Tony Featherstone Columnist

Tony is a former managing editor of BRW, Shares, Personal Investor, Asset and CFO magazines. He writes a weekly column for BRW and The Australian Financial Review, specialising in small listed companies,IPOs, entrepreneurship and innovation.

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Safe hands

Published 06 October 2011 05:04, Updated 13 October 2011 05:16

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Source: Morningstar, afr.com

This market feels like whiplash. Whatever happened to indices that rose or fell 10 or 20 points each day? Now, 50-plus swings seem normal. European and US investors must feel they are on a roller-coaster that refuses to stop.

In this environment, earnings stability is paramount. At times of high uncertainty, long-term historical data can be more useful than short-term predictions prone to forecasting error.

With that in mind, I ran a database scan to find small and mid-cap stocks with stable earnings growth and dividends, reasonable yields and high franking credits. Beware stocks with artificially high yields due to falling share prices; look for those with attractive, maintainable dividends paid by companies with less volatile earnings.

Remember that database scans are only a starting point for further analysis. They do not produce infallible ideas and data must not be taken at face value.

Nevertheless, I find such database scans useful to filter the market for ideas. This scan had three filters. The first was stocks with a market capitalisation below $2 billion, to stay true to this column’s small and mid-cap focus.

The second was earnings stability above 80 per cent. This useful data point, compiled by Morningstar, is a measure of stability in earnings growth from year to year, expressed as a percentage. A figure of 100 per cent shows earnings go up or down by the same percentage each year.

A low figure means earnings growth is more volatile and varies significantly each year. Of course, earnings stability is little help if profits grow by 1 per cent each year, but consistent, sustainable profit growth is usually a good sign in established small industrial companies.

Another helpful data point is dividend stability. It is a sign of the probability of future dividend cuts based on historical dividends. It is calculated by multiplying the number of times the annual dividend has been cut by the average percentage size of the cut. A higher figure is better. A dividend stability of 100 shows there have been no dividend cuts.

The table also shows each stock’s dividend and franking credits. Do not overlook franking in this market. With capital growth prospects muted, every point of yield is vital, and stocks with high franking bump up the grossed-up yield. Look for stocks on a higher yield than government-guaranteed term deposit rates (at about 6 per cent), with less risk of capital loss crunching the total shareholder return

The table prompts some interesting thoughts. Domino’s Pizza Enterprises continues to power ahead, but its 3 per cent yield is too low for income investors. A column favourite, Thorn Group, has a good record of earnings and dividends stability and a decent 5 per cent yield. Gerard Lighting Group, marketing services group Wellcom, and dental group 1300 Smiles are other well-run small caps that this column has featured. Spark Infrastructure Group looks the best bet on this list for risk-average investors.

Those who like to dabble in micro-cap industrials should keep an eye on Advanced Share Registry. I came across this stock a few years ago when it floated and have followed it since. Share registry clients have high switching costs, and Advanced Share Registry, which mostly services exploration companies avoiding costlier large share registries, is an underappreciated play on the mining boom. Shares in the thinly traded stock have fallen from a 52-week high of $1.20 to 68¢, but are still well up over three years. Advanced looks a good fit with a bigger share registry.

CompanyMarket Cap Earnings stability Dividend stability Current yield Franking (%)
Seek  1793 83 93 3.1 100
Spark Infrastructure Group 1639 89 100 9.3 0
DuluxGroup  915 97 100 3.6 100
Wotif.com Holdings  809 88 100 6.0 100
Domino’s Pizza Enterprises  490 88 100 3.3 100
Singapore Telecommunications  417 84 94 5.2 0
Sedgman  394 90 95 4.2 100
Austbrokers Holdings  338 82 100 4.2 100
Technology One  316 88 98 4.4 100
Slater & Gordon  277 97 97 3.3 100

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