How to find a bargain in the British market

Each week, a professional investor tells us where he’d put his money. This week: Richard Penny of the FP CRUX UK Special Situations Fund chooses three top-quality stocks.

Investment is often characterised as a trade-off between value and growth. However, this is not the case. Growth is a feature of a business, and value is a reflection of what you pay for shares in relation to their inherent qualities. It is possible for a low-growth company to be expensive, while growing companies can also be acquired cheaply. Investors are always on the hunt for a “bargain”: high-quality growth at an attractive valuation.

When it comes to finding these, we consider key factors to be an ability to generate cash, management demonstrating alignment with shareholders’ interests by investing in the business, and the sustainability of growth and returns. Smaller businesses often display these characteristics, and because institutional investors tend to ignore them they can trade at big discounts to larger peers.

Sometimes a business that would be highly valued as a standalone business is tucked away inside a large global entity. Bargains also arise when a company looking to grow depresses current profits by investing in new areas, prompting investors to mark it down, thus masking its true value.

Analysing the reasons why a seemingly high-quality company has a downtrodden valuation is important. By tuning out market noise and taking a long-term view, you will greatly improve your odds of finding a bargain in the UK market.

A leader in healthcare

Among the smaller companies at the forefront of rapid developments in the healthcare sector is MaxCyte (Aim: MXCT), a world leader in the field of gene therapy. MaxCyte supplies machines critical to the modification of human genes to 20 of the world’s top 25 pharmaceutical companies and boasts a portfolio of around 70 licensing deals. The investment case includes MaxCyte’s commitment to undertaking clinical trials to combat ovarian cancer. This is a riskier part of the business, but it could pay dividends: other similar platforms are selling at multiples of MaxCyte’s current valuation.

Unlocking value at the Pru

Growth divisions tucked away in larger companies can trade at a discount to their underlying value. Prudential (LSE: PRU) contains such a hidden gem: the Asian Life Insurance business, widely deemed one of the best global franchises in life assurance. Analysts also reckon Prudential shares trade at a discount to its sum-of-the-parts valuation. Valuing Prudential’s Asian operation in a similar way to pure-play pan-Asian life insurance group AIA implies considerable upside for the overall group’s shares.

Grappling with complex data First Derivatives (Aim: FDP), a UK-based IT service management company, looks well placed to benefit from the growing demand for products that can handle and process complex data quickly. Its database product, Kx Systems, is the fastest in existence and plays an integral role in complex financial-trading systems. The group’s margins of 20% have been depressed, but this has been due to fresh investments rather than slowing sales.

Similar businesses in America trade at far higher prices and in our opinion First Derivatives, having been hit disproportionately in recent market sell-offs, is currently undervalued.