Investors should prioritise cash generation and look for hidden catalysts in stocks to benefit over the long term, according to SVM’s Margaret Lawson (pictured), who has built up some of her sector’s best performance numbers on the back of investing in unloved companies.
The FE Alpha Manager, whose SVM UK Growth fund ranks ninth out of 275 funds in the UK All Companies sector for 10-year performance, believes that not understanding the underlying dynamics of a company is where investors often fall down.
As such, she chooses stocks across varying market caps, from large sustainable growth businesses and cyclical stocks to ‘special situation’ companies which she believes to be valuation anomalies. 
She attributes the fund’s stellar performance to this bottom-up approach. SVM UK Growth has achieved a top-decile return of 213.82 per cent over 10 years, outperforming its average peer and its FTSE All Share benchmark by a significant margin.
Performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
However, there are some surprising stock picks that investors may not expect to find in the £110m fund.
A choice that may seem unusual in a growth fund is Whitbread, the FTSE 100 multinational company that owns Costa Coffee, Premier Inn and Beefeater Grill among other popular hospitality chains.
“A lot of investors tell me that there’s nothing left to do with Costa Coffee now and that it’s mature. They’ll point out the huge number of Costas on high streets and will do the same with Premier Inns,” Lawson admitted.
“But what we found was, with Premier Inn growing its brand while other chains were not investing in theirs, it was taking market share away from all the independents.”
“After the recession, people’s attitudes became much more conservative in that they would rather go somewhere and know that for £69 the standard they were getting was good, clean and functional rather than some private hotel that couldn’t get banking finance. Travel Lodge, its competitor, was more concerned about paying back its debt than pumping money into growing the business.”
The FE Alpha Manager also drew attention to Premier Inn’s new high tech ‘Hub’ hotels, which revolve around an app that customers use to check in, order breakfast, dim the lights and change the temperature of their room.
The first Hub was opened at the end of last year in Covent Garden and there are plans for 11 more to open in London and Edinburgh hotspots over the next three years.
“It’s a lower-cost Premier Inn but it’s much smaller, because often the big problem is getting property,” Lawson explained.
“What they can find is a lot of office blocks. Obviously the rooms are much smaller but they’re designed in a way that you have everything you want, so they’re creating a new brand.”
Whitbread is also trialling Premier Inns in Germany, with the hope that it can open between 12 and 15 hotels there in the near future.
Similarly, Lawson says Costa has scope to become international, with prospects in Asia said to be very good. Even in the UK, the manager says there is still room for more Costas on Britain’s high streets.
“[Whitbread management] came up to see us last week and they were showing us a map of where they have Costas in Bedford. What they want to do is put a Costa in every direction where you’re going to your work, going to the supermarket, etc, so you might think it’s saturated but it’s clearly not.”
However, at the end of last month, the group’s share price plummeted by 4.2 per cent in 24 hours following the announcement of chief executive Andy Harrison is to leave Whitbread and join homeware retailer Dunelm as chairman.
The stock has failed to outperform the FTSE 100 benchmark over a three-month period, which is why Lawson believes that now is the right time to invest.
Performance of stock vs FTSE 100 over 3months
Source: FE Analytics
“He’s left the business in good shape and it’s not as though he suddenly decided he was going to leave yesterday,” she pointed out. “Obviously the board will have been looking for someone to replace him, so it’s probably quite a good time to be looking to buy Whitbread.”
As well as growth stocks, Lawson holds a number of companies in her portfolio that she refers to as ‘alpha kickers’, which she picks based on special situations, management turnaround or valuation anomalies skewing performance.
One of these stocks is Trinity Mirror, which publishes 240 regional papers as well as nationals including the Daily Mirror, the Sunday Mirror, People, Sunday Mail and the Daily Record.
“You might think ‘oh god that’s really awful’, but the point is about Trinity Mirror is that it really generates cash. All those court cases are out of the way and the pension deficit looks as though it’s going to be managed, it’s growing its online business as well. It’s got great optionality,” Lawson explained.
Another stock that the manager has invested in but says “needs some TLC” is Synthomer, which was added to SVM’s portfolio recently.
The company, which has its headquarters in Harlow and provides customer services from operational centres in Germany and Malaysia, supplies lattices and speciality emulsion polymers, which can be used for construction, textiles, paper and synthetic latex gloves.
Lawson said: “Its business in Asia is a nitrile business, which is the material used for the gloves.”
“As people get wealthier and food service and hygiene levels increase, the demand for this material is really growing very strongly and there’s a big growing market for it in Asia.”
“But it’s a market that wasn’t particularly mature, so you had a lot of people switching production from Asia to Europe. However, now the market has matured a bit, it’s much more stable.”
The manager says the stock previously lagged behind its FTSE 250 index because, despite high demand for nitrile, production was rife so the material’s value didn’t increase.
However, since the increased maturity in Asia’s market as well as the improvement of the European economy, she believes the business will continue to go from strength to strength.
In fact, over the last three months, Synthomer has outperformed the FTSE 250 by 15.39 percentage points, delivering returns of 34.38 per cent.
Performance of stock vs FTSE 250 over 1yr
Source: FE Analytics
“During the past, it’s always paid progressive dividends, but the money it hasn’t needed to use for investment or takeovers is always returned to shareholders. So I’ve got an interest here because the earnings revisions are starting to get better – people are becoming much more positive about it,” Lawson said.
Another positive trait that the company has, according to the fund manager, is chief executive Calum MacLean, who used to be the financial director of multinational chemical company Ineos.
“We think he’s credible, he’s got a history of deal-making that’s been successful,” Lawson explained.
“What I’m saying is we’ve got an improving business, and you’ve got the catalyst and the catalyst will be that he’ll do deals. That’s what he’ll do from here, so that says to me that this is a stock we should have.”
In contrast, one of the stocks that has been part of SVM UK Growth’s core portfolio for a long time is Ted Baker, the British luxury clothing retail company which is a constituent of the FTSE 250 index.
Lawson said: “We’ve had Ted Baker for a long period of time. When we purchased it, it was £10 and it’s valued at £30 today. A lot of people will say ‘Margaret, a lot of people would have sold that during the crash’. But I think Ted Baker is quite a niche brand – it’s run like a family company in that the chap who controls it, Ray Kelvin, is still involved in the day-to-day running of the company.”
The manager also says that the company has been very successful in growing its brand through social media, which has caused online sales to grow rapidly.
However, in a similar pattern to the fund’s other investments, Lawson believes that the main reason to hold Ted Baker is its opportunities to expand internationally.
“It’s expanding these opportunities through concessions, partnerships and wholesaling, but they’ve now started to put their own stores in the states – they’ve also got very little presence in Europe, they’ve only got about four or five stores in Europe,” she said.
“If you think about brands like Burberry, they’ve got 80 to 100 stores, so you can see there’s a good way to go, so the margin growth is good and the sales density is good as the business matures.”
What’s more, Lawson says that Ted Baker stores are able to successfully sell clothes at their recommended retail price while many high street retail stores resort to regular sales and selling stock at a discount.
“Even in retail and in design they’re not looking to replicate what Next do or anything else – it’s affordable luxury. It’s a bridge between luxury and the high street,” she said.