Each week, a professional investor tells MoneyWeek where he’d put his money now. This week: Charles Luke, manager, Murray Income Trust (LSE: MUT).
We have yet to see a sustained uptick in company earnings growth. But a look at the state of the global economy shows why markets have generated strong returns.
The UK recovery is proving robust, Europe has turned the corner, the US is making steady progress and emerging markets have stabilised after the wobbles of the past year.
When markets are performing well, it’s easy to be complacent. But it’s worth remembering that over the long run, dividends – and their reinvestment – generate the greatest proportion of total returns. And only those companies that can grow their earnings on a sustainable basis can grow their dividends.
Therefore, the way to invest successfully through the economic cycle is to focus on attractively valued companies that offer healthy organic growth, diversified revenues, strong balance sheets and leading positions in their markets, and that provide the ability to deliver long-term earnings and dividend growth. The following three fit the bill.
Ultra Electronics (LSE: ULE) provides high-tech electronic software solutions and products to the defence, security, transport and aerospace industries.
Ultra has an impressive track record driven by the strength of its intellectual property, which is a result of its heavy investment in research and development, and its ability to develop solutions for new markets.
The company has long-term opportunities in the cybersecurity, airport infrastructure and naval energy management sectors, among others. It could also profit from further geographic expansion.
It has a strong balance sheet and an attractive cash-flow profile, yet trades on a modest earnings multiple – the backdrop of muted US defence spending has created a buying opportunity for new investors.
My second choice is Unilever (LSE: ULVR), the consumer goods giant. More than 50% of its sales come from emerging markets. Although – as we have seen more recently – this can mean greater volatility, medium to long-term prospects are excellent, as emerging market consumers’ incomes continue to rise in ‘real’ (after-inflation) terms.
Unilever’s long history in many of these markets means it has developed comprehensive distribution channels, representing a real barrier to entry for potential rivals.
The company also has a range of strong brands, including Lynx, Dove, Knorr and Magnum. There is also the potential to improve margins in its European and North American operations via supply chain improvements and more efficient production.
Where appropriate, Unilever is likely to pursue bolt-on acquisitions and sell selected assets to improve its overall business mix. It has a visionary management team, and appealing financial characteristics, which should deliver attractive earnings and dividend growth.
Compass (LSE: CPG) is a leading global contract caterer. Growth is underpinned by opportunities for further outsourcing in the sector – only about half of this £200bn market is outsourced, and healthcare and education are particularly under-penetrated.
Compass has a tight focus on costs and should be able gradually to raise margins via greater efficiency and better operating leverage.
Over time it is growing its presence in emerging markets and underlying growth in these regions is helping. The cash-generative nature of the business has allowed the company to return cash to shareholders using both buy-backs and special dividends. Coupled with good earnings growth, this should deliver healthy long-term returns.