Switch into cyclical stocks
Investors should snap up bargains in the forgotten cyclical sectors, says professional stock picker Duncan Stratford. Here, he tips three such shares to buy now.
Each week, a professional investor tells MoneyWeek where he'd put his money now. This week: Duncan Stratford, investment director, Canaccord Genuity Wealth Management.
Until recently, investors had been stampeding towards the higher-yielding areas of the stock market, pursuing both the attractive income on offer and the perceived lower risk. But that is changing. Investors would fare better in the under-appreciated cyclical sectors, including technology, industrials and consumer services, which have been rather left behind in the stock market rally.
In the tech sector, we'd highlight Sage (LSE: SGE). Its longevity, huge customer base, strong distribution and customer support model, international brands and highly cash-generative business all make it attractive, particularly as a bid target. It has opportunities to grow in emerging markets and the current share price does not reflect its attractiveness to potential suitors.
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Sage is relatively conservative, and although little exciting news is likely to come out from the company, its mix of strong cash generation, modest growth and slight margin growth could combine to drive investor returns. Sage's recurring revenues make it an attractive holding in this uncertain environment. And its shares look cheap. Aside from a possible bid, there's not much obvious news to move the price in the near future, but the business model is unlikely to deteriorate quickly.
Another prudently run firm is publisher Reed Elsevier (LSE: REL). The main reason to invest is for its predictability, demonstrated by its recent results, which were unexciting but trending marginally better. The company is never going to set the world alight in terms of excitement, but it tends to be reliable, with continuous modest growth. It is continuing to move its business mix in the right direction, with exposure to America and emerging markets increasing at the expense of Europe.
Subscriptions are also growing at the expense of advertising, and electronic revenues (now accounting for nearly two-thirds of group turnover) at the expense of print. As chief executive Erik Engstrom recently noted: "We are continuing to improve the quality of our earnings and to deliver more predictable revenues, a higher growth profile and improving returns."
The shares trade at a significant discount to the heights of 2007, even though Reed is now a better-quality business. For 2013, the stock trades on a price/earnings ratio of 13.9, and yields 3.4%, with a well-covered dividend (dividend cover is 2.2 times) and a free cash flow yieldof 7.7%.
Another underappreciated company is engineer Weir Group (LSE: WEIR). It operates in specialised global markets, with solid long-term growth drivers. It has several divisions, which generate a diversified revenue stream, while sharing underlying investment themes. Full-year results showed an 11% rise in revenues and a 12% jump in underlying pre-tax profits. Operating margins hit a record high and the dividend was raised for the 30th year in a row.
Order flow has been hit recently as firms cut back, but Weir is steadily growing sales from the more stable and profitable aftermarket (where revenues come from servicing existing customers). With a significantly better record of historical returns and growth compared with other firms in its sector, we believe Weir deserves to trade at a premium to its peers.
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Duncan Stratford is investment director at Canaccord Genuity Wealth Management.
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