The double-edged sword of increased volatility

Richard Hemming

Equity market volatility has ratcheted up since late October last year and Small Caps have been in the firing line for good and for not so good performance. Under the Radar Report goes through recent winners and losers and our reactions.

TO BE A SUCCESSFUL INVESTOR HONESTY IS PARAMOUNT

Under the Radar has had recent winners, some of which have benefited from the recent bout of takeover activity we have previously discussed, while others have benefited simply from being “discovered” after producing good earnings numbers. These include Nearmap (NEA), Nanosonics (NAN), GBST (GBT), NetComm Wireless (NTC), Ruralco (RHL), Pacific Energy (PEA) and Spicers (SRS).

An image of a man holding two swords


But volatility is a double-edged sword. From going through a sustained bull market post the 2007-2009 financial crisis, there have been a couple of significant bear phases. One was in 2015, which was principally caused by slowing economic growth in China, but also by falling oil prices, the rise of ISIS and the now almost forgotten default of Greek debt.

The latest bear phase again involves China, which is in the midst of a trade war kicked of by the Trump Administration in the US, but also involves Britain and its desire (or not?) to leave the European Union. The sell-off occurred between October and December last year and you would be na├»ve to think that it’s going to be plain sailing from here, despite the market rebounding back to close to its August peak. If anything, the uncertainties have increased and the recent news that US interest rates aren’t rising might be positive until you consider that the reason is slowing economic growth.

OUR NOT SO GOOD STOCKS

These include road traffic reports provider GTN, the print specialist Ovato (code, OVT, and previously known as PMP), kitchen financier Silver Chef (SIV) and Pro-Pac Packaging (PPG).

There are differing reasons for all the troubles these stocks have faced, but the thing is, we knew that there were issues when we picked them. There can be difficulties with companies that are rated on sub-market multiples and certainly below where they have historically been trading. Caution is needed but if with methodical analysis, it is concluded that the problems are being resolved, with the right conditions, high earnings are a likely outcome along with a market re-rating. You want that double-whammy and of course there is risk-attached.

CASE STUDY: GTN

Where does this leave us when this doesn’t happen? Let’s look at GTN where one of the senior managers is the well-known traffic reporter Vic Lorusso.

The traffic reporting specialist sells advertising spots on radio and had a tough 1H19 but still managed to pay a 2.4 cent fully franked dividend and an on-market buy-back for up to $20m worth of shares.

The decline in revenue for the three months to 31 December in Australia, announced in late December 2018 caused the stock to decline almost 40 per cent on the day, the announcement having occurred so soon after positive statements for earnings at its AGM in October. The causes were difficult conditions and the loss of some key clients. When the market is looking to sell stocks, a stock which gives a reason to be sold is asking to be beaten down.

Having plumbed as low as 90 cents its stock has bounced back to current levels around $1.30. We believe the stock has further to run. For one thing, the issue of poor sales execution is being addressed. Its FY19 interim result showed that advertising rates have held steady and revenue increased in all other geographies in particular Canada where it has a strong position. The result showed that the second half has started better though the short sales cycle brings earnings uncertainty. However, radio is more resilient than television and print advertising.

GTN investors also benefit from all important dividends, supported by a sound balance sheet and very good cash flow generation. When you are down on paper, dividends do much to cushion the psychological blow.

DIVERSIFICATION IS PARAMOUNT

Diversification needed to successfully invest in this space as evidenced by Under the Radar’s Small Cap model portfolio. The portfolio of ASX listed small cap stocks has a defensive bias and manages for the long-term. The 20 companies it owns have strong balance sheets and are making profits. Because of the volatility the fund has outperformed by over 70 percentage points in the past seven years, proving that you don’t have to invest in the current “hot stocks” to generate strong long-term returns.

About the Author

Richard Hemming

Investment analyst and Editor of Under the Radar Report

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