Small caps hide a few diamonds in the rough

Post the Trump victory, the riskier small to mid-sized sector suddenly presents an unlikely safe harbour for yield.

As the large-cap stocks whipsaw on the great unanswered question of our time — what does Donald Trump really mean for markets? — the inherently riskier small to mid-sized sector suddenly presents an unlikely safe harbour for yield chasers.

The trick is to find the right mooring points — small cap stocks with sustained earnings and a proven dividend record — in a waterway strewn with shipwrecks which is notoriously hard to navigate.

“There are the funny little opportunities you can find when no one else is looking,’’ DMX Capital Partners’ stock picker Simon Turner says.

On DMX’s analysis, only one-quarter of the 1349 ASX entities with a market cap of up to $250 million are profitable, while only 14 per cent pay dividends.

Below the $100m market cap cut-off the picture is even starker: only 19 per cent are profitable and a mere 10 per cent pay dividends.

Bear in mind that more than half of the stocks are in the resources sector.

Taking the glass-half-full approach, at least there’s one quarter of companies out there paying their way and most receive little coverage.

“In our opinion, companies which are profitable with good visibility around future earnings growth and which have strong balance sheets offer a significant opportunity for long-term outperformance,’’ Turner says.

“This is particularly when you invest while broader market awareness of these businesses is low or non-existent.’’

DMX looks for stocks not just with growing earnings and consistent dividends, but with a net cash surplus and trading on an earnings multiple lower than the broader market.

This dramatically reduces the investment universe to less than 100 companies. Here are some of Turner’s selections that make for a safe yield hidey-hole in these turbulent geopolitical times:

Fiducian (FID) $3.41

A fast-growing fund manager, financial planner and fund administrator with excellent management and a strong balance sheet.

Fiducian’s financial planning division has $1.9 billion funds under advice with 65 financial advisers. Fiducian also manages top performing funds with $1.7bn under funds management.

The business has recorded consistently strong profit growth in recent years and is targeting sustainable double-digit earnings growth.

The board declared a 12.5c-a-share dividend in 2015-16, equating to a 4 per cent yield.

Pioneer Credit (PNC) $1.80

The smallest of the ASX-listed buyers of purchased debt-ledgers (PDLs are books of delinquent loans generally acquired from banks or utilities).

With a circa 10 per cent share of the Australian PDL market, Pioneer offers a debt purchasing market.

“We view the company as high quality with a solid and aligned management team, a well-defined growth strategy, a strong balance sheet and shareholder friendly dividend policies,’’ Turner says.

“The stock is currently trading at eight times its 2016-17 earnings guidance, a large discount to its two listed peers Credit Corp (CCP) and Collection House (CLH).’’

Paragon Healthcare (PGC) 86.5c

The medical equipment, device and consumables supplier has acquired a number of businesses supplying equipment and consumables to hospitals and aged-care facilities.

Paragon provides everything from beds to stethoscopes to leading hospital buying groups, a one-stop shop solution.

The stock is trading at 12 times estimated 2016-17 earnings with excellent growth prospects and a 2.5 per cent yield.

SDI (SDI) $1.015

A manufacturer of specialist dental products, SDI exports around 90 per cent of its output to more than 120 companies.

SDI boasts a strong balance sheet and a family/founder-led management team.

With a strong focus on research and development, SDI has developed an extensive portfolio of innovative restorative and cosmetic dental products. The company has generated strong sales from its non-amalgam products, which tend to be more visually appealing to clients.

SDI is trading at 13 times estimated current year earnings in one of the most defensive sectors. Yields around 2.5 per cent.

Gale Pacific (GAP) 35c

The global marketer and manufacturer of screening products has had its share of light and shade over the years, but now boasts excellent growth momentum in the Americas, Middle East/North Africa and Eurasia.

Gale stock is trading at 11 times estimated FY17 earnings with global growth opportunities ahead. Gale paid a 2.2c a share dividend in 2015-16, equating to a 4.5 per cent yield.

Global Masters Fund (GFL) $1.39

We’re in little more than thought-bubble territory here, but this local conduit for Berkshire Hathaway shares is one to consider given the likely ongoing market turmoil in the US.

Warren Buffett’s US-centric listed investment vehicle is famed for picking undervalued stocks and there are likely to be a few of those as investors try to divine the likely real impact of the Trump rhetoric.

Berkshire Hathaway has more than $US45bn ($59bn) of cash available for an acquisition.

Berkshire Hathaway shares change hands on the New York exchange for more than $US227,000 a pop. As an alternative to selling one’s house, Global Masters allows for a fractional investment: In other words you buy this ASX listed fund and it’s basically just a vehicle for holding Berkshire Hathaway shares but you get to do it on the ASX without the headaches of buying directly in the US market.

Like the US pollsters, the Oracle of Omaha doesn’t get it right all the time: he’s underwater on last year’s investment in local insurer IAG.

The Weekend Australian accepts no responsibility for stock recommendations. Readers should contact a licensed financial adviser. The author does not own any of the stocks mentioned.