With the ASX making a poor start to the year and the outlook for the economy being uncertain, many investors are understandably concerned about the risk of their investments. Certainly, a high return on capital is highly desirable, but many investors are now switching their attention to the return of capital after the ASX has shed 13.5% of its value in just six months.
On this front, Wesfarmers Ltd (ASX: WES) scores well since it retains a conglomerate structure. For example, it not only owns a variety of retail chains such as Coles, Bunnings and K-Mart, it also has other divisions such as energy consulting and fertiliser supply. They provide a return which is less cyclical and less highly correlated to the wider economic outlook than a pure play retailer would otherwise be.
Furthermore, Wesfarmers is in the process of diversifying even further with the purchase of the Homebase chain in the UK. This will not only provide the potential for long-term profit growth, but will also allow Wesfarmers to benefit further from the weaker Aussie dollar as well as provide greater exposure to a non-domestic economy. This should help it to maintain the track record of delivering annualised growth in earnings of 10% in the last five years.
Clearly, Wesfarmers is not without risk. A key risk is the rise of discount retailers such as Aldi and Costco, while challenges for the Aussie economy resulting from slowing Chinese growth and falling commodity prices could also hurt its financial performance. However, with a relatively well-diversified business model, a yield of 5.1% and a price to sales (P/S) ratio of 0.72 (versus 1.3 for the ASX), Wesfarmers seems to be a relatively appealing buy at the present time.
Similarly, Telstra Corporation Ltd (ASX: TLS) is also in the process of diversifying its income stream. For example, it is seeking to generate up to a third of its revenue from Asia by 2020 as it seeks to become less reliant on the domestic economy for its growth. And while China and Japan are currently posting relatively disappointing GDP numbers, the long-term prospects in the region remain bright and should reduce Telstra’s dependency on the Aussie mobile market.
In addition, Telstra has also diversified into e-healthcare. With an ageing population this seems to be a sound move to make – especially since communications within the industry have scope to improve rapidly over the coming years.
Clearly, Telstra is not without risk and even though its shares have fallen by 5% since the turn of the year it still trades at a premium to the wider index. Telstra has a price to earnings (P/E) ratio of 15.4 versus 15.1 for the index and with its bottom line due to grow by just 1.7% this year, investor sentiment may fail to pick up in the short run.
However, in the next financial year, Telstra’s earnings are expected to rise by 13.7% and, with the aforementioned diversification prospects plus a yield of 5.8%, Telstra appears to be a relatively sound place to invest for the long term.
Despite this, there are 3 other ASX stocks that I believe could outperform Telstra and Wesfarmers.
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Motley Fool contributor Peter Stephens has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.