Global share markets have started 2016 in an uncertain manner as investors around the world take stock and try to assess what the impact of weakness in commodity prices are on areas such emerging markets and bank balance sheets and how this will affect global growth and companies.

The Australian share market has also been caught up in this uncertainty as our banks and resource stocks have been sold off heavily on the back of concerns over slowing global economic growth and credit quality concerns respectively.

The reporting season: top 20 stocks doing it tough

The February reporting season has just concluded and it once again demonstrated the challenges of many sectors and stocks to grow their earnings on dividends in the current patchy economic environment.

The top 20 sector of the Australian share market – which is dominated by bank and resource companies – had a fairly lack lustre reporting season overall. While Australian banks continue to operate very profitably, the Commonwealth Bank of Australia’s (CBA) interim result released was flat overall demonstrating the difficulty for our major banks to grow their earnings and dividends in an environment of low credit growth and the impost of new capital requirements from regulators.

The resource sector had one of its worst reporting seasons on record with the profits of our heavyweight mining companies such as BHP Billiton (BHP), Rio Tinto (RIO) and Woodside (WPL) all reporting dramatically lower profits and dividends reflecting the large falls in the commodities that they produce.

The reporting season: sorting out the chaff from the wheat

On the other hand the S&P ASX ex20 sector, offering diversity in terms of industry sectors, provides investors with a far greater breadth of investment opportunities. Indeed many ex20 companies in sectors such as gaming, packaging, utilities and healthcare declared higher earnings for the 6 months to December 2015.

Many of these companies also reported increased dividends and a generally positive outlook for the next 12months – as shown below:

The table above clearly demonstrates the benefits for investors of diversifying away from the top 20 stocks of the Australian index in the current patchy economic environment and to having exposure to small to mid cap stocks outside the top 20.

3 quality mid and small cap dividend payers

1. Spark Infrastructure

Spark Infrastructure (SKI) is a listed infrastructure company who invests in regulated utility infrastructure. The company owns 49% of electricity distribution businesses in South Australia and Victoria, and 15% ownership of the recently acquired TransGrid electricity transmission business in New South Wales.

Spark has a reputation as a quality operator, with the company’s assets among the most cost efficient Australian utilities. Spark stands to make gains by applying efficiency measures to the recently acquired TransGrid business, which was previously owned by the New South Wales government.

While uncertainty surrounds many other companies, Spark’s regulated, stable earnings and cashflows, allowed the company to provide distribution guidance for the next three years – of at least 12.5c in FY16, at least 13c in FY17, and at least 13.5c. At current prices this represents an FY17 distribution yield of 6.3% by our estimates.

Source: Yahoo!7 Finance, 7 March 2016

2.Sky City

Sky City (SKC) owns and operates casinos in Auckland, Adelaide and Darwin as well as several smaller casino operations across NZ. The company generates the bulk of their earnings from the main gaming floor in Auckland and as such a large part of their earnings are generated local grind players, making their earnings fairly stable and predictable.

Management has upgraded facilities in recent years and the company is now benefiting from this investment combined with a renewed focus on high roller gaming, predominately at their Auckland property.

Sky’s recent result showed good growth across the business with revenue up 10% and profit up 28%, underpinned by good growth at their Auckland property, an improved result from Adelaide and strong growth in their international business, which was up 50%.

In light of the improved result the company increased in their interim dividend from 10c to 10.5c.

Source: Yahoo!7 Finance, 7 March 2016

3. Steadfast

Steadfast (SDF) is an industry leader in insurance broking and underwriting agencies, representing over 300 broker businesses and 22 underwriting agencies with combined billings of over $5bn in premium. The strength of the franchise lies in the scale of distribution and trusted relationships with insurers and SME clients. Brokers have low customer churn; they sell an essential product, help clients tailor insurance coverage and assist in lodging claims. Importantly, unlike insurance companies themselves, Steadfast’s broking and underwriting businesses take no insurance risk on their balance sheet, making their earnings less volatile than insurance companies.

We believe Steadfast can grow going forward through the continued acquisition of brokers in their existing network, the acquisition of further underwriting agencies and by extracting cost savings from previously acquired businesses. The company has a capable management team headed by a CEO with over 45 year’s industry experience.

In its interim reporting result, the company increased its dividend by 20% compared to a year ago, further cementing our belief in the company’s quality broking and underwriting business and growth prospects.

Source: Yahoo!7 Finance, 7 March 2016

Looking ahead

Against a backdrop of a subdued economic outlook both in Australia and overseas, IML believes it will remain a stock picker’s market. IML is finding that the ex20 sector of the market continues to represent an area of opportunity to invest in some of Australasia’s most innovative and growing companies.

Our focus continues to be on investing in companies that can continue to deliver consistent earnings and dividends and that can grow in the years ahead in what we believe will continue to be a low growth environment.

Exhibiting the key attributes of competitive advantage, with recurring earnings, run by capable management that can grow over time, quality ex20 companies have continued to prove the sustainability of their earnings & dividends.

In our view, investing prudently in a portfolio of quality ex20 companies will continue to provide investors with better diversification and access to many companies with consistent and reliable income streams, despite the current economic environment.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.