Top Stocks 2020

Preface

Economic uncertainty, political instability, trade wars, currency volatility and more seem to be exerting a growing influence on global financial markets. Yet, in the midst of this environment, numerous fine companies continue to emerge in Australia, with great potential for investors.

In Top Stocks 2020 there are 25 new companies, including 18 that have never appeared in any previous edition of the book. This is the second-highest number of new companies in the 26-year history of the book.

They are often smaller to medium-sized corporations. Some will be unfamiliar to investors. But all meet the stringent Top Stocks criteria, including solid profits and moderate debt levels.

Guiding investors towards value stocks has been one of the paramount aims of the book from the very first edition. Indeed, one of the rationales for the book has always been to highlight the truth that Australia boasts many excellent companies that enjoy high profits — and growing profits — regardless of the direction of the markets. Despite the title, Top Stocks is actually a book about companies.

Right from the start it has been an attempt to help investors find the best public companies in Australia, using strict criteria. These criteria are explained fully later. But, in essence, all companies in the book must have been publicly listed for at least five years and must have been making a profit and paying a dividend for each of those five years. They must also meet tough benchmarks of profitability and debt levels. It is completely objective. My own personal views count for nothing. In addition, share prices have never been relevant.

Of course, such stocks could not withstand the tidal wave of a substantial market sell-off. They too would be affected. But they should be affected less. And if they are good companies they will continue to thrive and to pay dividends. And they will bounce back faster than many others.

Of the 105 companies in Top Stocks 2020 — 10 more than in last year's edition — fully 74 reported a higher after-tax profit in the latest financial year (June 2019 for most of them), including 44 with double-digit profit growth and a further three that achieved triple-digit growth. In addition, 73 recorded higher earnings per share and 68 paid a higher dividend.

And though, as I wrote above, share prices are not relevant for selection to Top Stocks, more than half the companies in the book have provided investor returns — share price appreciation plus dividends — of an average of at least 10 per cent per year over a five-year period.

Australian companies with overseas activities

Each year I try to identify trends among the companies of Top Stocks. The weakening dollar has for several years become a feature of local financial markets. It has benefited exporters and companies with extensive overseas business. Conversely, it can hurt importers.

For investors interested in this theme, here are companies in Top Stocks 2020 that generate a substantial amount of their revenues abroad. Do note, however, that this does not automatically mean that they are beneficiaries of a weaker dollar. Some have a hedging program — or some other arrangement — in place that limits the potential gains from a weak dollar.

ALS provides laboratory analysis services around the world, with nearly 70 per cent of revenues from abroad.

Altium is a high-tech company with most of its activities overseas.

Ansell is a global leader in safety and healthcare products, with more than 90 per cent of sales overseas.

ARB exports its automotive accessories to more than 100 countries, with overseas business nearly 30 per cent of total sales.

BHP Group is a huge diversified resources company, with activities and sales around the world.

Blackmores is selling a lot of its healthcare products to Asia.

Brambles, a leader in the supply of pallets for global trade, derives most of its income abroad.

Breville Group sells its home appliances in more than 65 countries, with foreign revenues about 80 per cent of the total.

Clover Corporation makes nutrients for food products, with about half of its sales overseas.

Cochlear derives about 90 per cent of the sales for its ear implants from overseas customers.

Codan sells its metal detectors and high-frequency radios to more than 150 countries, representing 85 per cent of company turnover.

Corporate Travel Management derives more than 70 per cent of its revenues from overseas activities.

Flight Centre gets around half of its income from its overseas branches.

Fortescue Metals Group sells most of its iron ore abroad.

Hansen Technologies continues to expand its billing service activities, with overseas business now more than 80 per cent of total income.

Infomedia has most sales of its electronic car parts catalogues outside Australia.

Integrated Research's specialised performance monitoring software is mainly sold abroad.

IPH gets about 35 per cent of its intellectual property services income from its Asian operations.

IRESS derives more than half its revenues for its financial software from overseas customers.

Macquarie Group has banking operations in 25 countries, and international business accounts for around two-thirds of total income.

Mineral Resources is a big iron ore exporter, with much of its income from abroad.

Northern Star Resources is a major gold producer, with the international gold price determining its sales prices.

Orora derives half its revenues for its paper and packaging products from its North American operations.

Pro Medicus sells medical imaging software, with more than 80 per cent of revenues from abroad.

Regis Resources sells its gold on international markets.

Rio Tinto is a major global supplier of minerals.

Sandfire Resources sells its copper on the international market.

Schaffer Corporation sells its leather goods to auto makers around the world.

Servcorp, the serviced office space provider, has more than two-thirds of its business offshore.

Sonic Healthcare's fast-growing overseas pathology businesses now account for around 60 per cent of total revenues.

Treasury Wine Estates markets its wines around the world, with overseas sales more than 55 per cent of company revenues.

Webjet is now a leader in the international hotel bed intermediary market, with a substantial amount of its revenues coming from overseas.

Wellcom Group's corporate design services are enjoying increasing demand outside Australia, with overseas business more than a third of total revenues.

Gold

The gold price has been rising during 2019, putting a spotlight on gold stocks. Here are some from this edition of Top Stocks.

Codan is a world leader in the production of gold detectors for small-scale miners.

GR Engineering Services, an engineering consulting and contracting company, has a specialty in the construction of processing plants for the gold industry.

Northern Star Resources is one of Australia's largest gold producers. It sold

840 580 ounces of gold in the June 2019 year, with a forecast of 800 000 ounces to 900 000 ounces for June 2020.

Orica is a supplier of commercial explosives and sodium cyanide, with the gold sector representing around 20 per cent of sales.

Pacific Energy is a prominent supplier of off-grid electricity generating equipment for the mining industry. About two-thirds of its business is with the gold sector.

Regis Resources, a smaller gold production company, sold 369 721 ounces of gold in the June 2019 year.

Sandfire Resources is predominantly a copper miner, but in the June 2019 year it also produced 44 455 ounces of gold.

High-tech companies

It was back in Top Stocks 2011 that I first alerted readers to the phenomenon of a growing number of high-tech companies making it into the book. Ten years earlier only one technology company — Computershare — had been in Top Stocks. But since 2011 a dozen or so have regularly made it.

The Information Technology sector represents only around 4 per cent of market capitalisation in Australia (in the US it is more than 20 per cent), yet some of these companies have been outstanding performers.

They are generally small companies and it can sometimes be difficult for outsiders to understand just how they make their money. In addition, some are on high price/earnings ratios with low dividend yields. Thus, many investors avoid them.

But technology has infiltrated virtually every facet of our lives, and the best of these companies are set to grow. It is worth taking the time to learn more about them.

Information technology companies

Money management companies

Another trend — first noted a year ago — is the rise of listed fund management companies. One of these, Perpetual, has been in the book for many years. But others, like APN Property Group and Australian Ethical Investment, are new.

The companies are beneficiaries of the huge — and steadily growing — pool of superannuation money in Australia. Nevertheless, it must be recognised that their fortunes are linked to the financial markets. Their profits will take a hit if the markets fall badly. But they should also recover quickly once investors become active again.

Money management companies

High dividend yields

With interest rates remaining low, many investors have been seeking stocks offering high dividend yields. These are still a worthy target, as they can offer a degree of protection if the market is falling. Table N lists all companies in the book according to their dividend yields.

Six years ago, in Top Stocks 2014, with investors looking for smaller companies with high dividend yields, I published a list of smaller companies from the book — a market capitalisation of below $450 million — with a dividend yield of at least 5 per cent.

There were 22 such companies in Top Stocks 2014. Since then I have repeated the process each year. There were 10 companies in Top Stocks 2019. This year there are just seven.

Dividend yield: small companies

Acquisitions

It is a feature of the Top Stocks books that they contain many smaller companies. So almost every year one or more of them gets acquired by a larger corporation.

In this latest edition, Capilano Honey, which appeared in Top Stocks 2019, is omitted because it was acquired by a private equity firm in 2018.

But something new has occurred with Top Stocks 2020. No fewer than three of the companies that qualify for inclusion have announced that they are likely to be taken over. One or more of these friendly acquisitions may even have taken place by the time this book is printed and reaches the bookstores, leading to the delisting of the stock.

It was tempting not to include the companies in the book at all. But I have decided to leave them in. There is a remote possibility that the takeovers will not go ahead. It is unlikely — these are non-hostile takeover bids — but possible that they are voted down by shareholders.

I also remember one year, in the early days of Top Stocks, that I removed one company from the book when it appeared it would be acquired by a rival. But the takeover never went ahead.