In small-caps, look for dividend payers

Small companies have long presented opportunities for growth but a lack of research coverage. Australian investors may be familiar with the S&P/ASX Small Ordinaries Index (“Small Ords”) and information and analysis of many of the 200 companies in this index is not readily available. This means that many investment opportunities go unnoticed as small companies are often mispriced and in Australia trade in an inefficient market.

To achieve outperformance in Australian small companies it has been either:

1. time-consuming and risky for direct investors; or
2. costly for indirect investors in actively managed small companies funds. 

Enter the VanEck Small Companies Masters ETF (MVS). MVS includes only the most liquid Australian small-cap stocks that did not omit their most recent dividend.

There are compelling economic and theoretical reasons for using dividend paying as the stock filter for small companies including:

• dividends have provided most of the stock market’s total return over time according to Wharton Professor Jeremy Seigel, and by allocating only to dividend-paying stocks Siegel has been able to demonstrate outperformance¹;
• companies with the ability to pay out dividends typically have competitive business models and robust balance sheets with strong cash flows;
• dividends are employed to determine stock values and future earnings;
• dividends are an objective measure;
• paying dividends indicates that the company may be profitable; and
• dividends typically signal the presence of management teams that have a disciplined approach.

Many of the companies excluded from MVS have a negative return on equity (ROE). In other words, they are making a loss rather than making a profit and cannot pay dividends.

The dividend filter also has the effect of excluding companies with the least stable earnings.

By excluding companies based on ROE and earnings stability, the dividend filter excludes what would commonly be referred to as ‘lower quality’ companies. MVS therefore can be considered to have a ‘quality tilt’.

Another distinguishing feature of MVS is its increased exposure to low-volatility stocks as the dividend filter has the effect of excluding many of the higher-volatility stocks such as resource-explorers that litter the Small Ords. Numerous studies have concluded that a portfolio of low-volatility stocks produces higher risk-adjusted returns than a portfolio of high-volatility stocks.

So, let’s walk through the difference between MVS and the Small Ords.

MVS vs S&P/ASX Small Ordinaries Index – Fundamentals

Table 1: Statistics and fundamentals

Source: VanEck, S&P, FactSet, as at 30 November 2023.  You cannot invest directly in an index. The dividend yield is not an indication of future dividends.  

As you would expect, MVS has higher ROE and lower debt to equity than the Small Ords. Interestingly, it also has a lower price to book and price to sales, metrics associated with ‘value’ investing.

MVS vs S&P/ASX Small Ordinaries Index - Top 10 holdings

Below you can see the top 10 companies. The differences are stark – to see all the holdings in MVS and their weightings click here. 

Table 2: Top 10 Holdings MVS	Table 3: S&P/ASX Small Ordinaries Index
Source: Factset, VanEck, as at 30 November 2023	Source: Factset, VanEck, S&P, as at 30 November 2023

MVS vs S&P/ASX Small Ordinaries Index - Sectors

MVS is currently underweight the resources sector by 16.57%, which tends to include non-profitable mining companies, compared to the Small Ords. It is also underweight energy (-6.17%) and health care (-4.59%). Conversely, it is overweight industrials (+11.55%), financials (+9.99%) and real estate by (+8.77%).

Chart 1: MVS and S&P/ASX Small Ordinaries Index sector weightings

Source: Factset, 30 November 2023

MVS and S&P/ASX Small Ordinaries Index- Style

When looking at portfolios it is important to determine what style, e.g. value or growth and what size bias a portfolio holds, e.g. giant, large, mid or small. Below we can see MVS’s. Importantly MVS skews towards smaller-sized companies and it has a greater core/value bias than the Small Ords.

Chart 2 and 3: Holdings-based style map	Chart 3: S&P/ASX Small Ordinaries Index holdings-based style map
Source: Morningstar Direct, as at 30 November 2023

MVS vs S&P/ASX Small Ordinaries Index - Performance

Table 4: Trailing performance to 30 November 2023

* MVS Inception date is 4 May 2015 a copy of the factsheet is here.

Source: Morningstar Direct, VanEck as at 30 November 2023. The chart and table above show past performance of MVS and of the S&P/ASX Small Ordinaries Index. You cannot invest directly in an index. Results are calculated to the last business day of the month and assume immediate reinvestment of distributions. MVS results are net of management fees and other costs incurred in the fund, but before brokerage fees and bid/ask spreads incurred when investors buy/sell on the ASX. Returns for periods longer than one year are annualised. Past performance is not a reliable indicator of future performance. The S&P/ASX Small Ordinaries Index (“Small Ords”) is shown for comparison purposes as it is the widely recognised benchmark used to measure the performance of the 200 ASX-listed companies included in the S&P/ASX 300 but not in the S&P/ASX 100, weighted by market capitalisation. MVS’s index measures the performance of a portfolio of dividend paying small-cap companies, with a maximum weighting of 8%. It has fewer securities and different industry allocations than the Small Ords. ‘Click here for more details’. Click here for more details.

While different small company approaches can be considered for portfolio inclusion, you should assess all the risks and consider your investment objectives.

Past performance is no guarantee of future performance. The above is not a recommendation. Please speak to your financial adviser or stock broker.