2007 is set to be the year of the large cap – or so the New Year research hitting my desk suggests. Mid caps again outperformed their larger peers in 2006, but we’re not convinced that this automatically means the FTSE 100 is now more attractive. A prospective mean p/e ratio of 12 for the blue-chip index looks compelling, but this is distorted by the heavy weighting of lowly valued mega caps. If you take out the largest 15 stocks (accounting for around 50% of the FTSE All-Share’s market cap), then the FTSE 100 trades on a p/e of 14. This does not look out of line compared with a p/e of 15 for the faster-growing FTSE 250.
At Bramdean Equity Managers, we invest in shares across the FTSE 350. We take a bottom-up approach (looking at individual stocks rather than macroeconomic trends) and invest with strong conviction, holding a maximum of 30 stocks and evaluating mega caps on the same basis as mid caps; index weightings do not influence our stock choices.
So are mega caps cheap? Support from dividend yields limits the downside in many cases, but that doesn’t mean the firms offer good value. Many are struggling to grow, justifying lower ratings. The oil sector, dominated by BP and Shell, is one example. The share-price performance of these majors has been dire, and prospects remain uninspiring. Sluggish growth and rising costs are keeping returns under pressure. We see far more value in mid-cap oil firm Venture Production (VPC), which exploits assets that are uneconomic for the majors. Venture trades at a 30% valuation discount to BP and Shell, despite faster growth and superior execution.
The cheapest stock we hold is mid-cap insurer Catlin (CGL). After its recent merger with Wellington, Catlin is now the largest syndicate in the Lloyds market. The deal brings many benefits, most significantly scale in the US. But despite substantially improved earnings per share and greater diversification, the stock has not been re-rated as it should and remains one of the cheapest in the FTSE 350.
One of our largest holdings is Carphone Warehouse (CPW). Negative news flow has affected the group. However, neither Vodafone’s withdrawal of new contract connections – motivated by an attempt to restore its own profitability – nor teething troubles relating to the higher-than-expected popularity of its broadband offer derail the investment case. This is an exceptional growth opportunity on a highly attractive valuation.
We particularly favour ‘Growth At A Reasonable Price’ stocks and one of our favourites is Next (NXT). Current trading often dictates the performance of retail shares, but, as Sir Philip Green saw when he bid for Marks & Spencer, franchise potential is far more significant. Underspaced and undergeared, Next is substantially undervalued and we are confident that looking beyond choppy short-term trading will generate an excellent investment return.
We continue to find many compelling investment ideas across the market. The gap in valuations between fast- and slow-growth stocks is very tight, presenting us with great opportunities. Our Specialist UK Equity Fund holds both mega caps and mid caps, cyclicals and defensives. Overall, we think 2007 will be the year of the stockpicker.
The stocks Andrew Green likes
12mth high 12mth low Now
Venture Production 917.5p 566p 757.5p
Catlin 528p 400p 496p
Carphone Warehouse 370p 247.3p 324p
Next 1,984p 1,588p 1,935p