The Reserve Bank of Australia lowered the cash rate by 25 basis points to 1% on 2 July 2019. This was the second back-to-back interest rate cut announced by the central bank in 2019, highlighting the bank’s desperation towards reviving the country’s stalling economy. Meanwhile, RBA Governor Philip Lowe called for more spending on infrastructure and policies towards generating further employment opportunities.
On the same day, the four big banks of Australia, namely, Australia and New Zealand Banking Group Limited (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Limited (ASX: NAB) and Westpac Banking Corporation (ASX: WBC), announced their plans to pass on the interest rate cut to better serve their customers.
In June 2019, the Reserve Bank of Australia had made a similar move, reducing the interest rate by 25 basis points and bringing it to 1.25%. The major objective of these interest rate cuts is to help lower unemployment levels and give a boost to inflation in Australia back towards its target range of 2-3%.
Meanwhile, several market experts have predicted a similar announcement by the central bank regarding another interest rate cut before the end of 2019.
How low-interest rates impact businesses?
Business performance largely depends on the economic environment. Any changes in interest rates can be seen as a signal for businesses to either move towards expansion or pull it back. As a business owner, it is important to understand how lower interest rates influence company operations.
With low-interest rates, consumer spending on products and services increases. Consumers tend to borrow money, when interest rates are low, as they have to make lesser repayments towards their loans, which results in more disposable income. This is positive for businesses, as demand for their products and services increases with more consumer spending.
Most of the businesses take loans at some point. In the scenario of lower interest rates, businesses can borrow more readily, which means they can fund their business expansion and growth programs via debt.
Growth Investing or Value Investing in Low-Interest Rate Scenario: Growth and Value are the two different approaches to investing. Though both can maximise value for investors, their approaches are completely different. Let us first understand what exactly value investing and growth investing mean.
Growth investing/stocks: Under this approach, stocks with high growth in earnings due to product demand, product/service leadership, expected future growth of the company/industry due to sector tailwinds and many other such positive reasons are covered. Further, due to good prospects, the value of such stocks is usually higher than the broader market. Moreover, they have high price-to-earnings ratios and high price-to-book ratios. Investors shouldn’t expect dividend from these companies, as these companies are focusing on utilising the cash flow to expand and grow its business further, hence the investors in these companies usually get returns from future capital appreciation as against dividend distribution. Though sometimes investors get a dividend, but as these companies aim to grow faster, they believe in directing their earnings towards expanding their business. Growth stocks are also riskier, as they are more expensive as compared to regular stocks and if their growth plans don’t go as per the plans, their price could go down.
Investors prefer growth stocks, as these companies are glamorous and many things usually seem to go in favour of these companies.
Value investing/stocks: Value investing school of thought is a contrarian approach to investing, involves investing in stocks that are trading at a lower value as compared to their intrinsic value, and these stocks are usually surrounded by doubt regarding their future business prospects. Thus, these stocks trade at a lower multiple as against growth stocks. Despite this, investors keep an eye on these companies and consider factors such as its business model and financial statements, as they seem undervalued, with a strong possibility of mean revision of the business prospects from the current poor phase to the relatively better historic mean. These stocks have low current price-to-earnings ratios and low price-to-book ratios. Usually out of favour stocks/sectors fall under value category.
Value stocks are considered to be safer investments than growth stocks. Investors keep an eye on these companies, as they are better suited for investment horizons in the long term.
Both approaches have their benefits. In the low-interest rate scenario, businesses are at a benefit, as they can borrow more. Lower interest rates are a catalyst for growth for corporates, as they can inject the borrowed money in their expansion, acquisition and other operations, resulting in earnings potential in the future. As a result, their stock prices increase. So, we can say that growth investing performs better in a low-interest rate scenario, and currently, value stocks are underperforming across many major economies.
Low rates are here to stay. As earlier mentioned, the Reserve Bank of Australia might bring another cut to its benchmark rate to stimulate financial activity.
Some of the examples of growth and value stocks listed on ASX are discussed below.
ResMed Inc (ASX: RMD)
About the company: Founded in 1989, ResMed Inc is a medical device manufacturer and connected health solutions provider, which sells a range of products in more than 120 countries. It is a leading provider of remote and self-monitoring software. The company majorly focuses on people with sleep apnoea, chronic obstructive pulmonary disease (COPD) and other respiratory diseases. Moreover, the company is also engaged in spreading awareness related to these respiratory conditions and treatments. Additionally, ResMed directs 7% of its annual revenue towards research & development activities.
Stock performance: ResMed Inc has a P/E of 39.73x as against ASX 200 PE of 17.44x and an annual dividend yield of 0.82%. The shares of RMD have given a positive one-month return of 8.74%. The shares of RMD are trading at $ 17.660, down 0.282% or $ 0.050 from its previous close. RMD like a typical growth stock is trading close to its 52 weeks high price of $ 17.750. The company holds a market capitalization of $ 25.39 billion and approximately 1.43 billion outstanding shares (Data as at AEST: 1:31 PM, 08 July 2019).
Bingo Industries Limited (ASX: BIN)
About the company: Providing solutions across the complete waste management supply chain, Bingo Industries Limited serves domestic as well as commercial businesses in Australia. The company offers solutions for hazardous waste, cardboard, concrete, contaminated soils and other types of waste. Moreover, it offers more than over 30,000 bins, which are available in every shape and size. Bingo Industries Limited is a member of the Green Building Council of Australia. The company, which has its recycling centres in New South Wales and Victoria, was listed on the Australian Securities Exchange on May 2017.
Stock performance: BIN has a P/E of 31.17x as against ASX 200 PE of 17.44x and the company does not provide dividend. The shares of BIN have given a positive one-month return of 23.04%. the shares of BIN were trading at $ 2.350, unchanged from its previous close. The company holds a market capitalization of $ 1.55 billion and approximately 661.13 million outstanding shares (Data as at AEST: 1:40 PM, 08 July 2019).
Boral Limited (ASX: BLD)
About the company: Boral Limited is a major producer and supplier of building and construction materials, based out of Australia. The company, which got listed on ASX in February 2002, operates via its three divisions, namely, Boral North America, Boral Australia, and USG Boral, which serves clients in various countries in regions including Asia, Australasia and the Middle East. It serves engineering and infrastructure markets, in addition to residential and non-residential construction projects.
Stock performance: Boral Limited has a P/E of 12.78x as against ASX 200 PE of 17.44x and an annual dividend yield of 4.91%. The shares of BLD have given a positive one-month return of 5.16%. BLD is trading at $ 5.435, down 1.182% or $ 0.065 from its previous close. BIN like a typical value stock is trading near its 52 weeks low price of $ 4.400. The company holds a market capitalization of $ 6.45 billion and approximately 1.17 billion outstanding shares (Data as at AEST: 1:40 PM, 08 July 2019).
The Citadel Group Limited (ASX: CGL)
About the company: As a leading software and services company, The Citadel Group Limited (ASX: CGL) is engaged in the development and delivery of managed technology solutions. With its specialisation in secure information management in complex environments, CGL serves clients in the e-health, national security/defense, government, and tertiary education sectors. The company was formed in 2007 and listed on ASX in November 2014. It operates through offices in Sydney, Brisbane, Canberra, Melbourne and Adelaide.
Stock performance: CGL has a P/E of 12.690x as against ASX 200 PE of 17.44x and an annual dividend yield of 2.74%. The shares of CGL have given a positive one-month return of 21.20%. The shares of CGL were trading at $ 5.020, marginally down by 0.010% or 0.010 from its previous close. CGL is trading closer to its 52 weeks low price of $ 3.950. The company holds a market capitalization of $ 247.77 million and approximately 49.26 million outstanding shares. (Data as at AEST: 1:40 PM, 08 July 2019).
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