14 new stocks added to the ASX 300 - only 4 make a profit

In September last year, QVG Capital presented a webinar on the proportion of unprofitable companies entering the S&P/ASX 300. At the time, we noted that just three of the 13 new entries were profitable. For those wondering, the S&P/ASX 300 index is important. After all, it is the benchmark that index funds such as the $9.6 billion Vanguard Australian Shares Index (VAS) seek to replicate. It’s also the pool that many portfolio managers tend to use as a cut off for their potential investable universe. And with a new batch of additions entering the index last Friday, we felt it was worth updating this analysis.
Chris Prunty

QVG Capital

In September last year QVG Capital presented a webinar which talked about, among other things, the proportion of unprofitable companies entering the ASX300. At the time we noted just 3 of the 13 entries were profitable. Given, S&P came out with their next batch of 300 additions last Friday we felt it was worth updating this analysis.

Here goes:

(Source: QVG Capital)

The table above shows the 14 stocks that have recently been promoted into the S&P/ASX 300 index. Every 6 months - in March and September - the dark cabal that is S&P’s index committee get together and ‘promote’ and ‘delete’ stocks from various indices. The index committee don’t make exactly clear what criteria they use to make their decisions, but we do know entry and exits are largely dependent on the stock’s market capitalization, rank versus peers and its trading volumes.

To dumb it down; stocks going up and getting more liquid get promoted and those going down and less liquid can get cut.

Why the ASX300 is a big deal

The S&P/ASX 300 index is an important index. The 300 is the benchmark that index funds such as the $9.6B Vanguard Australian Shares Index (VAS) seek to replicate. It’s also the pool that many quantitative and institutional managers tend to use as a cut off for their potential investable universe. In other words, entering the S&P/ASX 300 is a sign companies have ‘made it’.

The most interesting thing about the most recent set of 300 entries is the lack of quality. Just 4 of the 14 companies going in to the 300 are profitable.

By way of example, AVZ Minerals is a Lithium developer operating in the Democratic Republic of the Congo. To AVZ’s credit they have a monster deposit but our enthusiasm is tempered by the fact the DRC ranks 175 out of 189 countries on the 2020 Human Development Index and is one of the most difficult mining jurisdictions in the world. With development and emerging market risk, a $3B market capitalisation and no meaningful cash flow until FY24 (at best) it doesn’t look like a great bet to us.

Just like the September cohort of 300 entries; battery minerals are still popular. AVZ Minerals, Calix, Core Lithium, Firefinch, Jervois Global, Lake Resources, Syona Mining and Syrah Resources all playing to this theme. The other thing they typically have in common is the significant need for capital and cash flows that are many years away.

So what is the practical application of all this?

We suggest the following:

  1. Be aware there are technical factors such as index inclusions that can drive share prices well above fair value.
  2. Don’t get caught up in thematic mania (or if you can’t help yourself keep your bets small).
  3. If you buy an index product, be aware you’re buying the good, the bad and the ugly.

And finally, stocks with weak fundamentals that are over-valued for technical reasons can present great shorting opportunities; ones the QVG Long Short fund seeks to take advantage of. 

Find out more via QVG's upcoming investor webinar

If you're interested in hearing more from the QVG Capital team please register for our upcoming invest webinar to be held on March 15. The webinar will cover the recent reporting season, QVG's portfolio positioning and the outlook for our funds. Register Here.

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Chris Prunty
Principal & Portfolio Manager
QVG Capital

Chris Prunty is a co-founder and Portfolio Manager at QVG Capital; a boutique investment management firm specialising in smaller companies. QVG manages money on behalf of high net worth individuals and institutions in a 'best ideas' portfolio of...

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