Market not for the faint-hearted

The market sentiment is gradually moving from caution to optimism, with investors showing a greater tendency to take on risk. The general trend of safety in banks and stocks with certainty of earnings has recently changed to areas with potentially higher growth. News Corporation and Telstra, stocks that have been well out of favour recently, now find themselves back

in town.

News Corporation has put on 12.3 % since its low of $11.82 in February and Telstra has moved up to a high of $5.44 recently. Both stocks include a fair growth story if the US economy starts to move ahead, with Telstra a major beneficiary of any restructuring internally.

Investors are looking closely at equity markets, with pundits expecting a continuation of the bullish tone set recently. “The improvement in economic indicators sends a warning for bond markets, which is reason enough for asset allocators to be underweight bonds relative to stocks at the moment,” said ABN Amro’s chief strategist, Gerard Minack.

With the prospects of strong GDP growth and the economic climate expected to be positive for sharemarket investors, the outlook is fairly sunny. In terms of the outlook for equities, there is a well-established correlation between the rate of economic growth and the performance of the sharemarket. When an economy enjoys strong expansion rates, corporate profits and share prices usually rise as well.

ERG Group

The investment community’s fears were realised last week when automated ticketing company ERG issued a profit warning that foreshadowed first-half losses of up to $195 million. ERG said the loss resulted from the reversal of its controversial accounting policy of exchanging software licences for equity in its unlisted smartcard joint ventures and recognising this as revenue

News of this announcement sent the company’s shares tumbling nearly 30% to close at a low of 29 cents. ERG has finally realised it must be “fair dinkum” with the equity market, and written down $140 to $160 million on the carrying value of these assets. The market reaction was to sell down, however, the medium-term outlook is much better after these “write downs”.

The company has suffered greatly in the sharemarket over the past year and a half, with the shares coming down from a high of $2.06. They are currently trading at 33.5 cents.

The management has been reshuffled with the recently departed chief financial officer, Mr Michael Slater lasting just over six months. The recently appointed Richard Howson has been with the company some time. The write-downs were not surprising, but it does help the company restore some credibility in the sharemarket.

The company’s chief executive, Peter Fogarty said, “the board made the decision – it was not requested by our auditors – to basically bring our policy with regard to these licences into line. That’s not saying we’ve written these investments off forever or that they are not worth anything but that it’s hard to determine their true value.”

The company has basically wiped the slate clean and is now looking forward to a brighter future. It is a similar situation to News Corporation – it is not well understood by the sharemarket, has recently written down plenty of losses and is a perennial growth story. Not for the faint-hearted, but a stock to play for the more risk-oriented.

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