Sometimes it can pay to sit up and take notice when an investment fund goes against the grain and buys stocks that everyone else has been selling.
In the case of Philip Matthews-managed Schroder UK Growth, its newly-published financial results explain why the fund has been buying FTSE 100 members Pearson (PSON) and Marks & Spencer (MKS).
Both stocks have disappointed the market at various points in 2016, so why does Schroder think the shares worth buying now?
REGULARLY REAPPRAISE THE INVESTMENT CASE
A good investor should be someone who is willing to listen to both the ‘for’ and ‘against’ argument for a stock. A positive story can turn bad, and vice versa, so you always need to look for reasons to reassess your view on a certain company.
Schroder says current market conditions are ripe for ‘good fundamental stock picking’. It claims there are large valuation variations between shares in the market, offering better opportunities for stock picking skills to be rewarded than has been seen for some time.
Pearson’s share price collapsed in 2015 and a recovery in early 2016 was short lived amid concerns about its prospects in the North American education market. Its share price has recently started to fight back and is now 11.2% up on the year.
However, nearly two fifths of the FTSE 100 has done much better than Pearson and even the index as a whole has outperformed the stock, up 13.8% so far in 2016.
Marks & Spencer has fared much worse; its shares are down 22.2% year to date as its non-food products underperform.
THE BULL CASE FOR PEARSON
‘We initiated a new position in education business Pearson whose shares have lagged as it grapples with structural and cyclical headwinds,’ explains Schroder.
‘Their US textbook sales have suffered due to declining higher-education enrolments, as employment levels recover. At the same time, Pearson has had to deal with an industry in transition from analogue to digital.’
The asset manager believes Pearson has cyclical recovery potential and should also benefit from management-induced self-help measures.
‘In the short term, we believe headwinds in the textbook market will abate. We anticipate continued progress with the analogue-to-digital transition, where digital revenues are growing in double digits,’ it says.
‘The company is making good progress with cost-saving, the balance sheet is strong, while depressed sentiment towards the stock has created a compelling valuation opportunity. Pearson is a global leader in its field and has a long track record of strong cash conversion which is testament to the high quality nature of its earnings streams.
THE BULL CASE FOR MARKS & SPENCER
The retailer’s shares have struggled amid concerns about its clothing and home division. ‘Both have underperformed for a number of years and in the short-term have been further impacted by unseasonable weather,’ explains Schroder.
‘In our opinion there is an opportunity to turn around this division as the new management team drives through self-help initiatives.
‘These are focused on improving price competitiveness and enhancing the customer experience more widely through changes such as simplifying ranges,’ it explains.
Schroder believes Marks & Spencer will also focus on supply-chain efficiencies, including better buying, to improve gross margins relative to peers.
‘In addition, there is a renewed company-wide cost discipline and we expect to see some strategic decisions on the international division. This could lead to a significant improvement in the group's free cash flow generation over the next three years.’
