Skip to the content

Alex Wright: The most interesting stock in my portfolio

01 May 2018

The manager of the Fidelity Special Values trust says the market has mis-read the structural transformation in this dominant firm.

By Anthony Luzio,

Editor, Trustnet Magazine

Pearson is a stock that has been through the wringer of late. The educational publishing company fell by more than 50 per cent between its 2015 peak and 2017 low on a series of profit warnings and the volatility has continued into this year on concerns over its US business.

Performance of stock over 3yrs

Source: FE Analytics

However, FE Alpha Manager Alex Wright (pictured) of the Fidelity Special Values trust described Pearson as “the most interesting stock in his portfolio” and has made it his largest “Stage 1” position at 3.3 per cent.

Wright divides the stocks in his trust into three categories based on where they are in their recovery cycle: Stage 1 comprises out of favour companies in which he has identified a catalyst for change; Stage 2 is where the turnaround thesis starts to come through, the company starts to outperform and the position becomes bigger; and Stage 3 companies are those in which sentiment is so positive that valuation no longer offers significant upside, leading him to sell the position down.

The manager began to build his position in Pearson in April 2017 and bought more in the October quarter after it suffered a further fall. While it is now up 50 per cent from its September low, Wright said the market’s misreading of the stock means there is still a long way to go before it enters Stage 2 or Stage 3.

“Pearson has done badly mainly for cyclical reasons,” the manager explained. “It is extremely unusual in that it is a reverse cyclical so when the economy does well, demand for its services falls.

“This is because in the US at the heart of its secondary education business are more vocational two-year college degrees and the demand for those varies dramatically depending on the employment prospects for the US economy.

“So, when the economy was weak through the recession, there was also a lot of stimulus in this area under Barack Obama and it had an incredibly strong period. Since then the US economy has really taken off and unemployment has fallen, so that’s been incredibly bad for enrolments.”

The other major issue at Pearson is the shift from physical publishing to digital.

While it has a number of successful digital-only businesses, the key higher education division which accounts for 40 per cent of profits is now split 50/50 between digital and physical publishing. Wright said supporting these two infrastructures creates problems.


“You’ve got all the old costs of selling and distributing textbooks to traditional customers as well as all the costs of running a large digital platform which were historically integrated,” he continued.

“So, as you have seen volumes fall in line with college enrolments, you’ve got all that investment cost and that is very negative for profits.”

The trend towards digital publishing has presented other problems – by removing the need to print and distribute thousands of textbooks, this has lowered barriers to entry and opened up the market to new competitors.

This also led to a growth in take-up of “open educational resources” – endowments and charities have opened up much of their content for free, which could then be delivered to universities and colleges.

There has been much talk of how these factors would displace Pearson from its dominant position, contributing to the drop in sentiment towards the firm – it went from being buy-rated by 70 per cent of analysts in 2015 to only 20 per cent in 2017 and from trading on 17x forward earnings to 11x over the same period.

However, Wright said this is what has created the buying opportunity, adding that the threat from open educational resources in particular has been overblown.

“These have been adopted by a couple of universities, but if anything what is actually happening is they are moving away from that,” he explained.

“Every three years the curriculum tends to change and Pearson updates its teaching methods.

“The problem with the open educational resources is that while there was some high-quality content released initially, because it was given away for free, there is no desire to update that, improve it or help the professors.

“So either the professors have had to do a lot of work around that themselves or universities have had to spend money on updating those resources – or actually professors have just dumped them and gone back to Pearson so that part of the market which was seen as a big threat has really gone away.”

Aside from this threat, Wright said that although the shift to digital has increased costs and harmed profits in the short term, it should be positive for the company in the long-run.

For example, he pointed out that with a fixed cost of setting up a global learning platform, Pearson’s dominant position will let it amortise that faster than its peers, allowing it to offer a better service.

“While a textbook is pretty much a textbook, the richness of its platform is quite a bit better and will be even better as it rolls out the new global learning resource in 2018/2019,” he continued.

“It has about 60 per cent digital market share and as the market becomes more digital – it is likely to reach 80 per cent digital in 2020 compared with 50 per cent in 2017 – that should naturally increase its market share. And with the US pretty much at full employment, the market is also likely to grow.”


Wright said the quality of the business is also dramatically improving.

“Before you would sell the textbook as a one-off sale and there were a lot of middle men in that process, with printing costs, distribution costs and the margin for the independent book shop.”

“Now the university bundles the cost of the coursework in with the programme, so you get 100 per cent compliance with everyone paying for it rather than some people sharing or renting the textbooks or getting second-hand ones.

“Then you cut out the middle man so again you get a bigger margin even though you offer a lower cost to the student.

“It’s a win-win, it’s very much a Spotify or a Netflix access model, not an ownership model which is much preferred. This makes it not just better for the students but also much more predictable for Pearson and so the quality of the business will be seen as much higher going forward.”

Data from FE Analytics shows Fidelity Special Values has made 182.02 per cent since Wright joined in September 2012, compared with gains of 95.32 per cent from its IT UK All Companies sector and 69.53 per cent from its FTSE All Share benchmark.

Performance of trust vs sector and index over manager tenure

Source: FE Analytics

It has an ongoing charges figure of 1.07 per cent and is on a discount of 1.26 per cent compared with 3.73 and 4.55 per cent from its one- and three-year averages. The trust is 7 per cent geared.

Editor's Picks

Loading...

Videos from BNY Mellon Investment Management

Loading...

Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.