Each week, a professional investor tells MoneyWeek where he’d put his money now. This week: David Taylor, co-fund manager of the Chelverton Equity Income Fund.
We operate in an area of the market which we believe to be one of the least efficiently priced in the UK – small- and mid-cap income stocks. Our investment universe comprises stocks that tend to be too small for the mainstream income funds and too ‘dull’ for conventional small and mid-cap funds, which – by and large – are seeking growth companies. The long-term relative outperformance of small and mid-cap value stocks is well documented and provides a compelling investment case. We believe that case has been reinforced as the past few years have been undermining the debt-driven earnings-growth model pursued by so many companies prior to the recent market falls.
The banking crisis highlighted the attractions of strong cash flow. The most tangible evidence of this is, arguably, the dividend payout to shareholders. It is very interesting to note the inflation-busting increases we have seen of late from a broad spread of small and midcap stocks as profits recover and confidence picks up. These are fundamentally strong and resilient businesses. More and more boards are coming to recognise that they will be rewarded for increasing dividends in a market that is still essentially short of income after the cuts over the past few years. At the same time more and more funds are looking overseas to diversify their income away from the ‘big five’ payers in the UK market. So it is reassuring to have a solution closer to hand.
A good example of the type of stock that we look for is Braemar Shipping (LSE: BMS). Currently yielding around 6%, with a twice-covered dividend, the company increased its dividend through the recent market turmoil – despite falling earnings. Around two-thirds of its income comes from brokerage. The balance comes from fee-based services, which it has been building through acquisition in the last few years. It is geared to a pick-up in world-trading volumes, is cash-generative and has cash on the balance sheet. Its employees are significant shareholders. We believe that the underlying quality of earnings will be re-rated over the next few years in line with a gradual pick-up in its trading environment.
Our investible universe focuses heavily on UK earnings, and Smiths News (LSE: NWS) is a domestic earner. It distributes newspapers and magazines and has benefited from a recent consolidation in its industry as the number of major players was reduced from three to two. The current p/e is around seven with a yield of just over 7%. The recent interim dividend was increased by 9%. This is a very cash-generative business, which will benefit as growth picks up, newspaper and magazine circulation improve and new titles are launched once more.
Our final choice of company is an internet stock, and an attractive growth story. Moneysupermarket.com (LSE: MONY) is the UK’s leading price comparison site and operates in four main areas – money, travel, insurance and most recently, home services. The company makes money by offering cost-effective customer access to a range of product providers. With gross margins of more than 70% the business is highly cash-generative. The group also has cash on its balance sheet and, as the UK consumer economy picks up, we expect its cash generation to be reflected in dividend increases to shareholders. In the meantime we are being paid a yield of around 5%.