In the share market, luck is what happens when preparation meets opportunity. The pull-back in the market over recent weeks presents us with opportunity, so let's summarize the preparation.
First, let's call upon the wisdom of Peter Lynch, one of the great fund managers ever. His 13 years as manager of Fidelity's Magellan Fund returned 29% per annum, thereby turning a $10,000 initial investment into $280,000.
He made popular the price/earnings-to-growth ratio (PEG), which helped identify undervalued stocks. This effectively undermined the P/E ratio, as a stock may still be undervalued with a high P/E.
I will not bore you with the screening techniques employed to whittle the original 24 stocks down to 10, as revealed in yesterday's Australian Financial Review. Most important though, was recognizing the importance of dividends to overall returns, by excluding non-dividend-payers.
10 companies trading cheaply
Two of these 10 companies are active in funds management, including specialist fund manager Magellan Financial Group (ASX: MFG) and the provider of investment and fund management services Macquarie Group (ASX: MQG). One needs look no further than increasing inflows for fund managers and last month's $11.8 billion of IPO activity, the strongest in history, as evidence of an uptick in investing momentum.
Four companies operate in the mining space and are setting a platform for future growth. Both Fortescue Metals Group (ASX: FMG) and Arrium (ASX: ARI), formerly One Steel, are relying upon huge cash flows to pay down debt. LNG producer Oil Search (ASX: OSH) has trimmed exploration expenditure to preserve cash for an exciting array of growth projects, while the highly diversified UGL (ASX: UGL) has exposure to the resources industry and both UGL and Arrium are planning demergers in 2015 to create value for shareholders.
The remaining four companies are a disparate group, comprising Crown Resorts (ASX: CWN), Cash Converters (ASX: CCV), M2 Telecommunications (ASX: MTU) and Nufarm (ASX: NUF). The first three have been performing exceptionally well operationally. Nufarm operates in a very cyclical industry and is currently battling hot-weather-induced weak Australian demand, yet is performing very well in export markets. Minimizing fears are recent management comments expecting earnings growth in 2014 and the full-year dividend of 8 cents per share, which is 33% up on last year.
Foolish takeaway
Quantitative screens are a good way to asses potential investments, but further research is still required to identify further catalysts for a share price re-rating.
Medium-to-long-term investors should be more than comfortable with 7 of the 10 stocks. In my opinion, investors should hold off on Arrium, Oil Search and Nufarm, as they lack those additional near-term tailwinds.
