Ten small cap stocks I’m investing in

Chairman, Wilson Asset Management
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It’s customary at this time to reflect on the year past and more importantly look at the year ahead and consider some stock ideas.

The year appears set to finish with a healthy return from the Australian stock market, delivering a positive return of around 12%. In the year ahead, driven by an abatement of fear and further falls in interest rates, we expect the Australian market to move ahead by 10%-15%.

As interest rates fall further, company values increase as Price Earning (P/E) multiples rise and economic activity improves. With around $1.6 trillion in Australian bank deposits and rates trending lower, the capacity for these funds to flow into other asset classes is significant, providing a boost for the stock market.

Business to improve

We also expect an increase in corporate activity as boards become less fearful and finally start to invest for growth. With a borrowing cost of 6%, the after-tax funding cost is 4.2%, providing a scenario where any acquisition on less than a P/E of 23.8 is earnings per share accretive for the bidder.

We remain in a decade of de-leveraging, both globally and domestically with domestic savings rates remaining high (around 10%), up from less than zero before the global financial crisis. Constrained consumer activity has created a particularly challenging environment for retailers, advertisers and media combined with a structural battle against changes generated by technology and the internet. The last few years have been characterised by huge change with previous blue chips such as Pacific Brands, Fairfax, David Jones, Harvey Norman and Ten Media feeling the brunt of investor uncertainty around the capacity of these companies to restructure and adapt to a new online world.

The collapse in these companies and others like them has impacted investor confidence in buy and hold blue-chip investing.

Stock suggestions

Despite these views, we remain confident that in any market there are good opportunities for those who are thorough, nimble and do their homework.

Following are 10 small-cap stocks that we like (and own at this time) and believe they represent attractive risk/reward scenarios:

1)      RXP Services Ltd (RXP)

IT professional services company in the early growth phase with strong management pedigree and potential for further growth via acquisition.

2)      Automotive Holdings Group (AHE)

Diverse automotive retail and logistics group with strong leverage to improved consumer confidence and industry consolidation.

3)      Energy Action (EAX)

Provides energy management services to organisations intending to minimise the cost of energy. Compelling P/E of 13 against a growth rate of +35%.

4)      Brickworks (BKW)

An undervalued, well-managed building products supplier well leveraged to an improvement in building activity.

5)      Cash Converters (CCV)

Global success story providing short-term pay-day style lending and used goods retailing, this company is reasonably cheap and growing in a challenging environment. On a 2013 P/E of 10.5x growing at around 30%+ the P/E to growth ratio is most attractive.

6)      Centre Point Alliance (CAF)

Specialises in insurance premium funding and commercial finance, growing strongly with a free option on industry consolidation. Very cheap based upon a large franking credit balance providing an ability to pay a 65c fully franked dividend.

7)      Magellan (MFG)

The new Platinum? Since launching Magellan has performed well, gobbling up market share that used to be the exclusive domain of Platinum Asset Management. Trend looks good.

8)      Sirtex (SRX)

Liver cancer treatment hopeful, SRX has huge potential upside. Not for the faint of heart though.

9)      Hills Holdings (HIL)

A recovery story from a former mini-blue chip, with Tedd Pretty of Telstra fame, coming in as MD, strong upside is hoped and its trading below net tangible assets (NTA).

10)   Empired LTD (EPD)

IT Managed Services and consulting business trading a forward P/E of 11x with earnings per share growth around 80%. New contract wins and acquisitions driving growth.

Disclaimer: WAM Capital and WAM Research, listed investment companies managed by Wilson Asset Management, are investors in the above stocks.

Important information: 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. Anyone should consider the appropriateness of the information in regards to their circumstances.

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