As investors scour the globe for growth, Australian market darlings have enjoyed unprecedented love, but Credit Suisse suggests investors are witnessing the beginning of a rotation and have offered some stocks with future darling potential.
Almost always considered growth stocks, the current crop of market darlings include Domino's Pizza, Sydney Airport, Treasury Wine and Technology One and are trading at a 140 per cent premium to the rest of the market with a current price-earnings multiple of 38 times.
But the impending bond market "eruption", the end of the profits recession and these exceptionally high valuations mean this crop of market darlings are beginning to fall out of favour.
"The rotation may have already began, these darlings are cheaper now than they were last month," says Hasan Tevfik, equity strategist at Credit Suisse.
"Many of the current darlings are great companies, but at current valuations we think they make poor stocks."
Instead of the likes of Cochlear, NextDC and Transurban, Mr Tevfik suggests Caltex, Eclipx, Mayne Pharma, Nufarm, Star Entertainment and South 32 are likely to sweep into favour and claim the crown of Australia's most adored stocks.
"We find more than 80 per cent of future Darlings trade on a P/E of 25x or less, two years before darling-hood," says Mr Tevfik. "We've added Eclipx to our long Portfolio and removed Macquarie Group."
The bank delivers this crop of future darlings after determining they trade on a P\E less than 25x, with two-year forward sales, and earnings-per-share growth of more than 5 per cent with positive momentum.
These companies also have EBITDA margins of more than 20 per cent, net debt of less than 1.5x that and less than 10 per cent equity issuance over the last two years.
"An environment where growth is less scarce and the discount rate is rising should be a negative one for the current batch of market darlings," says Mr Tevfik, who points out there has never been a gap as big as it is now between the expected EPS growth outlook for the market darlings and the ASX 200.
"Rather than worry which of the current market darlings will outperform from here, we believe investors should focus on which stocks could be the future darlings.
The love runs deep
Over time, Australians have become increasingly smitten with their darlings. In 1995, when Credit Suisse started keeping tabs on them, stocks like Harvey Norman, Westfield, Village Roadshow, Coca-Cola and Woolworths played into the domestic consumption story and traded on 17x forward earnings.
" Darlings tend to dominate much of the discussion we have with institutional investors and we find there is no middle-ground view," says Credit Suisse. "Growth managers love them, value investors avoid them."
Through the late 1990s, technology companies swept into favour and in 1999 the likes of Computershare, Citect, Aristocrat, ERG Group and Energy Developments traded on a stunning 45x forward earnings.
After the tech bubble popped, there was a sharp rotation out of the "new-economy" darlings and into interest rate and property friendly stocks, like Gandel and St George Bank, and consumer staples, like Foodland, Coca-Cola and Woolworths.
As investors tripped over themselves to get into the equity market in 2007, energy companies like Queensland Gas Company, Arrow Energy and Worley Parsons and consumer stocks like Flight Centre, David Jones and Woolworths traded on a P/E high over 26x.
Following the global financial crisis, valuations of the market darlings faltered and were trading at lows of 16x P/E, but Credit Suisse points out, they were still 70 per cent higher than the ASX200 average, which was just under 10x.
"Not only do Australia's market darlings trade at a premium to their international peers, but they also trade at a premium to their predecessors," says Mr Tevfik.
Credit Suisse considers CSL, apparently blessed with exceptional management, as the "most darlinged" stock, and has been in favour for 35 quarters.