Three value stocks to buy now

Stock markets won't stay down forever. So buy now for outsized returns, says professional investor Henry Dixon. Here, he tips three value stocks to add to your portfolio.

Each week, a professional investor tells MoneyWeek where he'd put his money now. This week: Henry Dixon, fund manager, Matterley Undervalued Assets, Charles Stanley.

In May, the UK stockmarket saw its worst monthly fall since February 2009, when we were gripped by the panic of the Lehman Brothers collapse and the knock-on effect this had on corporate balance sheets. This time, investor concerns were most notably centred on Europe, with the emerging threat of a Chinese hard landing lurking underneath.

While we can't deny the uncertainty of this backdrop, investor behaviour is now wholly reflective of this state of affairs. Data from the Investment Managers Association show that equities continued to be shunned in favour of the safe haven' status of fixed interest.

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These buying patterns have had a dramatic effect on the yield on offer, with ten-year gilts now yielding only 1.6%, which is less than half the level seen in February 2009. The return on offer from triple-A corporate bonds has also halved, from slightly over 5% to the current level of 2.6%.

Investors still seem more than happy to bid up these areas of safety, while choosing to shun UK equities despite the fact they are now yielding slightly over 4%. However, events of the last four years should have taught us that there is not only life after trauma in the equity market as long as you are paying an appropriate price for cash flow, cash and assets; but there's also the chance of outsized returns.

With cash flow in mind, I would highlight Smith & Nephew (LSE: SN), the orthopaedic company. In 2009, the business had close to $1bn in debt, but steady earnings progress over the last three years means the company has now moved into a healthy net cash position. This will pave the way for the dividend which has already grown by 35% since 2009 to grow even more quickly. There will also be the opportunity for attractively priced bolt-on acquisitions to bolster earnings growth.

With cash in mind, the biggest bang for his buck an investor can currently enjoy in the FTSE 100 is Schroders (LSE: SDRC). Every £1 you invest is backed by around 60p of cash. This is in no small part a function of the £2bn the company has generated after dividends in the last three years. The fact that the market cap has only progressed by £1.3bn since the trough in 2009 therefore looks harsh.

Courtesy of the corporate structure there is also the opportunity to acquire the company at a 20% discount via the non-voting share class. The cost of this discount is to forego your vote at the Annual General Meeting (AGM), but given that shareholder activism is currently in vogue, there is no shortage of people standing your corner. The benefits are that you rank pari passu on the dividend stream, and given the lower share price, the yield uplift is significant.

With assets in mind, I'd highlight Daejan Holdings (LSE: DJAN) in the FTSE 250. It is a lesser-known property company, but given the carnage seen in its sector during the downturn, investors can take much comfort from its financial performance. The company did not need a rights issue, unlike its large-cap peers, and even held its dividend when others were slashed.

The current asset backing is worth well over £50 a share, while the share price is standing at just £27. Discounts of this magnitude are usually reserved for heavily indebted businesses. However, financial gearing is modest at just 16%, when many large cap peers run at closer to 50%, and as such the size of the discount to assets looks anomalous to us.

Henry Dixon is fund manager at the Matterley Undervalued Assets Fund.