Every stock picker's goal is to achieve returns exceeding an index's, such as the All Ordinaries Index (ASX: XAO). It can sometimes be challenging, considering that less than half (44%) of ASX All Ord shares have outperformed the benchmark over the past five years.
Importantly, investors need to establish a strategy for sorting the wheat from the chaff to increase the likelihood of selecting high-quality companies capable of delivering exceptional returns. One such method is value investing — which involves identifying businesses trading for less than their intrinsic value.
It is usual for a value investor to analyse metrics such as price-to-earnings (P/E) ratio, book value, and cash flow. However, in addition to those, there's another factor I'd look at to find potential diamonds among ASX All Ord shares.
Profits that exceed price growth
Typically, a company's share price will follow its earnings. Ultimately, the value of a business is dependent on its earnings potential.
For this reason, I believe it can be helpful to look for meaningful discrepancies between earnings per share (EPS) growth and share price change over a five-year timeframe.
As Terry Smith postulates in his book Investing for Growth, 'boring' quality companies can be consistently undervalued partly because of the misconception that high risk is the only way to achieve a high return. At the same time, another cohort of investors is willing to pay a premium for predictability, resorting to bonds.
The outcome is a smaller number of people interested in the ASX All Ord shares sitting in the middle — steadily growing earnings, without much fanfare, but not with the level of certainty offered by bonds. Fewer people competing for shares in these modest companies can lead to share prices that lag their earnings growth.
Two examples that come to mind are Premier Investments Limited (ASX: PMV) and Aristocrat Leisure Limited (ASX: ALL).
| ASX-listed company | 5-year share price change | 5-years EPS change | P/E ratio |
| Premier Investments | 19.0% | 168.9% | 10.9 |
| Aristocrat Leisure | 23.1% | 65.9% | 23.1 |
Premier Investments is a retailer with brands that include Just Jeans, Jacqui E, Peter Alexander, Jay Jays, and more. Meanwhile, Aristocrat Leisure is a gaming technology company that makes poker machines and offers casino management solutions.
The earnings and free cash flow of these two ASX All Ord shares have steadily grown over many years. Without a similarly increasing share price, these two businesses have seen their P/E ratios compressed.
Why it's still not enough for some ASX All Ord shares
Not every company with a significant difference between its share price and earnings growth will be full of potential. There are plenty of other factors to consider before investing. Not the least of which is the cyclicality of some industries.
For example, many ASX All Ord shares that have grown their earnings faster than their share price are mining or energy companies. Knowing whether the growth will be sustained or a temporary fixture is tricky in such circumstances.
While outperforming investments can be made in these sectors, I prefer to scout out companies with more consistent earnings. Coincidentally, these ASX All Ord shares are more likely to have some form of competitive advantage — a trait more commonly associated with market-beating returns.
