Share selection process
The purpose of the NavraInvest share selection process is to select an approved list of high quality blue chip shares from the Australian Share Exchange.
Investments are only made in companies that our analysis shows:
- Are financially robust
- Have substantial financial history
- Are well managed
- Display share price volatility due to changing market sentiment
It is our belief that share markets are not efficient and companies are frequently over bought or over sold due to changing sentiment which is often irrational. The resulting fluctuations occur despite a sound underlying financial position, competitive strategies and good management of many of these companies. Clearly, these situations create opportunities for investors and it is these opportunities that the NavTraDE investment management system seeks to exploit.
If our analysis shows a share is over sold, we will buy that share. If the share price deteriorates further, but our analysis still indicates the company is financially sound and well managed, we will buy more of the share to lower the average cost.
Therefore, as we are buying a share when the price falls, that is, as it becomes cheaper, it is imperative the companies in which we invest are financially sound and are not candidates for insolvency.
Clearly, share prices can also be volatile for rational reasons such as a company carrying too much debt which may become insolvent if economic conditions deteriorate and revenues decline, or conversely interest rates rise. It is these companies that we need to avoid and the share selection process has been specifically tailored to meet this requirement.
The share selection process is both highly disciplined and rigorous. It utilises a series of discrete filters to "weed out" unsuitable candidate companies.
The final portfolio is well diversified across industry sectors. Risk is actively managed by not unduly weighting any one sector when the portfolio is fully invested.
The share selection process is based on publicly available financial information on companies in the S&P/ASX 200 Index.
Financial information sources include:
- Company annual reports
- Company quarterly / interim / final financial statements
- Company releases to the ASX
- Reserve Bank of Australia media releases and economic research
- Consensus company views from brokerage firms
Such information enables an overall rating of the quality of companies. The information available covers many aspects of companies such as solvency, sales growth, margins, competitive position and short term prospects.
NavraInvest also utilises external providers of research. In evaluating the overall quality of a company, numerous factors reflecting current financial status and future prospects are considered.
Shares Selection Filters
NavraInvest employs five successive individual filters to progressively filter the 200 shares by market capitalisation down to about 30 high quality shares on the approved list, and an eventual portfolio of about 20-25 shares.
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Filter 1: Over Health Check
The objective of this Filter is to select companies that have a strong overall quality rating; in essence, a “positive health check”. This is akin to a visit to the doctor for a health check up, where you are judged fit overall even though a specific aspect of your health may become unsatisfactory.
Preferred companies are those that are growing at least twice the rate of the underlying economy (GDP) and companies that move directly with the business cycle. There are many financially robust and well managed businesses in this category.
This filter allows us to avoid companies that are:
(i) ex-growth; that is they are past their prime in terms of growing revenues and earnings,
(ii) known to have either operational or financial difficulties that increase the risk of bankruptcy, and
(iii) asset plays, where the share price does not reflect a company’s reported net asset backing. Typically, such companies have fallen on hard times and may be “turnaround” situations or equally they could fold.
This Filter typically reduces the investment universe from 200 shares to about 100 shares
Filter 2: Good Current Prospect
As much of the data and ratios are based on reported (i.e. historic) financial statements, it is possible that the information could become dated and not particularly relevant.
For instance, if a company reports its financial statements to the Australian Stock Exchange (ASX) twice yearly, the data could conceivably be almost six months old before the company releases its latest statements.
In practice, this is very unlikely as companies are legally obliged to inform the market through a press release to the ASX if they are either unlikely to meet market expectations on their financial results or there have been material impacts on their business. However, the objective of this filter is to ensure for each company the timeliness of the financial data, and that there are no foreseeable problems on the horizon.
Current prospects are based on consensus views derived from broker analysts’ company reports which look at issues such as, future projected earnings for the company, its corporate strategy, the competitive environment, competency of management etc. This data is used to produce an assessment of the future outlook for the company and ensures its financial ratios are still reasonable and relevant.
As an example, if a building materials company had enjoyed bumper profits due to the housing boom, it could be adversely impacted if the Reserve Bank of Australia suddenly and aggressively raised interest rates to dampen the housing boom. Relying solely on the basis of an assessment of financial ratios based on its last reported statements (which showed it to be very robust) to make an investment in the company’s shares could result in the wrong decision. It is therefore imperative that the data be timely and the foreseeable future is benign.
The aim is to avoid companies whose reported financial statements show they are robust but who may face future difficulties and/or problems.
This Filter typically further reduces the investment universe to about 80 shares.
Filter 3: Large Market Capitalisation & High Liquidity
The companies comprising the S&P/ASX 200 Index range in market capitalisation from over $50 billion to around $250 million (the 100th share is about $1 billion). In terms of liquidity, the percentage of total shares of each company that trades daily varies enormously.
Consequently, the objective of this Filter is to ensure that:
(i) shares have adequate liquidity to establish the desired portfolio weightings, and
(ii) there is no impact on share prices arising from investment by a Navra fund.
Since our investment philosophy is not to “buy and hold” and the NavTrade investment management system generates frequent portfolio turnover, the liquidity of a share is important for us to attain our desired portfolio positions for each share.
Likewise, we do not want to unduly impact the price of the share (and ultimately performance) when we buy and sell shares.
For these reasons, we have set the market capitalisation filter to exclude companies whose market capitalisation is less than $1.0 billion.
Application of this filter reduces the investment universe to about 50 shares.
Filter 4: Financially Robust Shares
Whereas Filter 1 assessed the overall health of each company, this filter specifically focuses on their financial robustness.
The aim is to ensure that all the companies are fundamentally financially sound; that is, they have favourable:
(i) net Debt / Equity – not overly geared;
(ii) strong cashflow generation – to meet all expenses as and when required, and
(iii) strong interest cover – not adversely impacted by any increase in interest rates.
Continuous monitoring of these and other individual factors reveals deterioration in any of them and a likely downgrading of the overall financial fundamentals factor.
The application of this Filter results in the avoidance of companies with potential loan default, insolvency, or cash flow issues.
The resulting investment universe is about 30 of the most financially robust companies.
Filter 5: Sector Diversification
The objective of this Filter is to ensure that the ultimate portfolio of shares is well diversified across industry sectors and no undue weighting is given to one particular sector.
While the other filters are automatically applied using the stated selection rules, the application of this Filter is formally reviewed and all the candidate shares discussed at a weekly Investment Committee meeting. This ensures that in the Committee’s collective opinion only the most suitable candidate shares enter the portfolio.
The specific sector selection criteria that we apply are as follows:
I. Maximise the number of industry sectors – in essence, select all sectors for which at least one share has passed Filter 4
II. No exposure to the insurance sector or companies therein. This is a deliberate policy decision by the Investment Committee as it believes that the financial status of such companies is subject to unforeseeable exogenous events; such as natural disasters and terrorism. In addition, their financial fundamentals are also directly impacted by their exposure to the equity market through their investments
III. At least one company per industry sector that has a share passing Filter 4.
IV. Display share price volatility due to changing market sentiment.
Sector diversification typically reduces the number of suitable shares and the ultimate portfolio of about 20 – 25 shares is well diversified across industry sectors, without an undue bias to any particular one.
Portfolio Monitoring & Review
The companies in the portfolio are monitored daily and formally reviewed each week at the Investment Committee meeting. If any of the factors employed in the share selection process filters deteriorate for any of the companies, so that the company no longer passes a particular filter, it is automatically removed from the portfolio and a suitable replacement candidate included.
To view the current portfolio, please refer to the 'share in portfolios' in each fund.