The strong performance of the UK market this year has caused many industry experts to voice concerns over the price investors are paying for stocks. Davies, who runs the Jupiter Undervalued Assets fund, admits that until recent weeks most areas of the market had been overbought, but says that banking group Lloyds, wholesaler Booker Group and travel company Thomas Cook are still undervalued and have significant upside potential.
The manager explains that he splits stocks into three categories – growth, recovery or value – and holds all three types in the fund.
"Basically, undervalued assets fall under a multitude of sins," Davies said. "However, we class them as growth stocks at a reasonable price, or value or recovery names."
"We define growth stocks as companies that can deliver 5 to 6 per cent organic sales growth each year and that growth should be sustainable on a three- to five-year view."
"These companies have pricing power and operating leverage which can turn that 5 to 6 per cent into higher growth."
Davies says that value companies are stocks trading on lower multiples to their usual numbers and recovery names are ones with depressed earnings or businesses that have witnessed a catalyst for change.
Lloyds
Davies says he bought the banking group Lloyds because it fitted into his growth, value and recovery baskets, being an unloved stock and also one that has the potential to deliver good earnings growth as the UK economy recovers.
"Every now and again there are situations where a company has an element of both of our baskets, like the UK banking sector," he said.
"Lloyds’ share price is around 60p at the moment, but we have a target of just over £1, which would be more in line with its historic valuation multiples."
"Last week, the regulators confirmed that Lloyds had sufficient capital buffers so we are at last in sight of profits being returned to shareholders as dividends."
"We have held Lloyds in Jupiter UK Growth since the last rights issue in 2009. Its profits weren’t great at the time and they have had to pay off PPI which meant that the capital build-up wasn’t as fast as we would have liked."
"Fundamentally, we think it should trade on a book value of 1.5 to 2x and with the run we have had it is now closer to 1x."
"However, we are more confident that the UK economy is perking up and are now hoping for increased loan growth, which will help the valuation further," he added.
Shareholders in Lloyds – which is a FTSE 100 listed company – have had a very tough time over the long-term.
According to FE Analytics, investors who have held the stock over 10 years would have lost 37.54 per cent and over five years would have seen losses of 66.97 per cent.
However, that trend has changed in recent times; it has made 132.87 per cent over 12 months while the general index has returned 29.15 per cent.
Performance of stock vs index over 1yr
Source: FE Analytics
Lloyds is the largest individual holding in both the £110m Jupiter Undervalued Assets fund and the £842m Jupiter UK Growth fund, which Davies co-manages with FE Alpha Manager Ian McVeigh.
Our data shows there are 46 other funds in the IMA universe that count Lloyds as a top-10 holding.
These include the likes of FE Alpha Manager Guy de Blonay’s Jupiter Financial Opportunities fund and Sanjeev Shah’s Fidelity Special Situations fund.
Booker Group
Davies says the FTSE 250-listed Booker Group fits into his growth bracket, given the business’s underlying cash-flow.
"One of our other recent purchases is Booker Group," he said.
"Charles Wilson – the company’s chief executive officer – has done a fantastic job."
"Cash and carry had been very out of favour with investors but Booker performed well and has just completed the purchase of Makro, the European wholesaler."
"One of the great things about this company is that it has strong underlying cash-flow, so they don’t need capex [capital expenditure] to grow the business."
"The stock has made good progress, but I think there is still plenty more to come. Wilson owns a good chunk of the company, which aligns his interests with those of the shareholders," he added.
Our data shows that Booker Group’s share price has performed well over five years, up 461.18 per cent.
Performance of stock over 5yrs
Source: FE Analytics
Davies holds 1.25 per cent of his Jupiter UK Growth fund in Booker Group. The company has a market cap of £2bn and features in 12 IMA funds’ top-10 holdings.
These include FE Alpha Manager Giles Hargeave's Marlborough Special Situations fund and Julian Chillingworth’s Rathbone Recovery portfolio.
Chillingworth recently told FE Trustnet that buying Booker Group was the most satisfying investment he has ever made.
Thomas Cook
Davies says the reason he bought Thomas Cook was because the new chief executive officer represented a real catalyst for change.
"Thomas Cook is a classic recovery story," he said.
"Harriet Green took over around nine months ago and has made some really punchy changes to the company and has done a good job of re-structuring the business by cutting costs and addressing the debt on its balance sheet."
"Since then, the share price has rocketed," he added.
Like Lloyds, the FTSE 250-listed Thomas Cook has struggled over the longer term.
Over three and five years, shareholders would have seen double-digit losses while the index performed well – however, that has all changed in recent times.
Our data shows that shares in Thomas Cook have returned 522.92 per cent over six months, compared with 23.01 per cent from the FTSE 250 index.
Performance of stock vs index over 6 months
Source: FE Analytics
There are nine portfolios in the IMA universe that count Thomas Cook as a top-10 holding, one of which is FE Alpha Manager Martin Walker’s Invesco Perpetual UK Aggressive fund.
