I'm in no rush to buy BHP Billiton Limited (ASX: BHP) shares, Commonwealth Bank of Australia (ASX: CBA) shares and Coca-Cola Amatil Ltd (ASX: CCL) shares.
"Nobody goes there anymore. It's too crowded" – Yogi Berra
This article follows another piece I wrote on three blue chip ASX shares to avoid. In that article I explained why avoiding shares altogether is one of the greatest advantages to individual investors.
Basically, it boils down to the idea that we don't need to buy or sell all 2,000 shares on the market because we make money by holding shares – not buying or selling.
Academics have shown that if an investor knows what he or she is doing and builds a portfolio of 15-20 shares they will outperform investors who hold more shares.
The finding relates to two concepts:
- Backing your best investment ideas (aka 'conviction'), and
- Downside protection (read: diversification)
On the second point, academics have further shown that 10 stocks can reduce the diversifiable risk of a portfolio by as much as 70%, while 30 stocks is as good as it gets for random stock pickers.
A couple tips and tricks
To make the process of identifying good ASX businesses easier, I'm filtering out all of the industries and businesses that I believe are not worth my time. For example, I choose not to invest in mining companies.
Therefore, despite its size, BHP Billiton is a company I'm avoiding. That doesn't mean 'buy' or 'sell', just avoid. As I have repeatedly said, I have no ability to forecast commodity prices better than anyone else.
I won't invest in companies if I don't understand how they plan to make money in the future and prefer companies that can set the prices of their products and/or services.
After the filtering process, it's time to consider valuation. That's where these next two ASX companies fall down.
Coca-Cola Amatil is Australia's, and some neighbouring countries', bottler and distributor of Coca-Cola products. They also sell Beam alcohol beverages. I held shares of the company in the past (they were dark days) because I had hoped they would revive their brand's potential.
However, in the past five years, Coca-Cola's profits per share have fallen – each year.
Profits or earnings per share (EPS) is the best way to measure the profitability of a business.
Pro tip: If a company is NOT growing its EPS, the only way you make money is by sentiment changing.
What that means is, if you buy a company with a price-earnings ratio (P/E) of 10x and you plan to make money from it, the person you sell your shares to must buy the shares at a higher P/E ratio (e.g. 15x). The only way that can happen is if sentiment changes — because the EPS won't!
Of course, I'm talking about capital growth — you can still receive a dividend.
Unfortunately, I am not willing to bet the sentiment around Amatil's fizzy drinks and alcohol changes anytime soon.
Coca-Cola Amatil shares trade on a P/E of 24x — the market average is 18x.
This brings me to Commonwealth Bank of Australia.
Australia's largest company has done an exceptional job of growing its profits over the past two decades. However, its EPS growth has slowed dramatically over recent years. EPS is up 5% in two years.
Let's not forget that Australia's banking system has experienced booming house prices, plunging bad debt charges and non-stop economic growth.
Looking ahead, however, the outlook is not so rosy.
While the dividend should reward patient shareholders, I do not believe the profits will.
So, with over 2,000 companies on the ASX, why would I buy a company that I do not believe will grow its profits?
