Each week,a professional investor tells MoneyWeek where he'd put his money now. This week: Martin Cholwill, manager of the Royal London UK Equity Income Fund.
The anaemic economic outlook that began with the financial crisis of 2008 doesn't look set to end anytime soon. Money printing (quantitative easing, or QE) will help to remove the risk of another big crisis, but it won't result in the same rate of expansion that we enjoyed up to the credit crunch.
Deleveraging has further to go and will act as a big headwind for years to come. Since we can expect to live in a world of very low interest rates for the foreseeable future, equity-income strategies should be able to deliver attractive returns. The trick is to pick stocks that offer sustainable and growing dividends.
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Three stocks I currently favour are WH Smith, Booker and United Utilities. These firms reflect certain themes that have worked well for me in recent years and look set to continue to do so. These include sticking to quality, picking companies with strong balance sheets and identifying sustainable and growing dividends backed by cash flow.
An additional background theme here is survivor bias identifying companies that have benefited, or can benefit from competitors who are either seriously weakened or have disappeared.
My first tip is WH Smith (LSE: SMWH), one of the biggest short-selling (where traders bet on falling prices) targets for hedge funds in the FTSE 350 index. What's odd about this is that consensus earnings forecasts have been subject to steady upgrades over the last couple of years. The valuation is undemanding, the dividend yield is an attractive 4.1% and growth is underpinned by an ongoing share buyback scheme.
Yet investors seem to be overly focused on the firm's mature high-street presence and not enough on its growing travel business. The high street is actually very cash generative, especially since some competitors have disappeared in recent years. Management's focus is firmly on profit per square foot and further expanding what the firm offers. With such big short interest, alongside earnings upgrades and share buy backs, I see upside for the shares.
My next tip, Booker (LSE: BOK), got its acquisition of Makro (cash and carry) past the Competition Commission unscathed, giving management a great opportunity over the next couple of years. The deal was at a very attractive price, given the freehold property and tax losses (which can be used to reduce future tax) that came with it.
Booker has been transformed under CEO Charles Wilson. From being a highly indebted company whose future survival was in question, it's become very cash generative and has a growing food service business. With a cash pile building up there is huge scope to grow the dividend from its current 2.1% level.
My final tip, United Utilities (LSE: UU), operates in the water sector, where a lot of money could be made over the next couple of years. The sector has historically attracted bid interest from overseas investors, thanks to Britain's stable political and legal environment.
The firm's inflation-linked dividend yield of 4.6% looks attractive compared to index-linked gilts, and offers a cheap inflation hedge to investors worried about the impact of QE. Only three quoted water companies remain since the privatisation of the sector in 1989. I suspect that in five years' time there will be none left. That's another reason to buy this one.
Martin Cholwill is manager of the Royal London UK Equity Income Fund.
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