What do you look for in stocks for the portfolio?
“We look for three things in a company. We look at the fundamentals, the valuation and the thematic side of it. So on the fundamentals, we’re trying to assess how good a business is it. How strong is its competitive position, how good is the management, how does its finances look on the balance sheet and so on.”
“In terms of the valuation – how cheap is the company? How does it compare to other companies we can buy? How good is the dividend yield and how strong is the cashflow?”
“And thirdly in terms of thematically, what’s going to change? Because we live in a dynamic world so clearly we can’t just look at where we are historically, we’ve got to think where is the business going in the future, where is that industry in its own cycle. And most importantly perhaps, in terms of themes, what structural influences are there on the company. How is the business potentially threatened, for example, by the internet coming in to their area. Or potentially how is it benefitting from demographic changes or other structural changes.”
“So we try and bring those three together: the fundamentals, the valuation and the thematic to build a good picture of the company and how attractive it is.”
How do you avoid ‘value traps’?
“I think the most important thing is companies that look cheap but are cheap for a good reason, where there’s a structural pressure. So in the last few years a number of media businesses have suffered because of the internet. Classically newspaper companies have found life very difficult as news has gone online. That’s the kind of company where we have to be very careful not to fall into a value trap. Those structural challenges are probably the biggest thing we focus on to avoid.”
Where is the best place to find value in the UK market?
“We see value in two main areas at the moment. Some of the very big companies – Royal Dutch Shell, HSBC – have been a bit neglected by the stock market but are very solid, have good cashflows, good dividend yields, and we see those as really good, solid investments for the trust.”
“The second area is sort of the other extreme really, is companies that have issues, short term issues perhaps, recovery situations. Companies where we see, medium to long term are great opportunities but the market is concerned about shorter term problems. That may be the economic cycle, for example, in the construction companies we’re going through the trough of the cycle but we’re confident over time construction will recover.”
“So those type of recovery situations we think are interesting because the market is not pricing in the full medium term recovery that we see coming.”
Which asset class offers the best value?
“I think compared to bonds equities do look good value because bond yields, government bond yields in the UK, 2.5 per cent on 10 year, equities yield 3.5 per cent. So you get a 1 per cent higher dividend yield and you get hopefully real dividend growth, real growth over the long term whereas in bonds the best you’re going to make is your 2.5 per cent over 10 years, but clearly you get your money back in the end.”
“So we don’t’ find bonds particularly attractive. Equities do look better. The issue for equities is whether they’re cheap in absolute terms. There I think it’s less clear cut. Valuations are in the middle of the range. The economic outlook is sort of average. It’s improving but it’s not fantastic. So we think equities offer some value but it’s very specific. We can find a number of companies we want to buy and want to own but there’s quite a few we don’t want to own at this price.”
What is the objective of the Merchants Trust?
“The objectives of Merchants Trust are to deliver a high and rising dividend yield, income and capital growth over the long term. The dividend has been increased every year for 32 years in a row and so paying a high and rising dividend is a major priority for the board. We have an independent board of directors who represent shareholders and clearly they are there to ensure the trust is well positioned to deliver that.”
