It wasn't long ago that I wrote about the large number of companies that have been promising a better tomorrow recently. iSentia Group Ltd (ASX: ISD) and Ainsworth Game Technology Limited (ASX: AGI) are just two of them, while Vocus Communications Limited (ASX: VOC) was added to that list very recently.
Retail Food Group Limited (ASX: RFG) and G8 Education Ltd (ASX: GEM) are two other companies expecting a stronger second half, although G8's problem is associated with the timing of holiday periods.
There are three key issues with buying second-half superstars:
- Can management be trusted?
I've already written in some depth on that topic here. In short you want to make sure that management is being frank and transparent, that their forecasts seem grounded in reality (given the macro environment and challenges they have reported), and that they are not attempting to forecast the unforecastable.
- Does the company's valuation hinge on a stronger second half?
Is the company priced in a way that relies on a strong second half in order to make the valuation reasonable? Or in other words, if the second half forecasts don't come true, would shares plunge? If this is the case then you need to closely evaluate the likelihood of that forecast coming true.
Long-term investors should avoid anchoring on price, but there's no point paying up for a business with questionable forecasts if you could buy it 6 months later and 30% cheaper. High Price to Earnings (P/E) ratios are the first thing to look for, followed by other events such as the end of a big contract, rising impairments ('bad debts'), the potential impact of new regulations, and so on.
- What's the long-term view like?
A number of companies, like Vocus, look very cheap if you look out beyond the next two years. It's easy to get hung up on the second half – especially if your shares plunge 43% – and even more so if management is promising a stronger second half. Yet most investors who retire wealthy make their money over years and years of compounding earnings – not with a 50% gain or loss in a six-month period.
Find businesses with good management and a good opportunity, try to get them at a reasonable price, and then let the share price take care of itself.
