Four strong British mid-cap stocks to buy now

Each week, a professional investor tells MoneyWeek where he’d put his money now. This week: Jeremy Hall, partner and investment manager, Cartesian Capital Partners LLP.

The FTSE 100’s recent move back towards an all-time peak has perhaps disguised the relative volatility we’ve seen in small and mid-sized stocks. After a strong run (both in absolute terms and relative to large caps), since early 2009 mid-caps have retreated significantly in recent months. Is this a warning of a weakening economy?

There are some valid concerns for investors. The general election next year raises uncertainties, as does the Scottish independence vote. Surging house prices in southeast England are another reminder of the distortions we’ve seen as a result of quantitative easing and low interest rates.

This stimulus will have to normalise (not just in the UK) and the process may start soon. Even so, we believe now is a good time to maintain exposure to the UK economy and, given the recent pullback in small and mid-caps, to add to certain positions.

Since early last year, the message from the companies that we’ve been meeting has been that trading performance for those operating close to home is finally improving, but there remains plenty of potential to grow.

Years of austerity have led to healthy balance-sheet discipline, which suggests that companies have little to fear from rate rises. So we feel it is unlikely that policy decisions will be allowed to damage consumer confidence.

For example, in our view housing markets in most of the UK are not overheating. Prices adjusted for inflation are not at peak levels in most regions, and while higher mortgage rates may hit affordability, mortgage approvals are well off past peaks.

One beneficiary of housing activity is cooker maker Aga Rangemaster (LSE: AGA), which has already reported an encouraging start to 2014. Sales growth is accelerating, and should benefit from rising mortgage approvals and product innovation. We see scope for earnings upgrades. On less than 11 times next year’s earnings, it looks good value.

We should also remember that the UK is more than just one big housing market! Rates may rise, but economic activity, already ahead of many developed markets, will remain strong. Profits will keep growing, which should help dividend growth.

One stock offering significant income and benefiting from the UK recovery is NewRiver Retail (LSE: NRR). This specialist real estate investment trust (Reit) focuses on UK food and value retail. It has a great track record of asset management and development.

It recently bought 202 pubs from Marston’s, which it plans to convert for alternative uses – primarily supermarket convenience stores and restaurants. It did so at a net initial yield of 12.8%, offering lots of scope to generate capital (as prices rise). It trades on a dividend yield of more than 5%.

Similarly well placed is regional property specialist Real Estate Investors (LSE: RLE), which should benefit from its focus on regional UK property, where yields still offer significant opportunities.

Further afield, we like specialist electrical engineer Gooch & Housego (LSE: GHH). This maker of precision optical components has diversified away from a reliance on the ultra-cyclical Q-switch market into aerospace, defence and life sciences, and is enjoying good structural growth from these markets.

Gooch & Housego is also enjoying 12% growth in its order book year on year, and the backdrop is supportive. With a strong balance sheet and acquisition opportunities to boost growth, we see upside to the shares, which trade on 16 times next year’s earnings.

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