Investment Matters

A bird’s eye view

This week we take a bird's eye view of the 'metrics' of your Australian Equities sub-portfolio ('AEP').

In straightforward language - the portfolio:

  • is good value
  • has lots of upside
  • has companies that generate good cash flow, and pay moderate dividends
  • is slightly riskier than the market
  • has companies that are neither “trendy” nor are they chasing the momentum of the market

Below, we turn the above words into metrics and then explain each in comparison to the broader market.

The metrics

  AEP Market (ASX300)
Key metrics
Expected return 27% 9%
Relative stock volatility +19.0%  
Valuation metrics
Free cash flow yield 6.0% 4.1%
PE 16.1 21.0
Dividend yield 3.0% 2.9%
Other indicators
Relative non tracking score -15.1%  

Key numbers: expected return and volatility

The two metrics that matter most when it comes to your portfolio are:

  • What do we expect it will return?
  • How much could the portfolio to fluctuate in value on its path to achieving this return? 

Expected return

Expected return is the investment return that we expect your portfolio to achieve over a one-year time horizon.

The expected return for your portfolio is 27.0% - significantly higher than the market.

Why such a high return?

The market has fallen considerably and thus the expected return for many of your stocks is now higher. We have also taken the opportunity to invest in companies we see as materially undervalued.

Over time, a higher expected return than the market should translate to higher realised returns.  However, we won’t get every forecast right and the value in your stocks may not be recognised all in one year. 

Relative stock volatility

What risk are we taking on to earn these returns? Volatility is one way of answering this question.

Volatility reflects the bounds within which we expect the portfolio could fluctuate as it grows in the future.

Based on historical data, the individual stocks in your portfolio are expected to be more volatile than the market. This goes hand in hand with the portfolio’s higher expected return, but also reflects the contribution of some less liquid stocks in the portfolio. 

Valuation metrics

A second important question is: how does the portfolio compare to the broader market?

Valuation metrics give us a snapshot of this. 

Free cash flow yield

This is the measure we consider both the most important in the long run, and the measure with the highest tactical importance at this point in the cycle.

Free cash flow is the cash flow a company generates, after reinvestment.

A free cash flow yield (%) is the free cash flow a company is expected to generate per dollar of share price.  Companies in your portfolio currently have a free cash flow yield of 6% - which is significantly higher than the market.

Our companies make a lot of money per $ invested, compared to both the market, and prevailing interest rates.  This not an accidental outcome.

Broadly, we have looked to tilt the portfolio towards companies that generate a large amount of cash. These are also companies that will benefit in a reflationary environment – or an environment where prices rise. As introduced at recent CIO events we prefer to pay relatively little for company that produce real cash flows now, than relatively more for possible cash flows in the future.

Dividend yield

Dividend yields are important because they indicate the income your portfolio is expected to generate. But they are ultimately an outcome rather than an input to a portfolio. Why? Because a company could choose to pay out more than they earn and have a higher dividend yield but destroy value. On the flipside a company could choose to pay out very little (low dividend) despite making a great deal, simply because they have great reinvestment opportunities instead. Should we penalise them for generating more future value this value? Not in our mind.

As we have mentioned, dividends for the market over the coming period are expected to be lower. This is given the uncertainty companies have faced and may face in the future – they are more likely to conserve cash, as well as general price levels in the market.

However, your portfolio continues to maintain a higher than expected dividend yield than the market. This reflects a portfolio that has been constructed without sacrificing income. 

P/E ratio

P/E ratios are familiar to clients.

Your portfolio continues to have a lower price to earnings ratio than the market.

However, the P/E you can see in the table above is an output of our investment process - a low PE is rarely the reason why we would own a stock. Keeping it simple - we buy companies that are cheaper than their long-term value, not cheap based on P/E alone.

The PE ratio of your portfolio relative to the market can also be used as a proxy for how much of a “value” tilt the portfolio has. Your portfolio currently has a value bias relative to the market, however, it now has more “growth stocks” than it had in the past. 

Relative non-tracking score: how different are we to the market?

We look to be different than the market when we invest, or perhaps, the market looks different to us.

This can be seen through the non-tracking index score. The contrarian indicator tracks how similar your portfolio is to the market – based on the type of stocks fund managers are tilting their portfolios towards.

As you can see, your portfolio differs significantly from the market – it has a score that is 15.1% less than the broader market. 


The metrics above provide a broad, bird’s eye view of your portfolio.

Your portfolio is made up of stocks that may fluctuate more than the market, however, has a much higher expected return than the market.  

The companies you own generate a high amount of cash relative to their share price.  This partly reflects a tilt towards value and stocks that will benefit from reflation.

This has been achieved without sacrificing dividends - which are expected to be in line with the broader market.

Your portfolio also has less of a bias towards companies with recent price momentum or “trendy” stocks. This is part of taking a different view of the market.

We have continued to be different to the market and actively seek to outperform.



  • Expected return – Expected return for portfolio based on weighted expected returns relative to 20-year historical market return (XKOAI)
  • Relative stock volatility – Annualised weighted average realised volatility of securities within Australian Equities sub-portfolio relative to the market.
  • Dividend yield – Expected dividends per share for the current financial year (FY20) excluding stocks without earnings or low earnings relative to price (PE >60)
  • PE – one year forward price to earnings ratio. Excludes cash, stocks without earnings or low earnings relative to price (PE >60)
  • Free cash flow yield – Two year forward (FY21) free cash flow yield per share. Excludes cash, stocks without earnings or low earnings relative to price (PE >60)
  • Relative price momentum – Size weighted Thomson Reuters Momentum indicator score relative to ASX300 Index (XKO)
  • Relative non-tracking score – Size weighted Thomson Reuters SmartHoldings score relative to ASX300 Index (XKO)