Value investors’ patience will be rewarded by these three stocks

Professional value investor Hugh Sergeant looks to buy strong companies that trade at a discount to their true worth. Here, he picks three that should generate strong returns over the medium to long term.

A professional investor tells us where he'd put his money. This week: Hugh Sergeant of River & Mercantile and Alliance Trust highlights three favourites

Being a value investor, seeking strong companies trading at a discount to their true worth, has been the biggest challenge of recent years. Value investing is a strategy that has been out of favour not only this year, but for more than a decade. During this period there have been occasional glimpses of light at the end of the tunnel, but rare occasions of sustained reward for adopting a value approach.

Nonetheless, we are sticking by our core principles and committing to traditional value and recovery factors. Stocks such as the three we highlight below are, we believe, showing attractive levels of medium-term profit and cash-flow growth. Key value factors are yet to emerge from a bear market, but the potential for healthy profits and cash flow to help generate strong returns over the medium to long term is significant.

Capita: an outstanding outsourcing group

Capita (LSE: CPI) the UK's largest business process outsourcing company, has been one of the best performers out of the stocks we select for the Alliance Trust global equity portfolio.

It is benefiting from wide-ranging changes made by the CEO appointed in December 2017 that are now starting to come through. Cost reductions of £175m by 2020 are running ahead of schedule, and management says it is confident of ultimately earning more than 10% on operating margins.

The group has an estimated market share of between 25% and 30%, broadly split between the public and private sector. The share price has risen by around 50% since we first purchased the stock, but it nonetheless remains, in our opinion, very attractively valued.

Baidu:China's Google

While its share price has been hit by a short-term downturn in its core search business, Baidu's (Nasdaq: BIDU) current valuation remains an immense bargain. It is a mega-cap company, the so-called "Google of China", and it has undergone a period of significant reinvestment into areas such as video, artificial intelligence and autonomous vehicles.

However, it is this reinvestment that has temporarily depressed profitability. Coupled with some investors' general fears about the Chinese economy, this has left Baidu trading at a very attractive valuation. We believe there is an exceptional medium-term buying opportunity here and we have increased our position in the stock in the past year.

Prada will come back into fashion

Prada (Hong Kong: 1913) is synonymous with high-end fashion, but has suffered on the stockmarket in recent years due to a slowdown in sales in a rapidly evolving consumer marketplace. A slowdown in China, a key market for luxury brands, has also dented Prada's fortunes and led to drastic falls in its share price over the last five years.

Nonetheless, it is a household name working hard to improve its position. We hold it in the belief that we will benefit from the company's improving outlook. Management has already begun to take action to address the underlying issues holding the brand back and we believe that a strong recovery is in the pipeline. Its valuation is at a discount in terms of both historic and peer group measures. The scope for share-price gains from these depressed levels remains significant and worth waiting patiently for.

Recommended

Share tips of the week
Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
19 Feb 2021
Vaccines, value investing and UK stocks
Value investing

Vaccines, value investing and UK stocks

Vaccines promise a return to normal life. And that bodes well for “value” stocks, says Merryn Somerset Webb – and for the UK market in particular.
30 Nov 2020
Get decades of growth at a discount with this healthcare investment trust
Investment trusts

Get decades of growth at a discount with this healthcare investment trust

Healthcare is set for strong long-term expansion but looks cheap. That makes this investment trust worth buying, says Max King.
19 Apr 2021
Share tips of the week
Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
16 Apr 2021

Most Popular

“Joke” cryptocurrency dogecoin goes to the moon. What’s going on?
Bitcoin

“Joke” cryptocurrency dogecoin goes to the moon. What’s going on?

Dogecoin – a cryptocurrency created as a joke – has risen by more than 9,000% this year alone. Saloni Sardana looks at how something that began as an …
19 Apr 2021
The FTSE 100 has clawed back above 7,000 – how much higher can it go?
UK stockmarkets

The FTSE 100 has clawed back above 7,000 – how much higher can it go?

The FTSE 100 index has risen to over 7,000 for the first time in over a year – it now sits just above where it was in 1999. But its era of neglect cou…
19 Apr 2021
The bitcoin bubble will burst: here’s how to play it
Bitcoin

The bitcoin bubble will burst: here’s how to play it

The cryptocurrency’s price has soared far beyond its fundamentals, says Matthew Partridge. Here, he looks at how to short bitcoin.
12 Apr 2021