Readers may have seen the Reserve Bank of Australia (RBA) governor Glenn Stevens ruminating on low national growth in the news recently.
Mr Stevens feels that with our economy having run below 'trend' (the long-term average growth that can be expected) for 24 out of the last 27 quarters, our 'trend' growth may actually be substantially lower than what is expected.
So what?
The relationship between growth and profits is complex, but for companies that saturate the market (like the top-20 ASX stocks), lower growth generally means lower sales.
Take, for example, Woolworths Limited (ASX: WOW) and Wesfarmers Ltd (ASX: WES). While both businesses are diverse, there's only so much petrol, groceries and alcohol that a person – even a very wealthy one – can consume in a year.
Thus, profit growth is going to come from a combination of population growth (more people consuming more), wages growth (being able to afford more), cost and productivity savings (eg own-brand products, self-serve checkouts) and taking market share from competitors.
Population and wages are growing at a low-single digit % per annum presently. Cost and productivity savings are ongoing, but many of the big advances have already been made. Taking market share can successfully grow sales as Wesfarmers has shown, but gains are tenuous at best in such a competitive marketplace. Neither company is likely to knock your socks off over the next five years.
The relationship gets more complicated as you look at businesses like Insurance Australia Group Ltd (ASX: IAG), AMP Limited (ASX: AMP) and Origin Energy Ltd (ASX: ORG), but one thing that is apparent is that most of the S&P/ASX 20 (INDEXASX: XTL) is dependent either on the Australian economy or commodity markets for growth.
Are you saying I should avoid the Top 20 stocks?
Not necessarily. They're pretty good and some of them, like Macquarie Group Ltd (ASX: MQG), Westfield Corp Ltd (ASX: WFD) and CSL Limited (ASX: CSL) have strong overseas businesses and avenues of growth.
Speaking generally, however, many of the top stocks in the S&P/ ASX 200 (INDEXASX: XJO) are likely to suffer from a weak Australian economy.
What ARE you saying, then?
Investors looking to achieve outsized profit growth are likely NOT going to find it being delivered by the biggest names on the ASX. Search for either a sector or a business model that is growing faster than the economy. Here are just three examples:
- Pet services
Research commissioned by Greencross Limited (ASX: GXL) has forecast the pet sector to grow at 4% per annum, from $8.7 billion currently to $11 billion in 2020. Greencross controls only 8% of Australia's pet market and aims to reach 20% over the medium term. As the largest single player in the market by far, Greencross also has a big advantage in growing its market share.
Greencross is thus experiencing sector growth as well as growth in market share; this is a winning combination and part of the reason I recently turned 6% of my portfolio into Greencross shares.
- Online businesses
Awareness is growing of Australia's fledgling tech industry, but two of the most successful companies make their money in everyday businesses – buying and selling houses and cars. Carsales.Com Ltd (ASX: CAR) and REA Group Limited (ASX: REA) both continue to post very strong revenue growth and have investments overseas where they aim to replicate their success.
A slowing economy might impact listings, but low costs and a moat will see profits remain high while fledgling international operations should see both companies continue to grow.
- Data and the cloud
Different to 'online' businesses, cloud computing companies take advantage of the progress to online storage and operation. Big names like Vocus Communications Limited (ASX: VOC) and TPG Telecom Ltd (ASX: TPG) are leveraged to increasing demand for data transfer and internet use, while smaller companies like Nextdc Ltd (ASX: NXT) provide cloud storage at its nationwide data centres.
Regardless of what happens with the economy, one thing that is virtually guaranteed is that over the next decade we'll all be using a lot more internet.
