26th January 2018 by Darius McDermott
We all like to pick up a bargain and investments are no different. But with global stock markets around the world posting new highs on an almost daily basis, and stocks just getting more and more expensive (a bit like the last garment on the clothes shop rail in January), only the horrendously out-of-fashion investment opportunities look to be attractively-priced today.
Is it worth taking the risk on the stocks no-one else wants though? How can you tell if a cheap stock is just going to get cheaper? In the wake of the collapse of Carillion last week, we take a look at some warning signs to heed and some fund managers we think do ‘value investing’ well.
When it comes to researching an individual stock, careful scrutiny of the balance sheet is crucial. Forget what the company is telling you about profits – or adjusted profits (those that should appear in the future) and take a look at the cash flow statement. Is it positive? Is the company generating enough cash to cover its debt repayments?
Talking of debts, is it good or bad? Sometimes it can be a good thing: if the company is reinvesting in the business and can cover their debt repayments, for example. But if the company’s debts are rising for no good reason, and there isn’t enough in the bank to pay the creditors, you should be concerned. If its pension is also in deficit it is another red flag.
Profit margins can also be a useful tool. A company with a healthy margin, well into high double digits, has a cushion should things start to go wrong. A small margin on the other hand leaves little room for error.
Another sign can be a high dividend yield. While it can look attractive in the first instance, is it sustainable? The dividend tends to be the first thing that gets cut when a company gets into trouble.
The fund managers we talk to also say that conservative guidance from CEOs is preferable to over-confidence: it’s good to see a company managing expectations and being positive but realistic when talking about the outlook. Overexcitement or over-optimism leaves too much room for disappointment.
Value fund managers
You can make a lot of money from companies that look to be in trouble but eventually turn things around. However, you have to know the company and do your research. That’s why we prefer to leave the stock-picking to the professionals.
Here are four fund managers who spend all year looking at the cut-price gems they think will undergo a reversal of fortunes.
Alastair is one of the best-known value managers within the UK investment industry and boasts a deep-value, bottom-up approach to stock selection which focuses on unloved large-caps with strong balance sheets. He describes his approach to stock selection as “looking in other people’s dustbins” for value opportunities and will typically hold these companies for four-to-five years to maximise their recovery potential.
2. Ben Whitmore, Jupiter UK Special Situations
Managed with a distinct contrarian and value-based approach, this fund offers investors access to a reasonably diversified portfolio of large and mid-cap UK stocks. Ben is hugely experienced and has had considerable success running this type of mandate. He follows a methodical and well-defined investment philosophy looking to buy stocks that are out-of-fashion with the market.
3. Hugh Sergeant, R&M UK Equity Long Term Recovery
Finding undervalued companies that are yet to deliver on their potential is the aim of this fund. Hugh uses his three decades of investing experience to identify companies where he believes management have the capability to turn things around. He will also add to his holdings at almost fire-sale prices in volatile times, which further increases the possibility of long-term capital appreciation.
4. Nick Kirrage and Kevin Murphy, Schroder Income
This is a deep value-driven fund that invests in companies valued at less than their ‘true’ worth and waiting for a correction. It has little correlation with other income funds, tending to avoid the big income producers in favour of more niche names, where both capital as well as income can grow significantly.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.