Gervais Williams (pictured), manager of the CF Miton UK Multi Cap Income fund, says that retail investors often miss out because they tend to follow the crowd and only buy equities that already have a good deal of momentum behind them.
"There can be some great companies out there, but they don’t have momentum behind them, so they can be overlooked," he said.
In the next in our series of articles on how to become a better investor, we ask leading fund managers which stocks they are backing that have largely gone unnoticed by the rest of the market.
International Greetings Group
Williams’ first pick is the FTSE AIM-listed International Greetings Group. It is a business that designs, manufactures, imports and distributes gift packaging, stationery and creative play products.
"One company that comes to mind is International Greetings. It is an excellent company and though it does have a bit of debt, it is trading on just five times earnings," he said.
"They make things like wrapping paper, but it focuses on the value end of the market. They also make Tom Smith Crackers, which is a great business as we all buy crackers at Christmas."
"International Greetings is big in the UK, but it is also big in Europe and is growing in the US," Williams added.
Shares in International Greetings have been on a largely downward trend over the past three years. However, Williams says this means it is a great time to buy the stock.
Performance of stock vs index over 3yrs
Source: FE Analytics
"Its share price fell as a result of one of its Australian subsidiaries going into receivership through no fault of its own," he explained. "The effect of that meant the whole group was downgraded and that is why it is disgustingly cheap. The company is also seeing good growth again, which is encouraging."
It is Williams' largest holding in his CF Miton UK Smaller Companies fund, making up 6 per cent of his £10m portfolio. Elite Webb Capital Smaller Companies Income & Growth is the only other fund in the IMA universe to count it as a top-10 holding.
Fairpoint Group
Williams is also a fan of Fairpoint Group, which like International Greetings is listed on the FTSE AIM index.
"Even now, there are certain income stocks that have gone under the radar. Though the income stocks have been well picked over, there are still quite a lot of opportunities. Fairpoint, for instance, still yields more than 5 per cent," Williams said.
"More importantly, however, is that it has grown its dividend by 40 per cent over the last three years."
Shares in Fairpoint have returned close to 50 per cent so far this year. Although Williams expects its performance to be slightly weaker, he is keeping it in his portfolio.
"Fairpoint helps people who have excess personal debt. People can get overstretched if they lose their job or because of a divorce. The company tries to help the individual out by regulating their expenditure."
"If the individual is never going to pay off his or her debt, then they help them enter an IVA (individual voluntary arrangement) with the bank."
"It has cash on the balance sheet and though it sees accelerated growth when times are bad, it is always good to hold a stock that is negatively correlated to the UK economy," he added.
Fairpoint is a top-10 holding in both of Williams’ Multi Cap Income and UK Smaller Companies funds. FE Alpha Manager Giles Hargreave also counts it as a top-10 holding in his Marlborough UK Micro Cap Growth fund.
SQS Quality Software
Julian Chillingworth (pictured) looks for turnaround stories for his Rathbone Recovery fund. Because of that, he is backing SQS Quality Software, a FTSE AIM listed stock.
"SQS Quality Software is now being noticed by the market, but we believe it still offers good value. This company is the leading independent European tester of new software," he said. "Any company installing expensive software will want to test it before sign-off. It can either get its software installer to do this, or it may want independent verification, in which case it will turn to SQS," he added.
SQS’s returns have already been strong this year, as the graph below shows.
Performance of stock year-to-date
Source: FE Analytics
Chillingworth says that as the business becomes stronger, investors shouldn’t underestimate even higher returns in the future.
"In the past, the problem with this business was that it was quite unpredictable, as SQS constantly had expensive German and UK consultants coming off jobs, which it needed to re-deploy. This made forecasting profitability an absolute nightmare, and the shares became lowly rated after numerous profits warnings."
"SQS has since changed its business model, signing customers on long-term managed service contracts, where it carries out all of their software-testing requirements instead of just providing ad hoc testing," he added.
Although Chillingworth is a fan of SQS, Gervais Williams’ CF Miton UK Multi Cap Income fund is the only IMA portfolio to count it as a top-10 holding.
Aviva
Martin Cholwill (pictured), who runs the five crown-rated Royal London UK Equity Income fund, says it is harder to find un-loved stocks in the current market as investors are jumping on any bad news to deploy their capital.
However, he holds the FTSE 100 listed insurance company, Aviva, because although it has had a management change and had to cut its dividend, he expects it to deliver high returns. "Often the sort of thing you need to look for is a management change situation," said Cholwill.
"There is always the element of expectations being re-based downwards which can lead to a detrimental effect on the share price. We saw that with Aviva: the new management had to cut its dividend."
"We were fortunate to meet them and it was clear that the cut wasn’t as severe as some had made out. The share price bottomed out a few months ago and since then has had a good run," he added.
So far this year, investors in Aviva would have seen returns of more than 20 per cent, though the majority of those returns have come over the last six months or so.
Despite Aviva’s recent performance, the manager says he will keep it in his portfolio. The stock’s dividend yield is 3.3 per cent.
There are 26 funds in the IMA universe that hold Aviva in their top 10. Those include popular five crown-rated funds such as Liontrust Special Situations, Cazenove UK Opportunities and Threadneedle UK Equity Income – all of which are run by FE Alpha Managers.
Cobham
Cholwell also rates Cobham, which is a FTSE 250-listed defence company. Although it has rebounded since its share price fall last year, the manager says it is still undervalued by the market.
"We bought Cobham at the tail-end of last year, but the share price has already gone up from £1.80 to £2.80," he explained.
"The management team issued a warning over profits as they were concerned about the US defence industry because of sequestration and lower government spending. However, it had a dividend yield of 4.5 per cent and a growth rate of 10 per cent per annum."
"It was a good example of a company where you may only get a short window in which to buy, as there are some investors out there who will sell at the sign of any bad news," he added.
Performance of stock vs index over 1yr
Source: FE Analytics
As Cholwill pointed out, shares in Cobham have been on an upward trend recently. For instance, investors would have seen returns of 36.19 per cent if they had bought a year ago, which is roughly in line with the returns of the FTSE 250 index.
Cholwill expects Cobham to continue to perform well. Five funds in the IMA universe count it as a top-10 holding.