Next, Reckitt Benckiser and BAT are among a selection of stocks the market is wrong to be believe are overpriced relative to their longer term income potential, according to Jeremy Lang, manager of the Ardevora UK Equity Income fund, who believes their income performance will drive up their share prices.
The manager (pictured) of the £240m fund strikes a bearish tone by warning of value traps in the battered blue chip names in energy, mining, supermarkets and banking. 
“For the remainder of 2015, choosing to not own certain stocks will be at least as important as the choice of what to own. The management of these companies still look to be in denial, so for the investment horizon we operate on, these are best avoided,” he said.
However, he adds that pockets of value still remain.
The manager takes a relatively unique approach to UK equites which is based around cognitive psychology and the belief that people in financial markets – be it company management teams, analysts or investors – are prone to making predictable mistakes, errors of judgement or biases.
This has strategy has meant his Ardevora UK Income fund has been a top quartile performer in the IA UK Equity Income sector since its launch in January 2011 with returns of 73.67 per cent, beating its average peer by 20 percentage points.
Here, Lang reveals five UK stocks he currently holds which he believes are set to surprise on the upside.
Next
Lang likes this high street retailer which has seen a huge re-rating over the past decade thanks partly to growth in its online business, as he says a prudent financial strategy has been adopted since the firm almost went bust in the early 1990s.
Performance of stocks and index over 10 years
Source: FE Analytics
“We are attracted to Next as it has a long, consistent record of generating free cash flow, while still driving above average sales growth. This suggests management is careful and patient, investing to allow sustained growth without taking unnecessary risks,” he said.
“In the last two years, the business has kept delivering in a powerful, yet unfussy way. Results have consistently been a bit better than expected. This good operational performance has been underpinned by continued capital discipline: excess cash has been used to buy back shares or pay special dividends.
“Investors view Next as being run in the same risky way as your average fashion-sensitive retailer. Going forward, management is likely to continue to be pragmatic and cautious, despite the success of recent years. We expect analysts will continue to be caught out and investors be well rewarded.
Reckitt Benckiser
The recent spin-off of Reckitt Benckiser’s pharmaceutical business – Indivior – has boosted the multi-national consumer goods firm’s potenital value as well as creating a mis-pricing in its current share price, Lang says.
“Some analysts have argued it is a dead duck, others that it is a beauty. From experience, those businesses harbouring a quantitatively small source of high anxiety often get mispriced.”
“Since the spin-off, Reckitt has lost its anxiety anchor and its stock price has ascended fairly effortlessly. Now it can be viewed like any other good quality and resilient business that offers a little growth: boring. But boring is good.”
“The new Reckitt will continue to be rewarding, because analysts and investors will underappreciate the rarity of such businesses. However, at least investors will not have to put up with the prior stock price wobbles associated with anxiety over patent issues inside Indivior.”
British American Tobacco
Lang says that an incorrect, but widespread belief, that smoking is being broadly stubbed out over the longer term by a mixture of increasingly “draconian” set regulations and changes in taste and fashion means the core strength of this stalwart income stock is misunderstood.
“It has a good exposure to emerging markets, a good record on cost cutting, is a successful product innovator, has a strong balance sheet and is regarded as having excellent management.”
“Since 2000, the business has delivered steady growth in earnings and dividends. Shareholders have been well rewarded. No matter how unpalatable the product the company peddles, it is regarded as a good company.”
“Looking forward, it is easy to believe the glory days are over. The percentage of smokers around the world continues to gently decline – but this is offset by a still growing global population – and regulation gets ever more draconian. Analysts tend to worry about price wars and the damaging effect this has on industry profitability.”
He adds that the negative perception of tobacco investing means no-one else wants to own it, while regulation is not materially lowering the number of people smoking.
“We believe this company will continue to benefit from this benign environment and analysts are likely to continue to underestimate the profitability of the business.”
Whitbread
The two core revenue streams of this this Whitbread - Premier Inn and Costa Coffee – are deeply over-thought by most analysts, Lang says, who struggle to believe the simplicity of the business.
“They appear overconfident in their understanding, and because there is no new ‘story’ they undervalue and underappreciate the true strength of a business like this – its durability and sustainability.”
“To our eyes this is a low risk business and a low risk stock; but low risk does not mean low return. It is enjoying an unusually benign environment.”
Performance of stock and index over 10yrs
Source: FE Analytics
The stock is one of the best performing large cap since the market bottomed out, post financial crisis, in 2009 with a return to investors over more than 600 per cent.
Micro Focus International
Lang says despite being a tech stock, which some have warned against due to the sector’s bull run in recent years, Micro Focus International is a “steady plodder”.
“It does not do anything flashy. It produces tools to help programmers deal with enormous amounts of legacy computer code embedded in the IT systems of big companies. It is a good, but somewhat dull business.”
“We were attracted to Micro Focus as we felt management behaviour had changed following an unsuccessful growth period from 2007 to 2011. A series of acquisitions did not work out well and investors headed for the exit.
“In September the company announced a large acquisition, which initially made us feel nervous. On closer inspection, it seemed like it might be a rare example of an acquisition making sense.”
“Micro Focus is buying an American company called Attachmate, a similar business of similar size. The assets acquired are of mixed quality, but the Micro Focus management have a good track record in running unexciting software in an efficient way.”
He adds that the shares have responded well to the news, but that there is more to come.
“Going forward, the business remains as dull as ever, just bigger. We expect more gentle plodding, and surprisingly good returns.”