Each week, a professional investor tells MoneyWeek where he’d put his money now. This week: Alex Wright, portfolio manager, Fidelity Special Values.
Our aim is to invest in value stocks with downside protection and unrecognised potential for change. This typically means investing in companies that have already underperformed and where there is little or no value ascribed to any recovery potential. The companies I invest in tend to have very low valuations, or a balance sheet “moat” that should stop their share prices falling below a certain level (for example, high inventory and cash levels, intellectual property, etc).
By building a portfolio of stocks that are in different stages of recovery, the aim is to deliver outperformance across different market environments. Several types of events could significantly improve a company’s earning power but may not be reflected in the current share price – for example, changes in the company’s competitors or market, a new product line or an expansion into new business areas.
There’s currently a good supply of investment ideas across companies of all sizes and a range of sectors. However, with average valuations slightly lower among smaller companies, I continue to hold significant positions in this area. Financials stand out as unloved in the UK, with many investors highly sceptical of banks. But the consensus ignores the change in many banks’ corporate cultures and business models, which are becoming less risky and more focused on generating sensible cash returns.
Among small caps, my positions are much more stock-specific, tied to individual instances of change at industry or company level. Take UK car dealerships – these are poised to benefit from improved profit margins as rising new car sales boost demand for the lucrative after-sales support services they provide.
Companies I like include Lloyds Banking Group (LSE: LLOY). Today’s share price does not reflect the ongoing shift in the company, from being a high-risk business to a much less risky one. Lloyds now has an attractive, dominant position in the consolidated UK retail market.
So it offers exposure to an economy on the way to recovery. It will also have the ability to pay higher dividends in time. As the bank’s fundamentals began to improve, it started paying dividends again, signalling its return to growth, and attracting new income investors. Our analysis suggests the stock could yield 6% in 18 months, a level of income growth that is scarce among large companies.
HomeServe (LSE: HSV) sells insurance against boiler breakdowns, and is making good progress in what could prove a very profitable international expansion. The company offers a mix of accelerating growth, a high dividend and very strong cash generation. There are very few companies in this industry growing revenues organically at 10%, with very little macro risk, while converting close to 100% of profits into cash. These relatively low-risk growth opportunities combined with a capital-light business model mean shareholders could see significant returns of capital over time.
UDG Healthcare (LSE: UDG) operates in the stable healthcare industry, providing supply chain, distribution and marketing services. The strong, cash-generative company should benefit from healthcare firms shifting towards outsourcing their non-core, fixed-cost activities – the market hasn’t appreciated this opportunity sufficiently. In order to profit from this shift, UDG is boosting its market share by adding complementary businesses, boosting its top line and earnings.