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Seven magnificent stocks for 2017

Photo of Elio D’Amato, Lincoln By Elio D’Amato, Lincoln

min read

Share pullbacks are healthy and create great opportunities.

Sharemarkets have always been volatile, regularly taking two steps forward and one step back. The factors that lead to whether your portfolio resembles a Viennese Waltz rather than a barnyard shindig will be the quality of the businesses you hold at any one time.

But from time to time other influencing factors can impact share prices in the short-term. This is often referred to as a “market cycle”.

What we saw during 2016

Focusing on the overall health of the market, in 2016 we saw the usual dispersion between healthy and unhealthy companies, with more than 70 per cent of the market exposed to unacceptable levels of financial risks.

DSHE Holdings (Dick Smith) and Arrium Limited were the highest-profile corporate failures in 2016. Both were easily avoided, according to the Lincoln Financial Health Methodology, which measures the financial position of ASX-listed companies.

Source: Lincoln Stock Doctor

Another prevalent theme can best be described as a cycle where “high-quality premium stocks” were shunned for the “low-quality value businesses”.

For years, many investors accepted the fact that, to invest in quality businesses, they often had to pay a premium price. While disciplined investors took the opportunity to periodically pocket gains via a disciplined profit-taking strategy, others were left holding the can as more sombre outlooks saw prices revert to market multiples rather than the lofty levels they had been trading at previously.

Where did all the high Price Earnings (PE) multiples go?

This PE compression that we have witnessed (reducing PE multiples) comes after years when many had said the market was fully valued. With much of the market remaining above historic PE levels, many still feel there are more bubbles set to burst.

At Lincoln, as growth investors, we feel the recent pullback in many of these businesses late in the year creates a great opportunity for those who may have felt they missed out.

Source: Bloomberg sector PE, positive and market cap weighted

Pullbacks in share prices are healthy. Often, it is the steeper the share price rise, the larger the fall. And most investors are likely to buy somewhere near the top.

Just as a healthy rose bush needs a good trim every now and again to ensure future blooms, so do our stocks need healthy pullbacks to avoid over-heating. This gives them the opportunity to rebase before the next leg-up.

This has been the case with many of the small to mid-cap growth stocks that were the drivers of much outperformance over the past few years. They are now being shunned by a market that has started returning to the large-caps and several speculative mining investments.

Stocks to watch in 2017

We remain unwavering in our belief that over the long-term the key to successful investing is being proactive and making disciplined decisions to exit stocks, particularly when the fundamentals change. Do not let moments in time lead you down the path of knee-jerk investing.

As successful long-term investors, we remain steadfast to an approach that has seen us outperform the market in all but three periods since we first identified Star Growth Stocks more than 20 years ago.

Now the sun has set on 2016, we have dusted ourselves off and are already focusing on this year’s Magnificent Seven. These are businesses we believe are primed for a good year. We temper those expectations with the reality that, if they do not make the fundamental grade throughout the year, we will have no hesitation in pulling the pin and moving on.

(Editor's note: Do not read the following ideas as stock recommendations. Do further research of your own or talk to a financial adviser before acting on themes in this article.)

Lincoln’s Magnificent Seven are:

1. Credit Corp Group (CCP)

CCP is a Borderline Star Growth Stock and Star Income Stock that suits growth and income investors looking for capital appreciation and above-market distribution growth. The company has a strong management team that continues to deliver consistent earnings growth, as the Australian market leader in the purchased debt ledger (PDL) sector, with around 65 per cent market share.

The continued development of its consumer lending business, which has been a key earnings driver over the last several periods, has potential for further earnings upside in the medium-term from the US PDL business should improvements continue.

2. Eclipx Group (ECX)

ECX is a Star Income Stock that suits income-focused investors looking for an attractive yield supported by positive growth prospects. ECX is a technology-driven financial services organisation focused on leasing and equipment finance. Led by a strong management team, ECX has been growing market share from contract wins and acquisitions in horizontally related business channels such as replacement car hire and car-share networks, which are high-margin users of the existing fleet.

3. Event Hospitality and Entertainment (EVT)

EVT is a Star Growth Stock in Strong Financial Health that suits growth investors looking for capital appreciation. EVT is currently benefiting from a strong-performing cinema business and increased inbound tourism. Although the recent half of the year was impacted by an interruption to the German cinema release schedule, this should correct itself as movie releases are ramped up.

The company recently announced the retirement of its long-serving managing director, who will see out a transition period.

4. Hansen Technologies (HSN)

HSN is a Star Growth Stock in Strong Financial Health and is a billing and customer solution provider. It has a growing earnings stream that is defensive in nature. Management has a solid track record of profitability and is led by long-term manager and founder Andrew Hansen, who retains a significant stake in the business. HSN recently completed acquisitions that should contribute to future growth. Management reaffirmed its FY17 earnings guidance at its AGM in November, and we remain comfortable with the business outlook.

5. Rural Funds Group (RFF)
RFF is an interesting Australian Real Estate Investment Trust (A-REIT) specialising in agriculture. This Lincoln Star Income Stock suits investors looking for a company paying an above-market yield. It has a track record of increasing dividend payments, with high visibility on distributable income and forecast distributions from a yield perspective.

This is supported by a long-dated, weighted average lease expiry (WALE) profile and project development visibility. A recently completed acquisition of cattle and cotton properties continues the execution of a diversification strategy from a climatic cycle perspective.

6. Servcorp (SRV)
Servcorp is a Star Growth Stock that has a consistent track record of demonstrating Strong Financial Health. We believe that, with strong organic growth, the company will continue to meet our Star Growth Stock criteria. SRV’s US division remains the only unprofitable contributor, although it showed signs of improvement in the last period. Investors should note the lower liquidity that SRV exhibits. We believe the business benefits from the presence of founder and CEO, Alfred Moufarrige.

7. Technology One Limited (TNE)

TNE is a specialist software services and provisions business that is a Star Growth Stock in Strong Financial Health. The company has successfully demonstrated a long history of profitability and the market has historically attributed a premium on account of this and its excellent management. Recent management guidance was for continued growth of 10 to 15 per cent over the medium term (five years) as it expands margins in its core business and drives profitability from its Nascent Cloud business and UK venture.

Lincoln’s Magnificent Seven

Star Growth and Borderline Star Growth Stocks ASX code Status Health Forecast Return on assets Forecast revenue growth Forecast earnings per share growth
Credit Corp* CCP Borderline Strong 19.47% 18.21% 18.09%
Event Hospitality and Entertainment EVT Star Growth Strong 12.48% 8.04% 9.28%
Hansen Technologies HSN Star Growth Strong 26.08% 15.91% 8.58%
Servcorp SRV Star Growth Strong 13.64% 11.78% 12.25%
Technology One TNE Star Growth Strong 24.10% 14.58% 13.41%
Star Income Stocks Code Status Health Forecast EPS Forecast Annual DPS Forecast Gross Div Yield
Credit Corp* CCP Star Income Strong Stable Growing 4.59%
Eclipx Group EVT Star Income Strong Stable Growing 6.03%
Rural Funds Group RFF Star Income Strong Stable Growing 5.95%

* Credit Corp Limited is both a Borderline Star Growth Stock and a Star Income Stock
Gross dividend yield includes franking credits
Source: Lincoln Stock Doctor

About the author

Elio D’Amato is chief executive of Lincoln, a leading Australian share researcher and investor.

Follow on Twitter: @LIStockDoctor

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