Welcome to the October 2024 Investment Update for the Switzer Dividend Growth Fund (SWTZ or the Fund).

The Fund’s portfolio delivered a return of 2.22% during the month, compared with the benchmark S&P/ASX 100 Accumulation Index (ASX 100) return of 3.97%. The rise in the ASX 100 was mainly driven by the Information Technology and Utilities sectors. However, these gains were partially offset by a decline in the Resources sector.

A significant drag to the Fund’s relative performance was due to its defensive low beta nature, which makes it less sensitive to market movements. From a stock specific perspective, its zero holding in Commonwealth Bank of Australia (CBA) continued to be the biggest detractor to relative performance. CBA’s valuation rose to record highs, as its price to earnings (or PE) ratio continued to expand beyond the underlying movement in its earnings prospects. This stretched valuation is a key reason why CBA is not held in the Fund. Over the last 12 months, CBA’s share price has been fuelled by a 46% expansion in its PE ratio, despite a modest 6% increase in forward earnings. This substantial valuation expansion is highly unusual for a mature bank with significant exposure to a highly indebted household sector. The current PE ratio of 26x implies either minimal earnings risk or double-digit earnings growth, neither of which we believe is realistic.

Despite the underweight position in CBA, the Fund’s performance was supported by investments in Block (SQ2), Xero (XRO) and Orica (ORI). SQ2’s valuation continued to improve, driven by its attractive valuation and double-digit earnings growth prospects. The potential inclusion of SQ2 in the S&P500 index in December could further boost investor appeal. XRO’s first-half FY25 result was rewarded by the market as it showed strong operating leverage. The company has achieved a good balance between revenue growth and profit margin and surpassed its aspirational ‘Rule of 40’ target (revenue growth plus free cash flow margin equalling 40%). ORI’s FY24 results were in line with expectations. Importantly, the company raised medium-term return on net asset targets to 13-15% reflecting its positive outlook.

In November, global investor confidence was bolstered by Donald Trump’s US election win, strong US economic growth, additional Chinese stimulus and central bank rate cuts which helped drive economic demand. In Australia, the Reserve Bank of Australia kept interest rates steady at 4.35%. Minutes from the RBA’s meeting on 6 November revealed mixed signals, while emphasising the need for two consecutive strong quarterly inflation readings before cutting interest rates.

Looking ahead, the market landscape remains uncertain, with pockets of extreme overvaluation. By avoiding these areas and focusing on undervalued stocks, the Fund is well positioned to generate attractive income and sustainable long-term returns. The Funds remains focused on delivering higher income and lower volatility than the ASX 100, with the potential for capital growth.