By Tansy Harcourt
More than a quarter of Australian companies included in the MSCI World Index have negative operating cashflow and risk stock price collapses, according to prominent Plato Investment Management fund manager David Allen.
“Australia currently has a higher proportion of companies with negative operating cashflow than any other country in the MSCI World index,” said Mr Allen, a pro bono fund manager for Future Generation Australia. “Some 28 per cent of our companies have had negative operating cashflow over the preceding 12 months.”
The fund manager, whose Plato Global Net Zero Hedge Fund currently ranks sixth of the 200 funds in Morningstar large cap companies, said his firm had a “red flag” system to try root out companies that are likely to see stock price drops, with negative cash flow being the biggest predictor.
Another significant red flag predictor his firm uses is the one that comes from forensic accounting literature called “Benford’s Law”, which can be an indicator of fraud, Mr Allen said. Mr Allen said Benford’s Law was a reliable indicator when considering the 300-plus line items in a profit and loss statement.
“Ordinarily, you’d expect the accounts to contain a jumble of random numbers, but what you should find is that around 30 per cent of the numbers start with a ‘one’, and only around 3.5 per cent start with a ‘nine’,” he said. “It’s weird but this is an incredibly reliable test.”
Using its red flag system, Plato has shorted a number of companies. Queensland-based BrainChip, which aims to use machine learning to make semiconductors more efficient, is one that has 22 red flags under its methodology, the second highest number out of the 10,000 companies Plato assesses.
“A few months ago, it had a market cap of $2.5bn, on less revenue than some cafes have,” Mr Allen said. “Before I invest, I want the company to prove to me that they can do it – I’m not one to dive in and take a leap of faith.”
Another company his firm has shorted is Weebit Nano, which has 10 red flags under the Plato system, and also property company Lendlease.
“Lendlease’s cumulative free cashflow is negative since 2009, which is remarkable in an incredibly supportive environment of record low interest rates and property appreciation,” Mr Allen said. “And the company also has low interest cover and high offshore debt.”
Companies that Plato sees value in include BMW, which is trading at 6.5 times full year 2023 earnings and has strong growth in EVs, compared with Tesla, which trades on 50 times earnings.
The fund manager also likes Novo Nordisk, which is one of the largest pharmaceutical companies in the world “that no one has heard of”, and is a leader in anti-obesity drugs.