 10,000 3 Origin Energy ORG 10,000 4 Rio Tinto RIO 10,000 5 Wesfarmers WES 10,000 6 Telstra TLS 5,000 7 QBE Insurance QBE 5,000 8 BHP BHP 5,000 9 Woodside Petroleum* WPL 5, Commonwealth Bank CBA 5, CSL CSL 5, Macquarie Group MQG 5, Westpac WBC 5, Westfield Group WDC 5, NAB NAB 5,000 Total 100,000 *Woodside Petroleum was downgraded to Sell on 2 Jun 2014, subsequent to this rankings finalisation. You may also prefer to be more concentrated in your approach. For instance, you might simply invest across the Top 10 stocks in our value ranking, although we d urge you to consider 11th-placed CSL because it offers such a different risk profile to other stocks on the list. The final point is more broadly-based. Just a few years back, large blue chip stocks were relatively cheap. Now, many are relatively expensive, as this research indicates. Before diving in and establishing a portfolio based around the Top 20 stocks, you may want to question the veracity of what has become a shibboleth in Australian investing; that the big four banks are always a good bet. A portfolio based around the Top 20 stocks as shown in Table 3 leaves investors highly exposed to the banking and resources sectors. The value-based approach shown in Table 4 reduces this exposure considerably which is all to the good but it still retains a heavy concentration in two sectors, with resources accounting for 35% or 40% (depending on how you classify Wesfarmers and Origin Energy) and the big banks, excluding Macquarie, which is a rather different beast, 15%. Intelligent Investor Share Advisor has repeatedly warned members not to be over-exposed to the banking sector, largely because the macro threats Australia faces, which include 23 years without a recession, a huge slowdown in mining investment and the threat of a Chinese property bubble, are mounting. The value-based portfolio in Table 4 meets our portfolio limit of having less than 20% of one s portfolio in the major banks. But conservative investors should halve that limit, which means the above portfolio would breach this guideline. What to do? The first point of call is to read another special report, Time to Switch Banks. It surveys the local banking environment and gives some context to our bank portfolio limits. Then it analyses two top US banks, which, in comparison with their local counterparts, offer very good value. It s a way to retain bank exposure without taking on the risks that the local banks face. With the Australian dollar relatively high, it s also a very good time to seek out international diversification, especially when you can buy first class, reliable businesses that you can t buy locally. Remember, too, that the US banking industry has had its crisis. That s not to say the local banks will face a moment of disaster, but one should be aware of the risks, which are probably greater than many people calculate. The final point ties in to the international theme. By buying a conglomerate like Berkshire Hathaway, you also get far better diversification by industry, geography and currency than you do among the top 20 local stocks. And you get the added advantage of having an unrivalled owner/ operator in the form of Warren Buffett at the helm. So, your options are broad and attractive. Many investors prefer to stick with big, local stocks and if that s you, this report shows you a way to build a portfolio that incorporates value as well as size and diversification. But if you are prepared to look a little further afield, right now you can achieve even better diversification and better value. Plus there s the potential kicker of a falling Australian dollar to boost your returns.

8 Share advisor 8 Prudence stuck on Blue Chips The indomitable Prudence Warywallet is in a bit of a quandary. She feels her portfolio is a little out of kilter, but she s not getting much help with it, explains James Carlisle. Originally publised june 2007 She d checked The Intelligent Investor s recommendations on her large blue chips holdings, but was slightly frustrated to find an overwhelming preponderance of Hold recommendations. You need more in resources, said Bert, and a bit less in banks. I see, replied Prudence Warywallet. She felt that need was rather a strong word; she wasn t even sure what she wanted. Why is that, then? Resources is where it s all happening at the moment, Mrs W, replied Bert. The BRIC economies are growing fast and they need our raw materials. Profits have been soaring. It s all part of the supercycle. As for banks, well the internet is putting pressure on margins and we just don t think they have the same growth trajectory as they used to. Prudence was used to not understanding a word Bert said, but he was a nice enough boy and her father had always sworn by BusyTrade Brokers before he passed away. She generally did her own research on investments, with the help of The Intelligent Investor, and had had some success. In particular, she felt she had done well to avoid the rush into infrastructure funds (see our feature from 15 Mar 06, Prudence says no to infrastructure.) But Prudence mainly tinkered around the edges of her portfolio, leaving its blue chip core largely intact. lopsided This didn t appear to have held back its performance, but she was worried that it was becoming a bit lopsided in certain areas. She d checked The Intelligent Investor s recommendations on her large blue chips holdings, but was slightly frustrated to find an overwhelming preponderance of Hold recommendations. From one point of view, this was fine. After all, holding was exactly what she was doing. And she d understood the point made in the feature on 30 Jan 07, Buckle down for a blue chip bonanza, that blue chips tend to present fewer obvious opportunities because they re followed so closely. But, all the same, it didn t give her much to go on. So Prudence had made her way down to Melbourne to talk things over with Bert. But Bert s jargon seemed to be ripening with age and she came away more confused than ever. Prudence returned to The Intelligent Investor website to see what else she could turn up. She was pleased to find that, among blue chip resources stocks, Rio Tinto was a pretty clear favourite. BHP Billiton had a Take Part Profits recommendation compared to Rio s Hold, and the reasoning was clear from the articles If tough times arrive, Rio Tinto looks better placed to weather the storm she read in an update on BHP from 12 Feb 07 (Take Part Profits $28.52). But Prudence had heard on the news that Rio s share price had passed $100 recently and she wondered whether the opinion still held. Remembering something she d read in one of The Intelligent Investor s updates, Prudence fired in a query via the Ask the Experts tab on the website: Hello. With the Rio share price hitting $100 recently, do you still prefer it to BHP? Also, are there any other blue chip resources stocks you d be interested in? Thanks. Pru W. Soaring share prices Prudence wasn t able to watch the Ask the Experts forum live on Thursday as it was her day looking after the grandchildren. But that night she checked back and was pleased to see her question had been answered by Greg Hoffman: Hi Pru. You probably remember a few years back, in 2003, when we issued a series of Long Term Buy recommendations on Rio at around the $30 mark and BHP Billiton around $9. At the same time, we were also keen on Woodside Petroleum when it was around $13 and Santos at around $6. But the price of each these stocks has soared since then. We ve done very well from these investments but we re not keen to add to any holdings at what may prove to be the top of a cycle (see our feature from 10 May 06, titled A fresh spin on the supercycle). We do still prefer Rio to BHP. The $100 mark is itself of no significance and, though Rio s share price has been rising strongly lately, BHP s has been no slouch. Our preference for Rio still stems largely from the different ways the companies are approaching the current boom. In its 2006 annual report, BHP s outgoing head honcho Chip Goodyear wrote: We believe the world may be witnessing just the beginning of a whole new period of change and BHP Billiton is an essential element of that change. In Rio s 2006 annual report, the following more measured comments came from chairman Paul Skinner: I have warned in previous messages about the risk of complacency that can flow from a period of strong markets and sustained success. We remain alert to this and recognise the long-term cyclical nature of our industry. In short, Rio s conservative approach sits more comfortably with us. Though, if it really is different this time, then BHP may well do much better than Rio over the coming years.

9 9 Special report Her next major issue was banks. She held both NAB and Commonwealth Bank and between them they d come to represent nearly a quarter of her portfolio, so she wondered whether she should reduce one or both of the holdings. Bringing in the oils, we d place Woodside and Santos between Rio and BHP, with a slight preference for Woodside owing to the higher quality of its reserves. If one wanted exposure to long-term oil price rises, then Woodside might be preferable to Rio, but otherwise Rio s broader diversification would probably appeal. In a larger portfolio, it might make sense to have an oil and gas company as well as Rio. The former could be Woodside or Santos, but our preferred means of getting specific oil and gas exposure at the moment is the somewhat riskier Roc Oil. Wondering about banks Prudence was delighted with this response. She resolved to look back at a few earlier reviews of the stocks, but it sounded like it was going to be an easy decision to maintain her holdings in Rio and Woodside and cut BHP back a bit, despite the capital gains tax that would be payable. Her next major issue was banks. She held both NAB and Commonwealth Bank and between them they d come to represent nearly a quarter of her portfolio, so she wondered whether she should reduce one or both of the holdings. On top of the comments from Bert from BusyTrade, The Intelligent Investor had recommended limiting banks to 15% of a portfolio in an article on 21 Jun 06, Is your bank going broke?. Prudence was a little reluctant to take such drastic action, since there would be a big tax bill involved. And, as much as she had enjoyed the Is your bank going broke? article, it hadn t really said which of the big four was best and which was worst. So she fired in another question to Ask the Experts. Hello again, Prudence wrote. Thanks for your response on resources last time. Now I m wondering about banks. Do you still feel that 15% is the most I should have in banks? Is the internet going to cause them problems? And, although I know you have Hold recommendations on each of the big four, do you have a preference between them? Thanks. Pru W. Again, Prudence was rewarded with a reply, this time from James Greenhalgh: Hello Pru. I m afraid we re not permitted to give personal advice according to the terms of our licence, but I can explain our views on banks in general terms. First of all, the 15% figure you mention should be thought of as a general ballpark figure, and it needs to be considered alongside your personal situation and tax position. The internet is certainly causing problems for the big banks, but then it s also providing opportunities, as we wrote in our feature on 12 Feb 07, What the internet means for banks. Overall, prospects for the banking sector are probably the same as ever, but risks may be increasing. Because times have been so good for so long, there s the risk of complacency in lending practices, and the increasing reliance on derivatives around the world could magnify any problems. There s also the danger of internet fraud. All this is hard to quantify, but that s the way with risk. The main reason we mentioned the 15% figure is that we know a lot of people have large holdings in banks because they ve been held for so long and they ve performed so well. In terms of the big four banks themselves, as you mention, we don t see much to choose between them and our preferences are therefore somewhat fluid. That s why we don t tend to say which we prefer we just don t want people reading too much into it. But since you ve pushed us to it, at the moment we d favour Westpac over the others. It s a well managed bank and seems content to stick to its knitting rather than run off and expand overseas. It has a good mix of traditional banking and funds management through its BT business. Our least favourite is NAB. This is a legacy of the disasters the bank experienced a few years ago. While it has hardly put a foot wrong since then, the share price already seems to be factoring in all the benefits of its comeback. As between Commonwealth Bank and ANZ, in the middle spots, we d probably just favour the former. Commonwealth Bank is similar to Westpac in that it has very strong local banking and funds management businesses. The main downer is that it is the most expensive of the big four using the basic PER measure. Still it has a slight edge over ANZ, mostly because we see it as a slightly safer option. The appointment of Michael Smith (formerly boss of HSBC s Asian operations) as the new CEO of ANZ no doubt foreshadows further international expansion and we ve increased its risk ratings accordingly. Note that we currently have a negative recommendation on St George you can see our reasoning in our review on 7 Nov 06 (Take Part Profits $36.23). All this put Prudence in a bit of a quandary. NAB sounded like the one to reduce, and that would involve less capital gains tax for her than selling Commonwealth. But Commonwealth had grown to be the bigger holding, so selling some of that would probably make for a better balance. She decided to stew on it some more. At least she felt she now had a better foundation for making a decision, and she was reassured to know there wasn t much in it. Similar position If you have a large blue chip portfolio, there s a good chance you re in a similar position to Prudence, finding that we don t make many clear distinctions between the stocks that form the bulk of your portfolio. So we ve taken the unusual step of listing the market s top 20 stocks by market cap, according to our preference, based on our return expectations tempered a little by risk. Our views on each stock s risk are reflected in our ratings for fundamental risk and share price risk. (These range from 1 to 5, with the latter being most risky.) You can see Table 1 over the page. Hopefully it will give you a flavour for our feelings about these

10 Share advisor 10 stocks. Just don t ask us what it is about the letter W. Bear in mind, though, that we re making some very fine distinctions between some of these stocks, and when we wake up tomorrow one or two of the places could have shifted. Large movements up or down the list, though, would be unlikely without major relative share price movements or big news on the business front. And remember that at any time you can ask us about our feelings on these, or indeed any other, stocks via our Ask the Experts forums. We also frequently discuss the largest blue chip stocks in our podcasts. Table 1: Our ranking of the ASX s largest 20 stocks by market capitalisation* Stock price Market cap. business Share price Recommendation and (ASX code) ($) ($bn) risk risk previous review 1 Westfield (WDC) Low Medium 14 Jun 07 (Long Term Buy $20.90) 2 Westpac (WBC) Low Med Medium 8 May 07 (Hold $27.32) 3 Woolworths (WOW) Low Medium 18 Apr 07 (Hold $28.78) 4 Comm. Bank (CBA) Low Low Med 15 Feb 07 (Hold $51.35) 5 ANZ (ANZ) Low Medium 2 May 07 (Hold $30.67) 6 Telstra (TLS) Low Med Medium 23 Apr 07 (Hold $4.72) Remember that at any time you can ask us about our feelings on these, or indeed any other, stocks via our Ask the Experts forums. 7 Rio Tinto (RIO) Low Med High 12 Feb 07 (Hold $75.44) 8 Macquarie Bank (MBL) Low Med High 27 Jun 07 (Hold $85.44) 9 Woodside (WPL) Low Med High 29 Aug 06 (Hold $41.78) 10 PBL (PBL) Medium Medium 18 Jun 07 (Hold $19.02) 11 NAB (NAB) Low Med Medium 10 May 07 (Hold $43.63) 12 CSL (CSL) Med High High 22 Feb 07 (Hold $77.65) 13 Brambles (BXB) Medium Med High 14 May 07 (Hold $13.62) 14 Coles (CGJ) Low Medium 5 Jun 07 (Hold $16.88) 15 Wesfarmers (WES) Low Med High 12 Jun 07 (Hold $39.03) 16 QBE (QBE) Medium Very High 18 Jan 05 (Better Value Elsewhere $23.66) 17 St George (SGB) Medium High 10 May 07 (Take Part Profits $36.23) 18 BHP Billiton (BHP) Low Med High 12 Feb 07 (Take Part Profits $28.52) 19 AMP (AMP) Med High Med High 23 May 06 (Avoid $9.05) 20 Suncorp (SUN) Low Medium 26 May 07 (Sell $20.72) * News Corp has been excluded because we don t cover it; Rinker because it s about to be taken over. Disclosure: The author, James Carlisle, at the time owned securities in Westfield Group. See our staff portfolio on page 2 for a full list of staff holdings. Intelligent Investor Share Advisor PO Box Q744 Queen Vic. Bldg NSW 1230 T F info@intelligentinvestor.com.au shares.intelligentinvestor.com.au