Finding quality companies at reasonable prices is getting harder and harder. The index of Australia's top 200 listed companies is up 32% since mid-2012 and 15% since June this year. Investors looking for stock ideas should concentrate on companies that are likely to grow earnings strongly over the next two to three years.
Buy: Oil Search (ASX: OSH)
LNG producer Oil Search's half-year results earlier this year were fairly lackluster, with net profit growing 6% as exploration spending was cut, while production volumes fell 2%. The result was largely expected and actually didn't matter much in the grand scheme of things.
The presentation was dominated by news that the company's Papua New Guinea (PNG) LNG project is on track and due to produce first gas in 2014. The project, in which Oil Search has a 29% stake, is expected to increase annual production fivefold and is over 90% complete.
Oil Search's share price has largely tracked the ASX 200 index for the past 18 months and is expected to get a nice boost when the PNG LNG project successfully starts producing in 2014. The key risk is that any delays in the project could result in a significant drop in the share price.
Hold: Carsales (ASX: CRZ)
Unlike Oil Search, there are few significant near-term growth catalysts for Carsales. The company's share price was punished in October when a presentation at the AGM noted that market conditions were weak, leading to lower volumes and earnings.
A decision by major brands Subaru, Holden, VW, Nissan, Honda and Suzuki to pull new car ads from the website had meaningfully impacted volumes, however the company noted that it had strategies in place to address the shortfall and make the platform more appealing for new car sales.
A recent analysis by the folks at Intelligent Investor noted that while competitors had a similar amount of sale listings, potential buyers spent far more time on Carsales, 76% of total time in fact. This gives the company a competitive advantage over its peers in order to maintain market share, however in the medium term there are few catalysts to drive meaningful earnings growth while consumer confidence remains weak.
Sell: Mermaid Marine (ASX: MRM)
Shares in marine service provider Mermaid Marine were punished earlier this month when the company announced that 2013-14 earnings would be on par with those from 2012-13. The shares plunged more than 15% during intra-day trade to $2.98 before recovering slightly to now trade around $3.36.
Analysts had previously flagged 10% growth in earnings spurred by offshore exploration and drilling programs, however Mermaid announced that Western Australia volumes were down 30% on expected levels. Mermaid had been tracking well, and exposure to the oil and gas fields off WA had provided some insulation to slowing mining capital expenditure. Mermaid is basing the new earnings estimate on a 60% second-half earnings bias, indicating that the share price may come under further pressure if a revival in activity does not materialise. Investors may be wise waiting for progress updates in 2014 before diving in.
Foolish takeaway
A key theme for the above companies is sustainability and growth of earnings and profit. At times such as these when share prices have risen so strongly over a short period, companies that disappoint investors with lower earnings or lost market share are likely to get punished. Conversely, those with growing earnings — such as the string of web-based IPOs recently — will to see strong demand.
