Three bargain-basement stocks for income and growth

A professional investor tells us where he’d put his money. This week: Simon Gergel, manager of The Merchants Trust, highlights three recent purchases.

Our investment approach is to seek out high-yielding stocks that we believe can deliver a high income and an attractive total return. We consider three key aspects of a company.

First, the fundamental strengths, notably the structure of the industry it operates in, the group’s competitive position, balance sheet and cash generation, and also environmental, social and governance factors.

Second, we gauge the valuation of the shares compared with history and other companies in the market.

Finally, we assess long-term structural trends affecting the industry as well as shorter-term cyclical threats and opportunities. Ultimately, we are seeking sound businesses that are attractively valued and poised to benefit from cyclical or structural trends.

Here are three we bought in the last financial year:

Cashing in on mass affluence

Wealth management group St. James’s Place (LSE: STJ) boasts a strong and widely recognised brand and very high retention of client assets. Cash flows are highly predictable for a financials business, given the recurring nature of fee-earned income, notwithstanding market fluctuations. The business has a good track record of growth in fund flows, translating into cash available for distribution to shareholders and reinvestment.

St. James’s Place has been able to grow both the number and the productivity of its advisers effectively over the longer term. The firm benefits from a number of structural trends, such as a growing affluent population and increasing need for financial advice with a shift out of final-salary pension schemes among younger workers.

Strong foundations for growth

Keller (LSE: KLR) is a world leader in geotechnical engineering, or ground engineering, with about half the business in the US. It operates in a market where local knowledge and specialised equipment is critical, as ground conditions vary from place to place, but technical knowhow can be transferred from one region to another if necessary. Long-term growth is being driven by ageing infrastructure in the West, and growing urbanisation and increasing population density in large cities, especially in emerging markets.

In order to increase urban density and replace infrastructure, today’s developers have to dig deeper and more complex foundations, and deal with increasingly challenging ground conditions. The valuation of the shares was very depressed last year, partly owing to a number of operational difficulties, but also because of its UK stockmarket listing. With less than 5% of sales in the UK, we thought the business was wrongly categorised as a UK construction business, resulting in an unreasonably low valuation.

New markets for a tobacco giant

Having owned no tobacco shares for almost a year, we bought back into Imperial Brands (LSE: IMB) last year after the shares had suffered a very significant de-rating. The business has a strong market share and generates substantial cash flows. Structurally, the industry is less attractive than some other sectors, with declining trends in smoking, though profits have grown historically and there are new, less harmful tobacco products that may bolster future growth. The valuation was extremely attractive and the dividend yield was high and growing.