More gains in pipeline following 69pc rise?
A top fund manager’s previous tips for us rose by two thirds. Can he pull off the same trick again, asks James Connington
Abusiness that makes plastic pipes, another that sells software to housing associations and a firm that produces electronic components may not sound exciting, but all are owned by one of Britain’s most successful fund managers.
James Baker’s Chelverton UK Equity Growth fund has topped the “UK all companies” sector over the past three years with a return of 97pc.
The fund focuses on companies that aren’t large enough to belong to the FTSE 100 index and avoids previously troublesome sectors such as mining and banking.
“The important thing for us is that a business converts most of its profit into cash and can fund its own growth – either because it has very high margins, or because it doesn’t need to invest much to grow. A combination of those two things is the real sweet spot,” Mr Baker told Telegraph Money.
Two years ago Mr Baker identified three stocks that he expected to perform well in 2016 and beyond: dotDigital, IMImobile and Victrex. All three have performed strongly, returning 116pc, 48pc and 43pc respectively, compared with 31pc for the FTSE All Share index.
Now Mr Baker names three of the stocks he is backing for 2018 and reaffirms his view on dotDigital.
Market value £280m; turnover £32m; pre-tax profit £8m Founded in 1999, dotDigital is a digital marketing firm that helps clients grow their business online.
Mr Baker said: “It started as a UK
business but in the past few years it has started to grow internationally. Now around a quarter of its business is overseas and that portion is growing at more than 50pc a year.”
He said the valuation of about 25 times future earnings was not excessive when the overall growth rate of 25pc was considered.
“The firm has high margins and generates a lot of cash, which it is investing to fund its international business. Very few businesses can grow at 20pc plus and generate lots of cash,” he added. Market value £230m; turnover £338m; pre-tax profit £5m DiscoverIC produces specialised electronic components, which it designs and manufactures inhouse. The business has about 25,000 industrial customers and its components end up in everything from trains to coffee machines.
“Acal gets its components designed into its customers’ products,” said Mr Baker. “They’re a small part of the cost but critical to performance, so they don’t tend to get designed out once they’re in. Therefore the business is able to charge a decent margin.”
He said that, with a valuation of about 13 times future earnings, the firm was “somewhat underappreciated for a business of its quality”.
“Its revenues aren’t as predictable as a software stock, but it has specialised, customised components designed specifically for its customers,” Mr Baker added.
“It released results this week and is growing at 9pc a year – a very good rate of growth in the current lowinflation environment.” Market value £750m; turnover £440m; pre-tax profit £54m Polypipe makes plastic drainage pipes for residential, commercial and infrastructure developments, in addition to ventilation systems.
Mr Baker explained that while Britain might officially use metric units, in practice imperial units were frequently used, making it hard for a foreign business to compete with Polypipe.
“No one wants to ship a lot of plastic and air to Britain either, thanks to the cost, so it dominates the UK market,” he said.
He added that government spending on housing projects, legacy clay pipe infrastructure that needs replacing and the increased attention paid to the risk of flooding should drive the company’s growth.
“It’s a mid-single-digit growth business with very high margins. It made a big acquisition a couple of years ago so is paying down debt relating to that, and has a generous dividend policy,” he said.
Market value £50m; turnover £20m; pre-tax loss £0.5m This company creates software that allows housing associations to manage functions such as rent collection, document management and repair scheduling.
Mr Baker said the firm had made a number of acquisitions over the years, which it had integrated into one complete package that is mobileenabled and available via the “cloud” – in other words, online rather than on the organisation’s own computers.
“It’s a very modern product for this market,” he said. “They’re up against large companies for which this is only a small focus and which haven’t brought their products into the 21st century yet. So it’s starting to gain market share.”
The company recently made two major sales of its complete system, and once those are up and running Mr Baker said he hoped it would attract a lot more interest.
“Authorities are under pressure to keep rents down and be efficient – this software is good for that,” he said. The stock trades at about 12 times future earnings.
Home ground: foreign firms find it hard to compete with Polypipe because imperial units are still frequently used in Britain