Three top small cap stocks that could withstand an economic meltdown
The gyrations of the market are saying that there is a tremendous anxiety around the prospect of a second wave of COVID-19 infections occurring. After a small spike in infections in Beijing and rising infections in parts of the US, the reverberations have been significant. This is a game changer, although it remains a relatively small probability at this stage.
The key takeout, however, is that investors should not discount small possibilities, simply because the leverage in the market is bigger than ever. Below we tell you what you should do to protect your portfolio and take advantage of such an occurrence. But first some recent history.
Learnings from Bill Ackman’s Pershing Square
The period reminds of last February (which seems like last century) when Bill Ackman’s Pershing Square’s portfolio made its famous US$27m (A$39m) insurance hedge to generate a US$2.6bn profit in less than a month, which he then proceeded to invest into equities at the height of the selling. Let’s look at how the fund came to make these super profits.
When Ackman’s fund purchased the credit default swap insurance on investment grade and high-yield bonds in January, the probability of default would have been in the order of 3%; by the time the fund profited, that probability had risen to 6%; still low, but double what it had been.
In the same way the market is factoring a low probability of lockdowns associated with a second wave of infections. But if this probability appreciates, it will produce a violent reaction in markets and is perfectly rational. We’re talking about the leverage embedded in risk assets, which can produce convulsive change when investor expectations change even a small amount.
More to the point, volatility is here to stay, at least until we get a comprehensive global programme of vaccination for COVID-19. The question is, what do investors do in the meantime?
Under the Radar’s advice
In this environment, as we keep stressing, it’s all about stock picking. There are lots of stocks listed on the ASX, some 2.5k and it’s about taking a gradualist approach. It’s not all or nothing. Under the Radar Report concentrates on buying stocks when we think they’re cheap. That’s the best discipline you can have and how we make strong and consistent returns over the long-term. We can’t all be Bill Ackman!
In order to protect yourself you want to be buying some rock solid Small Caps that can withstand another economic shutdown. The stocks we’re talking about have all been able to sustain dividends through this period. They might have yields of only 1% or 2%, but these dividends come from cashflow, not from the balance sheet and they have varying sources. That’s right, diversified earnings streams is the key to maintaining your portfolio’s equilibrium during market pain. Below are three stocks to consider owning for when the proverbial (again) hits the fan.
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Austal (ASB)
The ship builder essentially has the gold ticket for the pandemic. It receives large cheques from the US and Australian governments for an essential service. The stock has bounced back after it disappointed an its unsuccessful bid in a four way competition for the US guided missile frigate program. The resilience of this company has been on full display, however. Subsequently it upgraded its current year earnings and then announced a US$50m injection from the US Department of Defense into its Alabama plant.
Ingenia Communities (INA)
We have been covering this property trust for seven and a half years and in that time it has been increasing its distributions, but it has also been raising even more capital. A property trust can only grow if it has money to invest. Because of its innovative capital light model, Ingenia’s return on that capital has exceeded its costs and its shares have steadily risen as well. Fast forward to today and a company whose market cap was a couple of hundred million is now $1.4bn and it’s a member of the S&P/ASX200 property trust index.
Although it has a slender yield, it was one of the few in its sector to raise money during the COVID-19 crisis at a premium to its net tangible assets. Following its latest $175m equity capital raising at $3.50 a share the trust is back on the acquisition bandwagon.
Tassal (TGR)
We admit, we almost lost our appetite on the news that the humble salmon may have been responsible for a fresh outbreak of coronavirus in Beijing and China’s subsequent indication of restrictions on the pink fish. We got hungry last week when China agreed with global experts that it’s unlikely food trade was responsible and is no longer going to impose restrictions.
The fact is that Tassal doesn’t export much salmon into china. The Tasmanian company’s trade is mostly domestic. The excitement in the stock is the growth of its prawn business, which has escaped any sort of international approbrium.
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