Investors should concentrate on finding “gold nuggets” that can maintain returns rather than overly worry about concerns such as Chinese growth and US interest rates, according to Margaret Lawson (pictured). 
The FE Alpha Manager, who runs the five crown-rated SVM UK Growth fund, has adopted this process since the fund’s launch in 2005 and says that it has become more useful than ever given market volatility seen at the start of the year.
“At the beginning of the year people were worried about several things – they were worried about China, about what was happening to rates in the States and what was happening with QE in Europe. You had a confluence of a number of worries and that took people’s focus off of what had done well,” she said.
“In terms of how we’re positioned, we’re trying to find the businesses that can maintain a consistency and a high return on capital employed. We really focus on cash flow as well because, at the end of the day, a stock price is just the discounted stream of the cash that comes back to shareholders.”
“We’re trying to find the companies that can maintain these high returns, grow their business and return cash to shareholders at the same time. There aren’t many businesses that can do all of these things so when you do, it’s like finding a gold nugget.”
As such, Lawson talks through five of the top stocks in her portfolio that she believes have significant growth potential.
Paddy Power Betfair
Irish betting firm Paddy Power hit the headlines after completing a merger with Betfair in February this year. While the stock initially jumped, it has since experienced heightened levels of volatility and has made a loss of 1.81 per cent year-to-date.
Since Paddy Power floated in 2002 though, it has made a total return of 3378.8 per cent and moved from the FTSE 250 index to the FTSE 100 two months ago.
Performance of stock since IPO
Source: FE Analytics
“Betfair is a technology platform, so the cash-flow that the company now generates gets re-invested in the technology and in more products which captures more customers and more cash-flow – it’s a virtuous cycle,” Lawson explained.
“It’s a global company in that it has positions in Australia, Italy and increasingly it will have more positions in the US and the UK. It’s regulated markets – that’s the important thing about it.”
While the manager says that gaming companies are challenged by increasing government taxes surrounding online betting, she adds that the firm has attractive bottom-up characteristics nonetheless.
“The firm doesn’t like debt – it’s all about focusing on returns and handing back capital that isn’t required for the business, that’s the beauty of it,” she said.
St James’s Place
Wealth management firm St James’s Place is headquartered in Cirencester and has 20 offices across the UK. Like Paddy Power Betfair, it resides in SVM UK Growth’s ‘core’ bucket as a stock that has the ability to grow consistently over the long term.
“Obviously with the Budget changes, people are looking for more information and guidance. You want businesses that are sticky, that hold customers. With things like financial services, there isn’t an awful lot of competition out there,” the manager said.
“What’s happened as a result of the global crash is that people of a certain age have been able to pay off their mortgages because interest rates are low. There’s a lot of wealth out there and people need to know how to manage it for their own pensions.”
Lawson says that people have a choice between cheaper and more expensive models and argues that those with money to look after are likely to opt for the higher-priced firm for peace of mind.
“People want to have confidence in a brand name because it’s their assets and if they get a decent experience, they’re not going anywhere,” she continued.
“On the whole people don’t want change, so I think that’s a very good franchise, although it can be volatile with the stock market.”
The stock, which had its IPO back in 1995, has outperformed the FTSE 100 index over one, three, five and 10 years although it has underperformed over recent months. Its strongest performance has been over the last five years as it has outperformed the index more than four times over with a total return of 200.25 per cent.
Performance of stock vs index over 5yrs
Source: FE Analytics
DCC
Investment group and holding company DCC is a FTSE 100 stock with a market cap of £5.4bn. The firm focuses on four market sectors – healthcare, technology, energy and environmental companies.
“DCC is a low-margin, low-growth business and it’s a consolidator, particularly of energy distribution,” Lawson explained.
“DCC has been doing this since 2000. It first bought distribution assets in the UK from BP, then in 2009 it bought distribution assets in Denmark from Shell and then it has recently just bought Butagaz, which is the number two LNG producer in France.”
“It’s moved from a UK focus to a European focus and it’s probably now looking to have a global focus.”
The manager says the business has been characterised by its low-leveraged high returns on the capital that has been deployed. “It’s all about operational efficiency, which is something this firm has,” she added.
DCC, which has outperformed the FTSE 100 by more than 10 times over the last five years, has a P/E ratio of 35.2 per cent and yields 1.47 per cent.
Performance of stock vs index over 5yrs
Source: FE Analytics
Petrofac
In order to play the gradually rising price of oil without exposing the fund to balance sheet risk (SVM UK Growth holds less than a tenth of the oil weighting of the FTSE All Share), Lawson says a good way to retain some exposure to the sector is through oil services firms.
The manager currently holds oilfield services provider Petrofac, which has a market cap of £2.9bn and is headquartered in central London.
While the stock has underperformed the FTSE 250 by 95.14 percentage points over five years with a loss of 31.9 per cent, Lawson says the company’s performance is likely to improve over the longer term.
Performance of stock vs index over 5yrs
Source: FE Analytics
“A few years ago it tried to diversify its business and capture more of the development side. What it found was that was that it should focus on its core competency – it had overrun some projects and it really shouldn’t have been in that business whatsoever,” she explained.
“The firm is now retrenching. The only thing the big oil companies can continue to do is cut costs and that’s going to go on for another year, so margins are going to remain under pressure over the short term.”
“What you’re going to see probably is an improvement in technology – there will be new ways to do things. This industry doesn’t go away but it has to change its mode of operation until things return to equilibrium.”
Ryanair
Ryanair is the third largest holding within SVM UK Growth’s ‘core’ bucket. Lawson says that the Dublin-based airline – which is headed up by Michael O’Leary – has a good self-help dynamic and therefore has further scope for high levels of growth.
“You might say that the low-cost airline story has been going on forever, but the beauty of Ryanair is that it’s the lowest cost operator out of all the low-cost airlines. Its costs of operations are 50 per cent lower than its nearest rival,” she said.
“What they did two years ago was release a new campaign called ‘always getting better’. Ryanair really didn’t have very good customer experience – it didn’t have a very good brand name. It was cheap and cheerful and it went to places you didn’t really want to go.”
“What people didn’t understand about this business was it was a very well-invested business. It has the most efficient fleet of aircrafts and it was all about working the assets of the business.”
“What it decided to do was focus itself on primary airports. 12 per cent of its business is currently in prime airports and it’s now focusing on business customers, quicker routes, greater frequency of flights, better customer experience, and it’s done that through technology.”
Lawson says the revenue per seat on Ryanair flights is currently half that of its average competitors and she points out that there is still room for the business to improve and grow its revenue.
“Obviously it’s cyclical and you can have internal or external shocks – oil price, terrorism, and they’re very capital-intensive. But we’re still at the beginning of the opportunity for Ryanair so I think, even though it’s a cyclical stock, it’s going to be a structural winner.”
