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Small cap filter: Only seven comply

Beware of Comair and Crookes, hold Afrocentric and Torre – Keith McLachlan.

Some of you may recall that I run market-wide equity filters as a “catch all” to see if there are any really incredible small caps out there that I might be missing.

An equity filter is only as good as your parameters, and I’ve been working on tightening these parameters up a lot…

So, across the whole of the South African stock market, I ran the following inclusive filters (i.e. a stock has to comply with all of them or it is excluded from the results):

  • Net debt:equity must be lower than its relative sector (global); in other words, the company is less geared than most others operating its business model around the world.
  • Five-year average Return on Equity (ROE) must be above average versus the rest of the JSE (domestic); in other words, the company must be more profitable (despite being less geared) than its local peers.
  • EV/Ebitda must be lower than the average in its sector (global): in other words, it is relatively cheap on a global comparative basis, despite any differences in its gearing structure to its peers.
  • The average growth over six years in its HEPS must be greater than the average company on the JSE (domestic): In other words, it is growing faster than the average in South Africa.

Note: I built and ran the filter out of Bloomberg’s EQS function.

Across the entire JSE All Share, there were only seven stocks that complied with all of these conditions, and here they are (in order of their EV/Ebitda ratio, for what it is worth):

Comair (COM) – A nasty oil hedge taken out at a much higher oil price, soft domestic demand and continued government support for its competitor makes me averse to this counter, despite its great track record.

Crookes Brothers (CKS) – The current drought will likely hurt this listed farming counter’s operations a lot in the current year. Until the damage is quantified, I would avoid it.

Afrocentric (ACT) – It’s nice to see counters you own popping up in your own filters (unless that is just circular logic where I choose stocks with fundamentals I am biased to and build filters with the same bias). All that said, though, it’s a solid, defensive, cash generative and deeply undervalued group, with good upside in its recent Sanlam/WAD deal. 

Barloworld (BAW) – This is a great business, just operating in a tough space where it is selling Caterpillar equipment across Africa and Russia just as mining and oil fall off a cliff… Still, not a counter I would write-off immediately and one that a bullish investor might consider picking up at these levels.

Workforce (WKF) – A very thinly traded labour broker trying to become a payroll and HR BPO player. I prefer CSG Holdings as a play in this space, as it evolves into a mini-Bidvest Group under the radar.

Hudaco (HDC) – A longstanding, solid industrial supplies business into South African mining and industrial sectors, but I much prefer Torre below…

Torre Industries (TOR) – Once again, great to have a counter that I hold appear in my aggressive fundamental filter. Read all about Torre here.

All in all, quite interesting to see that (1) there are only seven stocks in the domestic market that comply with my strict equity filter, and (2) that they are all small caps.

Like I say above, I would be wary of Comair and Crookes above while I hold and really like Afrocentric and Torre.

This article first appeared on Smallcaps.co.za, to view the original please click here.

*Keith McLachlan is an equity analyst and small cap specialist.

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