Three out-of-favour blue chips

Jeremy Smith, manager of the Schroder UK Large Cap Fund tells MoneyWeek where he'd put his money now.

Our approach to investing is a simple one. We adopt a portfolio strategy, with investments diversified across a broad range of industries. However, the characteristics of our individual stocks are similar they are out of favour with short-term investors, but attractively valued, and they have strong franchises, robust balance sheets and the ability to deliver high returns over the longer term. Right now, according to these criteria, we think larger companies offer some of the best investment opportunities.

Centrica (CNA) is one of the stocks we have been buying. There is a perception that the company has been poorly managed, and the management's inability to correctly match supply and demand has cost the firm dearly, especially at a time of rising energy prices. In addition, relatively low margins in all its businesses and the highest variable cost per customer for a company in the UK-listed utility sector have seen the shares underperform.

However, we are looking beyond the short-term. The company has started to expand into higher-margin areas, such as maintenance and breakdown cover, home insurance and telecoms. Given the strong awareness of its British Gas brand, the potential to improve operating margins is huge. This potential, combined with a dividend yield of more than 5% and the fact that Centrica is the only utility with net cash, makes the shares an attractive medium to long-term proposition.

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Another firm we like is former dotcom darling Pearson (PSON), best known as the publisher of the FT. The firm had been on a massive spending spree, buying assets such as Madame Tussauds. But the firm has now made a series of disposals to focus on its core areas of expertise. As well as the FT, Pearson owns Penguin and is one of the top three companies in the US educational publishing market.

Still, the share price is around the same level as when the restructuring efforts kicked off. Again, the firm's attractions lie in its future potential. It owns brands that are known the world over, but its three key businesses operate on lower margins than most of its competitors. A new finance director was appointed last year and improvements have been seen in cash flows and debt levels. At the moment, the company has one of the lowest EV/sales (enterprise value to sales) ratios in the UK media sector, showing the potential for valuation improvements if management can continue to get things right.

Royal Dutch Shell (RDSA) is also on our list of favoured stocks. We started buying the shares following the reserves scandal last year, which shattered the market's view of the firm as having quality management. However, it has now been announced that Jorma Ollila, currently chairman and CEO of Nokia, will become non-executive chairman from June next year. Given what he has achieved at Nokia, investors will be hoping he can work his magic at Shell.

Although the shares have recovered well since last year's lows, helped by a record oil price, we believe they still have some way to go. The company has around $90bn in assets, similar in size and dispersion to those of Exxon Mobil although returns at the latter are some 30% higher. Assuming Royal Dutch Shell can match these returns, earnings per share would rise from 196p to 251p. The company is also undervalued relative to BP. On an EV/DACF (enterprise value to discount adjusted cash flow) basis, the shares trade at around a 26% discount to BP. Things won't get better at Royal Dutch Shell overnight, but on a medium to long-term view, it is our preferred play in the oil sector.