In a global financial environment of rising inflation and interest rates, Neale Goldston-Morris says this shifting regime will see company price-to-earning (PE) ratios fall.

"That means that if your stock price is going to go either sideways or up, it's got to compensate with earnings growth."

In what he anticipates will be a period of major dispersion, with some companies' earnings rising while others fall, "that means volatility".

"It's a bit like when the tide turns--waves start crashing into each other--that's what's happening in the market, volatility is going up.

"Previously stable portfolios are starting to shift in their allocations and exposures, and that doesn't occur in a seamless way, it's always bumpy," Goldston-Morris says.

Retirees most affected

He believes these investors, who are the most reliant on a long-term, sustainable portfolio, are most at risk in this scenario. Drawing a contrast between Telstra (ASX: TLS) and CSL (ASX: CSL) shares--the two most commonly-held stocks by self-managed super funds--he points out Telstra is a dividend stock while CSL is a growth stock.

"Twenty years ago, both companies' shares prices were about $3--Telstra still is, CSL is now about $160.

"The reason for that is earnings growth from Telstra over that time has been zero, whereas CSL earnings has grown at 20 per cent, compounded," he says.

With a 6 per cent dividend yield on Telstra, versus 2 per cent for CSL, "the message here is that, in the early years, yes Telstra gave you a better income, but because of the compounding of the earnings, there's a certain point where the growth stock is providing you far more in earnings, because the share price has gone up so much."

"And the important thing is, retirees need their money particularly in the latter stages, because you're going to spend more than half your medical costs in the last five years of life," Goldston-Morris says.

He suggests investors should hold high quality companies that will grow over time because they're customer-focused.

"The object of a company is to successfully service customers…it's not to pay dividends, they're an outcome of a service you give to clients.

"If you're focused on dividends, you've lost sight of the customer," he says.

He believes the high level of concentration in the Australian share market, with a significant number of very large-cap, very low growth stocks that are purely domestically-focus is a problematic.

"The four banks, Telstra, Woolworths (ASX: WOW), Wesfarmers (ASX: WES)…they've all been held up by those lower interest rates, despite their very low growth.

"As interest rates rise, that low growth will not be enough to compensate, as far as PE is concerned," Goldston-Morris says.

He compares these companies with CSL, which is a globally-focused company not restricted in catering solely to a domestic market of around 25 million people.

"Stocks like CSL can grow so quickly because they're globally-focused, and they're constantly re-investing in the company.

"Cost-cutting is what everyone does, but that is a zero-sum game, that will not drive a company forward."

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Glenn Freeman is a senior editor at Morningstar.

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