16 new stocks added to the ASX 300 - only 7 make a profit

In March, 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 4 of the 14 entries were profitable. Given, the next batch of companies entered the S&P/ASX300 last Friday we felt it was worth updating this analysis.

Here it is

The table above shows the 16 stocks that have recently been promoted into the S&P/ASX 300 index. Every 6 months - in March and September - the champions that comprise 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 simplify; 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 $11.3B 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’.

Beware the index

The most interesting thing about the most recent set of 300 entries is the lack of quality. Just 7 of the 16 companies going in to the 300 are profitable.

By way of example, Deep Yellow and Boss Energy are unprofitable Uranium developers. Deep Yellow has been listed for 20 years and Boss for 15 years. Despite both being around a long time the track-record of earnings is abysmal. The Uranium market is tricky. Bulls point out that the spot price has been below cost of production for years so it’s inevitable that the spot price must rise to incentivise new production. Bears, such as us, point out that even Australia’s largest listed Uranium stock Paladin has only once made free cash flow in the 18 years it’s been listed. Amazing but true!

Just like the March cohort of 300 entries; speculative mining stocks are still popular. Argosy Minerals (ASX: AGY), Arafrura Resources ASX: ARU, Boss Energy and Deep Yellow, Mincor and Neometals all playing to this theme. The other thing they typically have in common is the need for further equity to support them to the promised land of profits.

So what is the practical application of all this?

Benchmark inclusion can be a trap for investors! Inclusion is a nice milestone but says nothing about the long-term prospects for a company.

Don’t get caught up in thematic mania (or if you can’t help yourself keep your bets small).

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 October 4. The webinar will cover the recent reporting season, QVG's portfolio positioning and the outlook for our funds. Register Here.