Why your own experiences can lead to investment riches. Learn how Under the Radar’s business experience has led us to making wise and profitable investment decisions.
WHAT A HARD EARNED WORK EXPERIENCE LED TO
Most investors use their experiences to govern where to put their hard earned savings to work, and guess what? I’m no different.
For a number of years I worked for newspapers and magazines both here and in the UK and towards the end of my time as a journalist it became apparent to me that the advertising business model wasn’t working. Because there was less fat in the system (declining advertising revenues) management was squeezing the workers (like me) into doing more and more for less and less.
Those same media organisations have embraced the subscription model since then, putting up pay walls but their business models remain heavily reliant on advertising dollars. While they were embracing subscriptions, my partner and I were in business starting up a small cap equities newsletter model that relied solely on subscriptions.
It’s no accident that a good number of the stocks that we favour at Under the Radar have subscriptions as their business model.
A KEY TAKEOUT OF THE RECENT ASX PROFIT SEASON
One of the key take-outs in the current profit season is that those ASX Shares with business models that can handle difficult conditions are prospering, or at least prospering in investors eyes. I’m talking about companies whose earnings have annuity or recurring income at their base.
I’m not talking about companies that deliver high yields, like property trusts, which pass through rental income to their investors. It must be associated with growth.
Mark my words, when you look at successful stories in the current reporting period, the subscription model in its various forms is coming to life.
A PUBLISHING BUSINESS THAT HAS LEFT OTHERS FOR DEAD
Probably the best example from our perspective is the ASX Small Cap Infomedia (IFM), whose stock has skyrocketed 32 per cent from just under $1 a share to close to $1.30, since its full year profits were announced on 15 August.
Infomedia is the second largest global provider of parts catalogues for auto dealer networks, which need to be able to easily locate and to order hundreds and thousands of car parts. Compare this model to the business of selling cars. Even when a car dealer sells a car, they don’t make that much money. Most of their money is made from selling and providing insurance, finance, warranty, trade-ins and servicing.
But if you looked at the headline numbers for its fiscal 2018 result, they weren’t spectacular: a 3.5 per cent increase in revenues to just under $73 million to produce an 8 per cent rise in net profit after tax to $12.9m. Cash EBITDA, which includes capitalised R&D costs was actually down 10 per cent!
What’s going on? The share market liked that the big contract with Nissan was performing better than expected and delivered a strong second half result, which gives it that all important momentum. There’s nothing like a bit of momentum to get investors excited. Crucially, this momentum is sustainable because the group’s business model is for recurring subscriptions. We’re talking about a boost to earnings that will be compounded over a number of years.
Recent data showed that the decline in new car sales in Australia is accelerating, which hurts dealerships. Infomedia’s services allows those dealerships to grow the sales line by focussing on the growing business for parts and service. This small cap's business model means it can sustainably grow earnings even while car sales are declining.
SMALL CAPS: SUPERCHARGED PROPERTY TRUSTS
Another clear example is small cap Lifestyle Communities (LIC), which has increased close to 20 per cent in the past four months. This company isn’t simply about developing properties and selling them. It’s about the rental income the group is generating from a growing population of ageing people who desire affordable care, and on top of that, there’s the bonus of deferred management fees.
We have been also following another small cap Ingenia Communities (INA) for even longer, and I have written about this stock a number of times in this column. The same argument applies. Just look at its share price chart and you’ll see why. In mid-June it was trading at close to $2.60, then within a month it leapt as high as $3.22.
Some small companies we like are earlier in their life cycle and dividends remain some way off, but these companies employ the subscription model and we think they’re on the way to achieving the nirvana of free cash flow that comes from success.
OTHER SMALL CAP SUBSCRIPTION SUCCESS STORIES
These Small Caps are mostly in the technology space and include the sports analytics group Catapult (CAT), which generates 70 per cent of its revenues by selling its sports analytics hardware and software technology using a subscription-based model. The small cap medical sterilising group Nanosonics (NAN) has a business model of selling its patented hardware and then selling its consumables, which is analogous to the printer and ink model, while small cap Nearmap (NEA) provides areal images on a subscription basis.
In the end, however, it’s about how much you’re paying. Buy Cheap and Be Patient continues to be true, no matter what the business model.