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Preface

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The combination of low interest rates, political instability and an uncertain economic outlook has created a volatile environment for financial markets. Yet investors prepared to do their own research will readily find fine stocks with excellent prospects. Top Stocks 2017 showcases many of these companies.

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.

This is the 23rd edition of Top Stocks, and 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 its 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.

There was a time when investors needed to do little more than choose a sector that appeared to offer potential, knowing that most stocks in that sector would do well. This is a much riskier proposition today.

Look at retailers. A blue chip like Woolworths, held by numerous small investors, many of whom would surely view it as a ‘safe' stock, reported a sharp decline in profits in its June 2016 accounts.

Yet some smaller companies in the sector, such as shoe retailer RCG and mobile phones specialist Vita Group, have been recording big increases in their profits. It is important nowadays to look at individual companies, not just at sectors.

Another example is the mining services sector, companies whose business is to provide support services to mining and energy companies. At the height of the mining boom there could be as many as a dozen of these companies in Top Stocks. But as the resources downturn has continued to bite the number has been steadily falling. In Top Stocks 2017 only Monadelphous remains from earlier editions of the book, along with Mineral Resources, which derives about a third of its revenues from mining services.

But into this edition of the book comes a new entry, GR Engineering Services. At a time when other mining services companies have generally been seeing their profits still on the decline, GR Engineering reported an 18 per cent increase in revenues and a 50 per cent jump in its after-tax profit.

Of the 90 companies in Top Stocks 2017 – four fewer than in last year's edition – fully 72 reported higher profits in the latest financial year (June 2016 for most of them), while 67 achieved higher earnings per share and 70 paid a higher dividend.

Of the 72 companies reporting higher profits, 47 achieved double-digit profit growth, with five companies reporting a triple-digit increase. In addition, 47 of them saw profits growing at a faster rate than revenues, implying that their profit margins were expanding.

And though, as I wrote above, share prices are not relevant for selection to Top Stocks, 75 of the 90 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 five years. In fact, 48 of these 75 companies have given an annual average return of over 20 per cent.

And 12 of them – Altium, Corporate Travel Management, Domino's Pizza, G8 Education, Magellan Financial, MNF Group, Northern Star Resources, Objective Corporation, Pro Medicus, Prophecy International, Sirtex Medical and Vita Group – have provided an annual average return over five years of more than 50 per cent.

High-tech stocks

Probably the biggest trend in Top Stocks in recent years has been the rise and rise of high-tech stocks. This is significant. The Information Technology sector represents only around 1 per cent of market capitalisation in Australia (compared with more than 30 per cent in the US). Yet fully 12 companies in the current edition of Top Stocks are in the Information Technology sector, up from 11 last year and nine the year before.

They are generally small companies – though large enough to be in the All Ordinaries Index of Australia's 500 largest stocks – and it can sometimes be difficult for outsiders to understand just how they make their money. Thus, many investors avoid them.

But technology is steadily infiltrating 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.

Increasingly they are selling what has come to be known as software as a service. This means they will often charge an initial fee and then a subscription, so they have a high degree of recurring revenue. It gives a degree of consistency and predictability to their earnings. They can also generate high profits from a relatively small increase in sales, given that they are dealing especially in software.

Profit growth (and share price acceleration) for many of these companies has been outstanding. They are often on high price/earnings ratios, but that reflects the market's belief that high levels of growth will continue. They should be on the radar of all serious investors.


Top Stocks 2017: information technology companies

Healthcare companies

In past editions I have a number of times put the spotlight on the steady rise of the healthcare sector within the book. At one time the only healthcare-related company in Top Stocks was F.H. Faulding, a drugs manufacturer and distributor. In the latest edition we find a group of seven companies, one fewer than last year. Some have been growing strongly, though few offer high dividend yields.


Top Stocks 2017: healthcare companies

High dividend yields

With interest rates low, many investors have been seeking stocks offering high dividend yields. These are still a worthy target, as they should offer a degree of protection if the market is falling.

Three 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. In Top Stocks 2015 there were 15 stocks and last year there were 16.

In the latest edition of the book there are 11. Interest rates continue to fall, so I have added a further five companies with a yield of more than 4 per cent.


Dividend yield: small companies

Australian companies with overseas activities

Investors have on occasion been sceptical about Australian companies taking a big plunge into offshore activity, believing that such moves have a high chance of failure. These doubts have sometimes proven correct. Some local corporations, successful at home, have done poorly abroad. But others have performed very well, including many that are in Top Stocks.

With the Australian dollar relatively weak, and possibly set to fall further, astute investors will certainly wish to consider companies that have a large overseas presence. Here are companies in Top Stocks 2017 that generate a substantial amount of their revenues abroad. Do note, however, that this does not automatically mean they are beneficiaries of a weaker dollar. Some have a hedging program – or some other arrangement – in place that limits the potential gains from the weak dollar.

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

• Ansell is a global leader in safety and healthcare products, with 85 per cent of sales abroad.

• ARB exports its automotive accessories to more than 100 countries, with overseas business around a quarter of total sales.

• Beyond International is a prominent producer and distributor of television programming, with more than 40 per cent of sales to overseas buyers.

• Blackmores reports that direct exports of its healthcare products represent less than 20 per cent of total revenues, but the company estimates that a further 25 per cent of sales are to Chinese tourists or to wholesalers exporting to China.

• Breville Group sells its home appliances in more than 50 countries, with foreign revenues now about 60 per cent of the total.

• Coca-Cola Amatil has significant business operations in New Zealand, Indonesia, Fiji and Papua New Guinea.

• 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, following a series of acquisitions, undertakes a majority of company operations overseas.

• Domino's Pizza Enterprises does business in Japan, New Zealand, France, Belgium and the Netherlands, accounting for more than 70 per cent of total income.

• Flight Centre gets around 45 per cent of its income from its overseas branches.

• Fortescue Metals sells most of its iron ore to China.

• GBST Holdings makes more than half the sales of its financial software products to foreign customers.

• Hansen Technologies is rapidly expanding its billing services overseas, and this business represents around three-quarters of total income.

• IMF Bentham is opening offices in several countries, and these are bringing in a growing amount of the company's business.

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

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

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

• Lendlease is a financial giant that operates around the world, with more than 40 per cent of its revenues coming from outside Australia.

• Macquarie Group has banking operations in 28 countries, and international business accounts for more than two-thirds of total income.

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

• Navitas gets more than a third of its income as an education provider from overseas operations.

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

• Pro Medicus sells medical imaging software, with more than three-quarters of revenues from abroad.

• Rio Tinto is a major global supplier of minerals.

• SAI Global is a large specialist corporate consultancy with more than half its business overseas.

• Seek, Australia's online jobseeker leader, is growing rapidly thanks to its overseas businesses, which now represent more than 60 per cent of total company turnover.

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

• Sirtex Medical sells its liver cancer treatment around the world, and most company income derives from overseas buyers.

• Sonic Healthcare's fast-growing overseas pathology businesses now account for more than half of total revenues.

• Wellcom Group's corporate design services are enjoying increasing demand outside Australia, with overseas business now around half of total revenues.

Who Is Top Stocks written for?

Top Stocks is written for all those investors wishing to exercise a degree of control over their portfolios. It is for those just starting out as well as for those with plenty of experience but who still feel the need for some guidance through the thickets of around 2200 listed stocks.

It is not a how-to book. It does not give step-by-step instructions on ‘winning' in the stock market. Rather, it is an independent and objective evaluation of leading companies, based on rigid criteria, with the intention of yielding a large selection of stocks that can become the starting point for investors wishing to do their own research.

A large amount of information is presented on each company. Another key feature of the book is that the data is presented in a common format, to allow readers to make easy comparisons between companies.

It is necessarily a conservative book. All stocks must have been listed for five years even to be considered for inclusion. It is especially suited for those seeking out value stocks for longer-term investment.

Yet, perhaps ironically, the book is also being used by short-term traders seeking a goodly selection of financially sound and reliable companies whose shares they can trade.

In addition, there are many regular readers who buy the book each year, and to them in particular I express my thanks.

What are the entry criteria?

The criteria for inclusion in Top Stocks are strict:

• All companies must be included in the All Ordinaries Index, which comprises Australia's 500 largest stocks (out of around 2200). The reason for excluding smaller companies is that there is often little investor information available on many of them and some are so thinly traded as to be almost illiquid. In fact, the 500 All Ordinaries companies comprise, by market capitalisation, more than 90 per cent of the entire market. (Note that one company in the book, Beyond International, is no longer in the All Ordinaries Index. However, it was in Top Stocks 2016, so for continuity purposes it has been included in the present book.)

• It is necessary that all companies be publicly listed since at least the end of 2011, and have a five-year record of profits and dividend payouts, each year.

• All companies are required to post a return-on-equity ratio of at least 10 per cent in their latest financial year.

• No company should have a debt-to-equity ratio of more than 70 per cent.

• It must be stressed that share price performance is NOT one of the criteria for inclusion in this book. The purpose is to select companies with good profits and a strong balance sheet. These may not offer the spectacular share price returns of a biotech start-up or a promising gold miner, but they should also present far less risk.

• There are several notable exclusions. Listed managed investments – as defined by the ASX – are out, as these mainly buy other shares or investments. Examples are Australian Foundation Investment Company and all the real estate investment trusts.

• A further exclusion are the foreign stocks listed on the ASX. There is sometimes a lack of information available about such companies. In addition, their stock prices tend to move on events and trends in their home countries, making it difficult at times for local investors to follow them.

It is surely a tribute to the strength and resilience of Australian corporations that, once again, despite the volatility of recent years, so many companies have qualified for the book.

Changes to this edition

A total of 20 companies from Top Stocks 2016 have been omitted from this new edition.

One company was acquired during the year (Patties Foods).

Two did not pay a dividend for the year (Acrux, Metcash).

Some corporations took advantage of low interest rates to expand their borrowings, and five companies from Top Stocks 2016 saw their debt-to-equity ratio rise above the 70 per cent limit for this book (CSL, Orica, Prime Media Group, Thorn Group, TPG Telecom).

The remaining 12 excluded companies had return-on-equity figures that fell below the required 10 per cent (ALS, Crown Resorts, Decmil Group, ERM Power, Insurance Australia Group, Myer Holdings, Orotongroup, Pacific Current Group (formerly known as Treasury Group), RCR Tomlinson, Seymour Whyte, SMS Management and Technology, Woodside Petroleum).

There are 16 new companies in this book (although eight of them have appeared in earlier editions of the book but were not in Top Stocks 2016).


The new companies are:

*Companies that have not appeared in any previous edition of Top Stocks.


Companies in every edition of Top Stocks

This is the 23nd edition of Top Stocks. Just three companies have appeared in each one of those editions:

• ANZ Banking

• Commonwealth Bank of Australia

• Westpac Banking

Once again it is my hope that Top Stocks will serve you well.

Martin Roth

Melbourne

September 2016

Top Stocks 2017

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