Market leadership, margin growth, strong management teams and differentiated products are four of the most important factors when it comes to choosing stocks, according to Paul Marriage (pictured). 
The FE Alpha Manager, who runs the £479m Schroder UK Dynamic Smaller Companies fund alongside fellow FE Alpha Manager John Warren, has entitled this stock selection process ‘P3M’ and it constitutes for approximately 75 per cent of the portfolio weighting at any one time.
The remaining 25 per cent of the fund tends to be invested in value plays, where the managers look for familiar stocks that they believe to be the wrong price on the day.
“P3M is a silver bullet that goes through everything we do and all the good companies seem to be a bit similar based on these fundamentals,” Marriage explained.
“I realised that essentially we invest in companies that have got differentiated products – a really good example of this would be Fever-Tree tonic water which has been a really good investment for us. That’s a differentiated product because it’s a natural, premium, tasty tonic water compared to mass market tonic water. It’s a premium, craft, luxury item.”
“Then we’re looking for market leadership as a niche, so premium tonic is a pretty small niche but Fever-Tree is definitely number one in premium tonic by a country mile so we love that.”
The rocketing performance of Fever-Tree has been well-documented, with the stock outperforming its AIM All Share index by 109 times over the last year with a total return of 150.37 per cent.
Performance of stock vs index over 1yr
Source: FE Analytics
However, Marriage also has holdings smaller, under-the-radar stocks that he expects to deliver exciting growth stories over the coming years. In the article below, he talks through his top three hidden gems to watch:
Quixant
“One of our most exciting names that we’ve been in for about 18 months now is Quixant. It’s a really interesting company, it’s really below the radar. I met the management team about two years ago,” the manager said.
“The management owns a 40 per cent stake in the company which is promising. The product is what’s called a logic box which is basically a computer to you and me.”
“These logic boxes specifically go into gaming machines – all gambling machines have a computer in them and all the excitement is about the lights and the software and the graphics on the front to make you keep playing it, but in the middle there’s the computer.”
Marriage explains that gaming machine manufacturers have historically made the computers themselves, but points out that it’s more logical for a computer specialist to make these components and distribute them.
He adds that this is a particularly niche and specialist market, given the number of regulations surrounding gambling and win rates.
“They’re definitely number one in the world – it’s got massive growth potential,” he continued.
“They also cater for other areas such as self-service terminals – we’ve got the national living wage coming in there’s going to be a lot more demand for that.”
Quixant, which is headquartered outside of Cambridge, also has a US subsidiary which is based in Las Vegas and its own manufacturing operation in Taiwan.
Since the stock floated onto the AIM market in May 2013, it has returned 357.59 per cent compared to the AIM All Share’s return of 1.74 per cent.
Performance of stock vs index since IPO
Source: FE Analytics
Servelec
Another ‘hidden gem’ stock that Marriage particularly likes is Servelec, which has two arms to its business – a health and social care service which designs electronic patient records and administration systems, and an automation service which provides software to blue-chip energy and transport stocks.
“It’s two totally separate businesses under one PLC. It’s like having two P3M businesses together and in the long term they’ll probably split off and there’ll be some value in there,” the manager explained.
“It’s had a really good year this year. Healthcare has performed really strongly. With oil and gas, people are obviously worried because of the low oil price and all of the issues there but they’ve managed that really well.”
“They also have some exciting new products in water, water is a scarce resource as we know and their technology around measuring water is something that I think could be quite exciting.”
Servelec Group was originally founded in 1977 and holds significant intellectual property in terms of software. The £267m stock has provided a total return of 82.93 per cent since it floated in December 2013, compared to its FTSE Small Cap index’s return of 11.15 per cent.
Performance of stock vs index since IPO
Source: FE Analytics
Treatt
“Another hidden gem in what we think is an exciting market is Treatt. Treatt is a natural flavourings business. The core business was predominantly in fruit oils but they have quite a broad range of products now,” Marriage said.
“Five years ago products would have had a lot of artificial colours, sweeteners and flavourings in them and obviously manufacturers want to get rid of these – more and more products are now advertising themselves as being all-natural and these flavourings will often be made by the firm.”
The manager says that the company, which is based in Suffolk, also creates natural fragrances that are used in cosmetics and personal care products such as shampoos and shower gels.
Its cosmetic ingredients division is called Earthoil, which also supplies organic oils and cocoa butter both for direct use and as ingredients in various products.
The firm is £86.4m in size and exports to more than 90 countries from its sites in the UK, the US and Kenya. It also has sales offices located in China and France.
Treatt, which has more than doubled its FTSE Fledging index’s performance over the last five years, has a P/E ratio of 14.36 per cent and a dividend yield of 2.76 per cent.
Performance of stock vs index over 5yrs
Source: FE Analytics
“It’s a really interesting little company – it has a rabbit warren of a factory now and they’re building a whole new factory, a technology centre and I think it has further scope to really grow. It has a good order book and a lot of people haven’t really cottoned onto it,” Marriage said.
