Each week, a professional investor tells us where he'd put his money. This week: Mark Wright of Seneca Investment Managers picks his three favourites.
Two crucial observations shape our approach to UK equity investing. Firstly, mid-caps have outperformed both large and small-caps over the long run. Secondly, both high-yield and high-quality stocks outperform mid-caps. So we focus on high-quality and high-yielding mid-caps.
High dividend yields reflect negative sentiment towards a stock and a potential opportunity for contrarian investors. Contrarian investments typically perform well because investors suffer from loss aversion and therefore often ditch promising stocks in a panic. As Warren Buffett says, be "greedy when others are fearful".
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A star in a troubled sector
Babcock International (LSE: BAB)
We believe the company is fundamentally different to others in its sector. It has a very skilled workforce, and these workers are in short supply. The company operates in complex, highly-regulated and often secretive industries (such as nuclear submarines), so it would be hard for potential competitors to gain a foothold in Babcock's markets.
Contracts are long-term in nature. And unlike many peers, Babcock does not depend on cost-plus contracts with the hope of additional work to earn a decent overall return.
A bank with room to grow
OneSavings Bank (LSE: OSB)
Asset growth has been strong, despite negative press about the buy-to-let sector, whereas assets have been shrinking at bigger banks. This is exactly why we invest in mid-caps: they have much greater growth potential. OSB does not need the UK economy to expand in order for it to grow its business, but Lloyds does.
A European leader
Phoenix Group (LSE: PHNX)
The acquisition of Standard Life Aberdeen's insurance business will make the dividend more sustainable by bolstering assets under management. Regulatory costs are steadily increasing, as is the appetite of insurance firms to release capital from their closed life businesses. The acquisition environment is therefore positive, which is why we think more dividend increases are on the cards over the next few years.
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