My guest this week is Richard Hemming from Under the Radar Report. He shares three key investing lessons from his experience investing in small caps on the ASX.
Richard starts with diversification. He stresses itsimportance in small caps due to higher volatility. Under the Radar limits any stock to 10% of a portfolio. They hold 14 to 20 stocks in flagship portfolios and 14 to 16 in dividend ones. Richard buys small positions first—1% or 2%—and builds to 5%. If it hits 10%, he takes profits. This approach minimizes risk and leverages success. He diversifies across sectors, business models, and debt levels. Small caps offer more options than blue chips or ETFs, which often overweight banks or the MAG7.
Next, Richard discusses ETFs in portfolios. Passive fundsnow dominate inflows, driving up valuations in index-heavy stocks like CBA. This creates momentum but risks outflows causing sharp drops. Richard advises against chasing momentum. Instead, use ETFs as a core for beginners, then add small caps for outsized returns. He dollar-cost averages into indexes for his kids but focuses on individual blue chips and small caps himself.
The third lesson covers dividends. Australia’s frankingcredits boost returns. Dividends signal profitability and require strong balance sheets and cash flow. Richard checks payout ratios, working capital, and operating cash flow. Red flags include short-term liabilities exceeding assets or high capex needs. Dividends build confidence in uncertain small caps. His dividend portfolios return around 20% annually recently, with 14-16 stocks to spread risk.
We dive into business models. Mature companies paydividends; growth ones reinvest. Capital-light models like software offer operating leverage—fixed costs mean revenue growth boosts profits fast. Richard uses a “three bites of the cherry” framework: survival boost from cost cuts, earnings growth from sales, and index inclusion or takeover for rerating.
Richard highlights stocks. Articore (ATG) runs a T-shirtdesign platform. It doubled from 15 cents after cost cuts but needs sales growth. NZME yields 8% with steady earnings in media. It benefits from New Zealand’s improving economy and could sell its property portal. Appen (APX), down from $40, annotates AI data. It maintains margins with Chinese growth replacing lost US revenue, backed by $50M net cash.
As friends of Shares for Beginners, Under the Radar Report is happy to offer listeners 10% off our products. All you need to do is plug in the
promo code ‘SFB' into our website https://undertheradarreport.com.au/pricing/
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EPISODE TRANSCRIPT
Phil Musatello: Shares for Beginners. Phil Muscatello and FinPods are authorized reps of MoneySherpa. The information in this podcast is general in nature and doesn't take into account your personal situation.
Richard Hemming: Yeah, have your index funds, sure. Like we advocate them, but then as you get better, you go beyond them and then they're just a part of it. They're not the whole. And I think too many superannuation funds have thought, well, this is our, uh, easy solution. In life, things are always the solution until they aren't. And I think, well, this is a good strategy to diversify. To hedge your other holdings is to invest in 14 to 20 small caps that you like.
Phil Muscatello: G' day, and welcome back to Shares for Beginners. I'm Phil Muscatello. How much diversification is diversified enough to achieve full diversity? Can small caps shine on the ASX when some of the larger companies are showing signs of strain? Joining me with three big lessons in investing to start with is Richard Hemming from the under the Radar Report. G', Day, Richard.
Richard Hemming: Hi, Phil. It's great to be back on the show.
Phil Muscatello: Okay, so you came along this morning with your talking points for this episode. And the first is that, um, you wanted to, you did. So you wanted to give us some, um, investing lessons. And you've got three big lessons. And just to mention though, the first one was diversification. Tell us about diversification.
Richard Hemming: I think that's probably the best advice in the past half century that finances had to give. So it's advice that's well proven and everyone's familiar with it, but I think in the small cap world, it really, really does work because you've got obviously a greater variety of companies, so you probably need more discipline. And one of our disciplines is not to hold more than 10% of any one position. So, you know, like, we have 20 stocks in our flagship portfolio and our, uh, dividend portfolios typically have 14 to 16 stocks. And our learning is that, you know, the more stocks almost the better. Like, honestly, ETFs have too many stocks, so you get a kind of a dumbing down effect.
Phil Muscatello: Why hold all of the banks, for example?
Richard Hemming: Well, I guess you can say why hold all of the whole universe. But ETFs are definitely the most cost effective and I think for many people, they've de. Risked their, their investment life. But really, I think if you want to get the best returns, you need to hold a diversified portfolio of small caps. We include some blue chips, but really, if you have discipline around it, then you can really do great things. With your portfolio. And I think one of those disciplines is not buying too much at once. So typically I uh, just buy 1% or 2% and then build that up to 5% and then let it go. And then when it gets up to 10% we start taking profits. So it's that kind of balancing effect that you can, or rebalancing effect that you can get. That's like a stabilizer. That's a key learning I think. And it's uh, a learning for us in our dividend portfolios over time. We do one every six months. But I think it's a key learning in certainly portfolio management theory.
Phil Muscatello: So I guess the idea then is if you buy it, if you get into a position and you're only a small amount of it, that if it goes south, that's not going to affect your overall portfolio as much. Is that how it works?
Richard Hemming: Yeah, well I think if you were given all this money at once and they said just invest it, I think it would be the wrong thing to just invest it all at once. I think the best thing to do is just see how to let a uh, stock earn its position in your portfolio. So part of that is just investing a bit in the stock and seeing how it goes. Investing a bit more in the stock, but getting to like 5% and then not investing anymore and seeing how that 5% goes. And if it goes better then you start taking profits. So what I'm saying is you're leveraging into success, but you're minimizing the risk, as you said in your question of it not being successful. And sometimes that happens. And that's what happens in companies a lot. But what you're trying to do is pick winners. And that's the difference between what we're doing and an etf. The other thing is what we're doing is we're not trying to time everything to perfection. So we're just leveraging into success because timing is very hard, very hard. And the best advice is just leverage into success and build your position and see how it goes.
Phil Muscatello: And what about trying to achieve diversification across industries and sectors and so forth? Are you conscious about that when you're building up a portfolio in this manner?
Richard Hemming: Of course. And that's the beauty of small caps. And a lot of the problem with these passive monies or these index linked ETFs is
00:05:00
Richard Hemming: that they're not that diversified because they're leveraged, as you said in Australia's case to the banks, in America's case to the Mag 7. So what small caps enable you to do is to leverage across different industries, across different financial models, different business models, so different amounts of debt. Companies that pay dividends, companies that don't pay dividends. So you've got a lot more options. When you open up the universe to Those outside the ASX 200, would you.
Phil Muscatello: Not include a company in your portfolio because you've already got too much of a position in that particular sector already?
Richard Hemming: Yeah, I would, uh, definitely. I wouldn't go overboard in any one sector. But like, I guess in mining, it's a different case as well, because mining, you've got gold stocks and they're miners. Like nickel stocks are, or copper stocks are, or lithium stocks are uranium. But there's a big difference, isn't there, between a gold mining company and a lithium or a uranium mining company? So I might be holding more gold than lithium or uranium. But as it happens, we've been taking profits in some. Some of our gold stocks because they've done that, you know, like Evolution Mining got to well over 10%, so we started taking profits. And I think the mistake that I've made in the past is not taking profits. So I haven't had that discipline. And that discipline has been learned over the, you know, the hard way, over experience. Because, like, you know, my wife keeps telling me, you held these lithium stocks and they're way down. And I said, they're still. They're way down on where they were at their top, but they're like, Pilbara Minerals is still doing really well. It's just that knowing when to take profits is a really, really good discipline, what everyone asks. Whereas if you use this stabilizing factor like what I'm talking about, then it kind of takes the decision out of your hands a bit. And fund managers do that all the time. And, and what we're doing is we're taking some of the good things that fund managers do and we're applying it to ourselves. And that's how we can benefit without having their problem of being monitored every three months about how they're going against the index.
Phil Muscatello: Yeah, having to report all the time.
Richard Hemming: Well, having to report every time. But they're also being judged against indexes. And that brings me to the second big learning.
Phil Muscatello: Oh, and after badmouthing ETFs a moment ago, you want to talk about ETFs as part of a portfolio?
Richard Hemming: No, no, uh, what I'm talking about is in terms of. The big learning is definitely. Well, in our basic portfolios, we do have passive funds like index length ETFs in our portfolios. But I think the thing to remember here is just how powerful that ETF effect has been in the market. Basically that has been the big change that we've seen in the past decade to decade and a half. So in recent years, ETFs went from nothing. When I was like in my 20s, Vanguard was just starting up and now basically Vanguard's gone from a niche operation to a giant. But not only that, but they've got other giants of Blackrock. They've got, you know, it's just like the ETFs now, uh, are, uh, now like half of all fund flows. So what this means is if you have a stock that's heavily weighted in the index, they get like, say CBA gets, you know, is 10% of the ASX 200. So all that money that flows to CBA, half of it comes from passive funds that are blind to its fundamentals. So then they don't care what its fundamentals are. Uh, they just care that it's 10%. Got a 10% weighting in the ASX, AH200. So that's why the comm bank, without much change in earnings at all, can go from being on a PE of 15 times or 20 times or 15 to 20 times to 25 to 30 times now. So you've had a huge valuation effect. But that effect can also happen on the negative. So that effect only happens when there's fund inflows. So when there's fund outflows, the negative effect happens. And we haven't seen that fund outflow effect. But what I'm saying is you've got to be cognizant of that effect when you're investing. And that's what we are as private investors. We're not trying to match it with those indexes. We've got the ability to hold on for longer periods to really, you know, say a stock in your portfolio is not performing well. Well, that doesn't mean you have to throw the baby out with the bathwater and sell it. It means you can hold on. And that's, I guess that irons in the fire is what we're trying to how we manage our money as individuals.
Phil Muscatello: So you mentioned the funds. You have to be cognizant of funds outflow in an etf. What does that mean, a funds outflow?
Richard Hemming: Well, it's fund inflow and fund outflow at the moment.
00:10:00
Richard Hemming: See, what happened in Australia is this superannuation funds decided that, oh, uh, we need more transparency. We need to be Looking at how our money is performing against the index. And the result of that is that a lot of the superannuation funds now, they just say, well, we're just going to invest in the index. It's the cheapest way. So we've had a massive influx of money going into just a small amount of stocks in number. So when those flows stop and go the other way, or if there's a slowing down of that influx of money, then you can see that stocks can get really badly hit. They can get sold off. And that's what we saw in the last reporting season. We saw a lot more volatility at the big end of town with big Commonwealth Bank. Yeah, well, Commonwealth bank got sold off a bit, but then got bought very quickly. But a lot of, uh, the other banks got sold off and then sold off again. But, you know, I'm just saying that to make money in the long term, you don't want to be playing that momentum game. That's the bottom line about what I'm saying, Phil. You don't want to be trying to pick and choose when to buy these stocks because they're really expensive. You just want, maybe you want some of them in your portfolio, but you don't want to be playing that game. And I think the money that people have made in the indices in index funds, it's going to slow over time. It's not going to be as easy to keep making that money, because as we saw with gold, when it went up quickly, it went down quickly. So what goes up quickly, goes down quickly. That's the law of physics. Finds its way into financial markets all the time.
Phil Muscatello: Ditch the spreadsheets. Sharesite is Investopedia's top tracker for DIY investors. Invest smarter, not harder. Grab four months free on an annual premium plan at sharesite.com sharesforbeginners. So what you're saying is that, uh, like you started to talk about diversification and now about ETFs, should you have a balance? Um, a beginner, for example, should consider having some of their funds in an etf, an indexed etf, and then start trying to build up a portfolio of small caps as well to try and achieve some outsized returns.
Richard Hemming: I think that's a great way to put it because what we do with our kids, we do like dollar cost averaging. So we just have automatically they're buying into the index every three months. Not that they thank us for it. What I'm saying is that you're never going to pick the right time with markets or it's very, very hard. So if you're taking advantage of that, you know, maximalist diversification that you're getting with an etf, that's great, that's a good start. But then what do you think over time is going to really boost your returns? Was owning a portfolio of small caps. And I think that question really sums up our position and what we do. Although, to be honest with you, I concentrate on buying blue chips as well as small caps rather than ETFs now.
Phil Muscatello: Yeah. Well, presumably you're a reasonably expert at this at the moment.
Richard Hemming: Yeah, but it's good to have built up a core. So I like looking at life like, here are your core stocks and here are your satellite stocks. And some of those small caps, as we mentioned at the start. Well, it's. I like just throwing a bit of money at them and seeing how they go. Investing in a roughie is, uh, a lot less profitable than investing in some of these small caps. Because some of these small caps, they might not win straight away, but over time they can win. And that's what I'll get onto in a bit.
Phil Muscatello: So the third lesson you wanted to chat about is dividends. What part do dividends play in the portfolio?
Richard Hemming: They help you buy Christmas presents. So I think that as individuals, we're looking for cash. You know, cash means a lot to us. We like cash. But Australia has a pretty good tax system for investing in companies that have franking credits because we get bigger than average returns from those franking credits. So that's another benefit. And the other point is that dividends cannot be paid unless a company is profitable. So they. In the small end of town, there's often a lot more uncertainty about a company's future. So we spend a lot of time investigating the company's balance sheet and their cash flow. But if they're paying dividends, that does really give you a greater level of confidence. Definitely. That's, I think, one of the secrets as to why, I guess, our, uh, dividend portfolios perform so well because some of these companies are, uh, they're stayers. So, you know, they're not roughies, they're stayers, but they're not priced like the Commonwealth Bank. They're not priced to perfection. They're priced on good yields. And I'll come to one of those stocks a bit later.
Phil Muscatello: So when you're filtering for dividends, are there any things that you watch out for? Because, you know, sometimes some companies can pay out too much in dividends. I mean,
00:15:00
Phil Muscatello: do you look at the payout ratio for example to try and make sure that these dividends are sustainable.
Richard Hemming: Oh definitely look at the payout ratio but you also look at I guess the basic measures of solvency which is working capital needs. So working capital is a big factor in a company's cash flow. So you know, and it's dependent upon the company as to their working capital needs. So you're looking at their short term assets and liabilities and then you're looking at their operating cash flow. You're looking at the, you know, like how their accounting earnings compare with their operating cash flow. So we're looking at various measures and we're trying to gain an insight into how robust the earnings are. Because what we saw in Covid didn't we, we saw a lot of those companies that people consider the most robust companies in the world actually stopped paying dividends. And what we've seen with BHP and um, with even the big miners in the past, they said well you know, we're going to have this payout ratio that's going to be fixed. Well when times got tough they didn't fix that payout ratio. So you've got to be understanding of the business model of companies really. I mean that's the bottom line isn't it? Beyond the financial metrics you're buying a business model.
Phil Muscatello: Yeah. It's not just the story you're going to hear from your friend down at the pub, is it?
Richard Hemming: Well it's not about stories, it's about just using a process. And we have a uh, process where we look at four factors and we give each company a risk rating out of 5, subtract from the 5 number if they have a good balance sheet, if they're profitable, if they have a earning, if they have revenues that we consider quite large, you know, 100 plus million if they have a good, a diversified customer base. And then you whittle down, you get to a position where okay, you've got your valuation risks on the one side but on the other side you've also got your financial risks and that's what you factor in when it comes to paying dividends.
Phil Muscatello: So what sort of red flags do you look out for? What are some of the things that are like an amazing um, when the.
Richard Hemming: Short term liabilities are bigger than the short term assets, I think that's a basic, you know, if they're burning cash, if they've got a capex, you know, even at the bigger end, if they've got a capex hump M or that's like a term we use just if they've got a big project in front of it where they have to invest lots of money because investing costs, doesn't it? And that money has to come from somewhere. Like honestly, you can get it wrong. We got it wrong with alliance because we thought Alliance Aviation, they had a big debt pile, but like Qantas, they'd invested in planes and we thought those planes were going to pay off and we're going to get the operating cash flow and that operating cash flow was going to pay down that debt. But as well paid dividends and they paid a dividend last year. So we took that as a sign. But then recently they've had a downgrade because the costs were actually higher than they had anticipated. So with all the goodwill in the world, you can still get it wrong. And you know, so dividends aren't everything, but you're doing your financial analysis all the time and no matter how much analysis you, you do sometimes and invariably things will happen from left field.
And that's where it comes back to that first point that I made of diversification. So like I said before, one of our big learnings was with the dividend portfolios that I think at last count, the last three dividend portfolios have returned 20% a year or the recent three from February 23rd to October 23rd to May 24th. So they're not our most recent three, but our three, uh, three in the past few years. And what I'm saying is that we had portfolios that had 10 stocks originally, then we had 12 stocks, now we have 14 to 16 stocks because we find that you need more stocks to cope with your individual stock risk, like what we saw with alliance, so your whole returns don't get dragged down by, you know, a poor performing investment. And that's what you really want to do is be able to capture that upside and minimize the downside. And that's what dividends do. But what's more important than dividends is diversification and understanding the business model.
Phil Muscatello: So what kind of business models would you say differentiate between a company that's going to pay dividends and a company that's going to grow?
Richard Hemming: Well, the more mature companies can pay dividends, it's rare that you get less mature companies paying dividends. But having said that, I invested in some companies that paid dividends for ages, like Macquarie Technology, and then they just stopped paying dividends and invested in growth and that's when the company took off. So, like there's no hard and fast rules. Spill. Like I invested in Certex, and they paid a little dividend for ages. Then they got taken over and they were. I'm just saying. But I don't think the dividend was the reason I invested. It just gave me a bit of confidence. So sometimes there's no hard and fast rules, Bill. I think the main thing to look at is the financials behind
00:20:00
Richard Hemming: paying the dividend and whether they can get growth because growth really is the panacea for everything. When you get sales growth, when you get return on equity, that's compounding at the small, you know, that's compounding at 15%, 20%. If you get compounding return on equity, that's how you make money. That's what we're looking.
And so often a lot of the companies that people like that we like too sometimes are capital light businesses. And that's what a couple of the companies I'll be talking, uh, about in a second. So companies where they don't have to invest much capital. But having said that, it's not a hard and fast rule, is it? Like Austel, they've paid dividends in the past. I don't even know whether they pay dividends now. I don't think so. But they're a big, they're a capital intensive, they're a shipbuilder, they involve loads of capital. But with that you get big barriers to entry, don't you? Like they're the supplier of choice to the United States, the United States Navy. I mean, that's a fantastic business to be in. It's not. Nothing's foolproof, Phil. Nothing's foolproof. But Capital Light is obviously a go to. Everyone likes them. That's why Fintech's above his word. Like, you know, technologies everyone likes. Uh, you get these fixed costs and you get the operating leverage. And that is great. That is great. But really, really what you need to base a lot of investment on is just starting from the, from the bottom up. That's what I think. Looking at the balance sheet, does this company need to raise capital? What, what returns is it making? What returns can it make? Like all these questions you need to put into your mind. It's if it was simple, then shares for beginners wouldn't, wouldn't be a very, you, uh, know, ongoing program, would it? You just do an hour of, here, here are the simple things to learn. And then with these things you can just make millions of dollars. Well, it just doesn't work like that. But there are loads of companies on the asx. And the point that I'm making is a lot of them don't get the money from the free money that comes from being in an index. A lot of them. And I've seen these companies are getting better and better at uh, telling their story, at uh, delivering because they have to be good. There's natural selection out there.
Phil Musatello: Are you confused about how to invest? LifeSherpa can ease the burden of having to decide for yourself. Head to lifesherpa.com to find out more. Lifesherpa, uh, Australia's most affordable online financial advice.
Phil Muscatello: I love the point that you were making before about that, you know, if there wouldn't be a shares for beginners if it was easy. And that's, I mean this is the way I'm trying to make this podcast is that it's not easy, that you've got to learn a lot if you want to direct invest directly in the Australian share market or any stock market around the world.
Richard Hemming: And um, look, you have to learn a lot, but you also just have.
Phil Muscatello: To, you have to be warned, you have to be warned a lot as well.
Richard Hemming: You, you do, but you, you also just got it. It's a very much a practical sort of environment. It's like a TAFE rather than the university where you, where you, the more you do, the better, the better understanding you'll get. It's not like this is a very practical business where in no one can ever understand what it's like investing for you except you. So everyone thinks they can outsource it, but really I like the idea that we're in control. That's what I really like. I don't like being, thinking, oh, uh, I've got my money with those people, so, uh, I'll be fine. Whereas I think, well, I know where my money is and I can control where it is now and tomorrow, not just, oh, uh, well, it's locked here. I can't control it. And I think that that's very much what people want, is a feeling of control. And I think, yeah, have your index funds, sure, like we advocate them but then as you get better, you go beyond them and then they're just a part, they're in your core, but they're just a part of it. They're not the whole. And I think too many superannuation funds have thought, well, this is our easy solution in life. Things are always the solution until they aren't. So. And I think, well, this is a good strategy to diversify to hedge your other holdings is to invest in 14 to 20 small caps that ah, you like the Big learning is, it's how do you take advantage is what you were asking before. Uh, well, we're saying, well, look at our dividend portfolios. We've got a dividend portfolio review coming up. We own 14 to 16 stocks. And you know, they're not always the sexiest stocks because they're paying dividends. So they're not, you know, many stocks that we like don't pay dividends. But these
00:25:00
Richard Hemming: are dividend focused portfolios and they do, they do perform well. That's the first strategy is look for stocks that aren't too risky, but are stocks that you can get a handle around. And it's nice receiving dividends. It feels good, let me tell you. It feels better than not receiving dividends. And the other point to make is that you are looking to take advantage of what small caps have, which is operating leverage, as we, we mentioned before, which is.
Phil Muscatello: Yeah, that was one of your points. What is operating leverage? What, what does it actually mean?
Richard Hemming: Operating leverage is simply when you've got a smaller equity, uh, base or fixed costs, it's much easier to make returns on that than it is on a big equity base. So if you've got a software company, you know that that investment's fixed. Then if they sell their software to everyone, they don't have to invest anything or much more. So they've got a very good fixed cost base. And so all the revenue growth goes straight down to the bottom line. Whereas you, if you have a retailer, well, they have to invest in goods, they have to invest in inventory, they have to invest in stores. There's a lot of investments. Or even a manufacturer. If you're in a manufacturer, there's a limit to the demand that they can cater for. So operating leverage is simply a, uh, business that has a certain level of fixed costs. And when you get sales growth, that goes to the bottom line.
And I guess a company that I'll talk about in a second, that kind of illustrates that well. And it goes to our point about how we look at stocks, Phil. We look at stocks very much on this basis of, uh. I know it sounds a bit naff. Three bites of the cherry I never get.
Phil Muscatello: I was just gonna, just gonna bring up with the three bites of the.
Richard Hemming: Cherry sounds a bit naff, but that's me. I'm just a dad joke king.
Phil Muscatello: Even though they never thank you for the jokes, do they?
Richard Hemming: They don't really realize why I'm. But three bites of the cherry is very much what we're dealing with at the moment, with a Few of our stocks, like one of our stocks that we were buyers of, kind of like it's, it's really a fallen angel. Like so this, this company's article, atg, it was really trading at much bigger levels but then it got hit quite badly. They do platforms. So they do. They have a platform where you buy and sell T shirts. So they get these army of artists or creatives that create the artwork, create the design and they upload them onto their website. Then people say, oh yeah, I like that design, I want that T shirt. And they click on it and then they get third party supplies to deliver it. So they're, they're basically a really good business in terms of being a platform because you're clipping the ticket, you're clipping the ticket on the buy side and the sell side or on the supplier side. So you know, it's the network effect. They use this spinning reel or something, I don't know, the flywheel, I don't know. They use all this talk. But what it comes down to is the network effect of um, the more people that use it, the more money they make and they don't have to do much extra work. Well, that really worked in Covid. It worked big time because like clearly lots of people had a bit of extra money because it's a mass market product and lots of people had a lot of time. And then post Covid things have changed. So their sales line has gone backwards. But what they've been able to do is cut the costs out of the business and increase their efficiency. So they look at gross profit after marketing cost. Because the big difference between Covid and now is that in Covid you could just rely on, you know, Google search. So if you did something well enough and got the SEO up, people would notice it. Now everything is paid. Uh, advertising, like SEO's gone the wayside with the ChatGPT. Everything's paid. And these guys are adjusting to that new world well. They're adjusting well in their profits. And we saw the company double in share price off its lows from around 15 cents to 30 cents. But now what we need to see is growth. We need to see that. So we got the survival boost. Now what we need to see is that company get re rated from a, uh, PE multiple of 10 to PE multiple of 14 and you're getting a double wear meet. Because if they get that earnings growth, you get the multiple re rating. That stock can go from 30 cents to 60 cents quite easily. Easier said than done. And some stocks that have done that in the past, like.
Phil Muscatello: Sorry, what, Richard? I. I didn't get it. What was the name of that company that does the T shirt?
Richard Hemming: Sorry. It's called article. It's ATG is the code. So that's one stock that we've covered recently and it's done well. But what I'm saying is it's still not out of the woods. So it's got that survival boost, but, uh, that first bite of the cherry. But the second bite of the cherry is if it can
00:30:00
Richard Hemming: sustainably increase its profits. To sustainably increase its profits, Phil, it needs to grow earnings, it needs to grow sales. Because we were talking about before about sales and earnings. Well, if. And fixed costs. Well, if those sales growth and that earnings improvement, that earnings margin improvement drops down to the bottom line and you get the leverage effect. So it comes back to what we were talking about before, the operating leverage. So that's what you're getting. And if you get that, you can make a lot of money with this company. But it's, you know, this is the key quarter. So let's see how it goes. Like we had a buy on it before, you know, high conviction buy. We've downgraded to hold.
It's very much, you know, in the balance. But we've seen this happen before. And then if they can keep doing that, if they can keep getting that earnings growth, if they, you know, if their model keeps is good enough and their demand for their product is good enough that they keep getting earnings growth, one day they can get that third bite of the cherry. Do you know what that third bite of the cherry is, Phil? Yeah.
Phil Muscatello: Ah, you gave me your notes. I know what it is. So please. Yeah, that's right. Airlifted into an index.
Richard Hemming: So you get that ETF factor that we talked about up the top of the show, the passive funds, they're forced to buy it. So we've seen that happen with Northern Star, the mining company. We've seen that happen with Gentrack. We've seen that happen with Nick Scarley. We've seen that happen a number of times. We saw it happen with Austal recently, the shipbuilder. So once that happens, then a whole new class of investors, they're forced to buy the stock. They are forced to buy the stock. So that's how you beat the indices. And I understand that that doesn't happen all the time, clearly. But what happens more often than that is that stocks get taken over. And they get taken over because of the same qualities that we like corporates like, so we see that happen. One in five of the stocks that we've covered gets taken over. And in the dividend portfolios it's more often than that. And that's because there's more certainty in dividend paying companies that, you know, corporates like. So this is the benefit you get from owning a number of small caps is that these are companies that are positioned to benefit from these thematics, these takeovers.
Phil Muscatello: Are they takeover targets because they're in similar industries. I talked to a guest recently who talked about companies that aggregate, like the funeral industry for example, where they'll just keep on buying these businesses. Roll ups. Yeah, yeah. Is that part of what you're talking about in terms of acquiring other companies?
Richard Hemming: All those roll ups really work for small unlisted companies where they're their business models based on, okay, we're a listed company. We trade on this multiple. This company has earnings growth or has, makes earnings. But if we put that company into our business, it increases the value for us because it's under our umbrella. That's a different thing to what I'm talking about. I'm talking about corporates, private equity saying we need growth, small caps get growth. We want. You know, growth is hard to come by. We're all seeing that in real time. The economy is difficult, but we've got the balance sheet or the funds. We can buy this company and get growth. As simple as that.
Articore is a good dividend paying stock with good growth potential
Phil Muscatello: Okay, well let's have a look at some of these companies. Nzme, um, three stocks. We could talk about it if we got time for three stocks.
Richard Hemming: Talk about Articore. I talked about what I thought was, I'd talk about a dividend paying stock that's been on our, among our favorites for a while. We've got it on a buy at the moment. Nzme, they own radio, newspapers, digital media, they own a digital property portal kind of like Domain One Roof in New Zealand. So it's very New Zealand centric. And so this is very much a good dividend payer that can produce above average returns over and above the dividend yield. And the dividend yield's about 8%. That's pretty good. And the earnings have been pretty steady over the past three years in spite of New Zealand economy. But the New Zealand economy is starting to improve and this company gets, is among the first beneficiaries. Why is that? Because their customers are among the bigger corporates. Because they're, you know, they're at the top end of the food chain when it comes to advertising. So the biggest companies, you know, they've got the flagship radio stations, the flagship newspapers, flagship digital media, the big corporates. When they start boosting their media spend, this is one of their first ports of call. And so, you know, you're looking at a good dividend yield and you're looking at a stable company that's not priced,
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Richard Hemming: not priced to perfection like the CBA which trades on around 2 to 3% dividend yield. These guys trade on 8% dividend yield.
Phil Muscatello: What about its PE? What's that?
Richard Hemming: I think PE is about 14, 16.
Phil Muscatello: So sort of pretty average, you know, not cheap on that metric.
Richard Hemming: Well, considering it's, you know, it's a dominant player, I think it's pretty cheap for the quality of business. It is. It's not going to be on a going out of business PE like it's on a forecast PE of um, 15 times. So, yeah, you're not going to get your first bite of the cherry being your solvency boost out of this one. No.
Phil Muscatello: So you don't consider the traditional media might be in a long term downtrend, for example?
Richard Hemming: Yeah, it probably is in a long term downtrend. But this doesn't mean this is a great cash flow business. These businesses are making good returns. So you don't necessarily always want to dismiss a company because of its industry. What you want to do is the financial analysis behind whether it can pay the dividend stuff that we talked about. And this is a company, uh, that might not have been looked at by many people, but you can put this in your portfolio and you'll get good dividends and growth potential via the New Zealand economy, which we just talked about. Plus they could potentially sell one roof, which is their digital property.
Phil Muscatello: Uh, like a domain or an REA could come in. Yeah, sort of like take them over. Yeah, yeah.
Richard Hemming: So they're putting it through some sort of strategic review, I think. But, but yeah, I'm not saying, look, I mean you can make money out of companies that aren't in super sexy industries. You've got, you've just got to have your eyes open and this is one of them. This is a good stock to give you dividends and then there's the potential for growth. I don't know how many people would scoff at 8% dividend yields, Phil.
Phil Muscatello: We're not scoffing. We don't scoff on this podcast.
Richard Hemming: Well, that's good. That's good.
So Appen. Tell us about why you like it at the moment
Phil Muscatello: So Appen. Appin's been a technology darling for quite a long time on the asx. Tell us about why you like it at the moment.
Richard Hemming: Well, it's very far from a darling now. I mean, it was at $40. Now it's six.
Phil Muscatello: Maybe, maybe about what, seven or eight years ago. It was a darling.
Richard Hemming: Yeah. Six, six. What is it? Well, I think that's part of the point is it's, it's now 65 cents or something like, uh. I guess the point is that it's a fallen angel. And so you've got a lot of people on the register who have experienced pain. So it's now well below a dollar, having been at $40 a number of years ago. And they lost a big customer, Google, you know, which was about 20% of their income. How do they make money? What's the business model? Well, they have an army of a million contractors or subcontractors that work from home and they review, annotate data, the data used in AI models. So large language models as well as small language models. And I guess the big, the big factor that I like about Appen is that they've been able to maintain their gross margins at around 49%, I think, and they've got growth coming out of China. So the growth coming out of China is really, is really replacing the uncertainty of the US So their business, I think Sustainer, but it's definitely one of those businesses that, that is at the crossroads. But again, they've got a strong balance sheet. They've got US50 million in cash, in net cash. And I think it could go either way still. But it's one of those positions you could have in your portfolio at a small level at 1%, 2%, 3%, see how it goes. But it's definitely an eye in the fire. Like, you know, we saw what happened with articore went from $0.15 to $0.30 quickly. These stocks have no problem on the balance sheet front. Their problem is trying to get sales growth. Articore is in the balance, but it's improved its margins. Appen is in the balance, but it's improved its margins. So there is money, there is money potential to be made.
Phil Muscatello: And so Appen have been able to reduce their costs, have they?
Richard Hemming: Oh yeah, big time. They've reduced their costs, yep. And I guess it's just a question mark, is the sustainability of the Chinese market like this Chinese growth? Because it's about 50, 50 in in terms of its contribution versus the US in terms of revenues. So the market's always a bit nervous when it comes to revenue from China because there's not quite the transparency that there is in other places in the world. But they've certainly done the business. Their operating margins have been maintained. I like the guy up the top of the company. I think he's doing a really good job, and I think it's one that you wouldn't
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Richard Hemming: put too much money in, but one where I think it's a good stock to own as an option on greatness. That's how I refer to it.
Under Radar Report, we focus on small listed companies or small caps
Phil Muscatello: So, Richard, it's been way too long since you've been on the podcast, so remind, uh, listeners about under the Radar Report what you do and how they can find you and get in touch.
Richard Hemming: Well, under the Radar Report, we focus on small listed companies or small caps. We provide portfolios and we do a lot of research of people's companies, so they send their companies in and our analyst team covers them. We also have a blue chip product and we have an education product, so we cover the spectrum. But I guess we're best known for small caps. And I think at the moment, that's the place where you want to be. And undertheradareport.com is our website and we'll put a code for listeners to get them a 10% discount.
Phil Muscatello: Fantastic. Richard Hemming, thank you very much for joining me today.
Richard Hemming: Thanks, Phil.
Phil Musatello: Uh, thanks for listening to Shares for Beginners. You can find more@sharesforbeginners.com if you enjoy listening, please take a moment to rate or review in your podcast player or tell a friend who might want to learn more about investing for their future.
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