Adult nappies, milking equipment, plastic packaging, power converters and road signs rarely get pulses racing. In the investment world that distinction is more likely to be awarded to the next big technology buzz, or anything else capable of both revolutionising everyday lives and filling shareholder pockets in the process.
The likes of Twitter (US:TWTR), Amazon (US:AMZN) and Tesla (US:TSLA) have all offered investors the thrill of backing the next big thing, with mixed results over the past decade. Of course, splattering their stories all over the media and analyst notes played a massive role in raising their profile to a receptive audience infatuated with the lure of colossal returns.
"Never invest in any idea you can't illustrate with a crayon"
Mankind’s penchant for gambling at the high-stakes table of equity markets has baffled many in the industry for decades, including one of the world's most successful ever fund managers. Peter Lynch, who between 1977 and 1990 grew Fidelity's Magellan Fund's assets from $20m (£13.8m) to $14bn before penning several bestselling books, was known for championing what many in the trade label 'reassuringly dull' stocks. His track record, which included beating the S&P 500 index in 11 of his 13 years in the business with an annual average return of 29 per cent, suggests he may have been on to something.
Working in Mr Lynch's favour was the fact that companies offering lofty growth prospects tended to trade at huge premiums to the unfashionable, steady earners that he had his eyes on. High-profile profit surprises have a habit of attracting flocks of investors to buy stakes. An exciting strategy packed with the potential to deliver big earnings creates such a buzz that many are willing to pay over the odds for a slice of it.
Greed isn't always good
Unfortunately, history tells us that the majority of these companies struggle to live up to the hype, let alone maintain a strong market position for decades. When this realisation becomes apparent, the implication for share prices is often devastating.
So why is it that investors have spent years paying through the nose for the small chance of huge returns and too little for reliable breadwinners? According to Matthew Jennings, UK equities investment director at Fidelity, it's mostly down to greed, our desire to feel stimulated and a natural tendency to be overconfident.
Instead of backing those that have flown under the radar for predictably supplying the globe with mundane yet essential services, he reckons the majority of us prefer to chase the volatile prospect of making enormous short-term gains from disruptive technology. And while we're conscious that the next big thing to revolutionise consumer habits often goes belly up, our mind chooses to fixate on those small handful of success stories that we've witnessed over the years.
Following in the footsteps of Peter Lynch, the man many credit with transforming Fidelity into a household name, Mr Jennings has adopted a similar mentality when it comes to buying shares. "When you invest in a company the valuations you pay are based on the market expectations of its growth potential. Clearly, the higher expectation, the higher the valuation you are asked to pay. That's fine if the manager delivers on its strategy. But in the cases when it disappoints, you can see a significant derating. And lots often do miss their targets.
"The benefit of focusing on unloved companies is that there is less scope for losing your capital because there's less optimism reflected in the share price. In short, there are fewer hurdles to clear. That's why value investing has outperformed growth investing over the very long term."
Quality value no longer so easy to find
Mr Jennings believes the best recipe for long-term success is to first identify market leaders of stable industries offering steady growth. Once those credentials have been established, he then picks out those led by management teams determined to juggle between sensibly expanding the business and rewarding shareholders with a progressive dividend and share buybacks.
Examples he uses include DCC, which delivers fuel around the country and Europe to heat homes, and Bunzl, a logistics business that specialises in delivering consumables such as paper cups to offices.
Of course, readers familiar with these two support service firms will know that they no longer come cheap. In fact, finding any company that matches the profile set out by Mr Jennings and trades at a discount in today's environment is no longer as easy as it once was.
The driving force behind this changing landscape is an uncertain global economic outlook. As more central banks applied quantitative easing measures to lower interest rates and flooded financial institutions with capital, yields in bond markets hit rock-bottom. That backdrop subsequently led fixed-income investors to seek out more savoury returns elsewhere. Given their adversity to risk, most migrated to safer equities capable of grinding out predictable returns.
Those already holding stakes in so-called defensive stocks will be thrilled with these developments. But what does this newfound popularity mean for future opportunities in what was once almost always a sure-fire way to generate healthy returns without taking on too much risk?
According to Mr Jennings, the obvious answer is to either explore smaller companies less in the public eye or to take a more contrarian approach to investing. One area where he currently sees opportunities that have been overlooked by markets is in financial services.
When sectors get ostracised, many in the game choose to flee without giving it much thought. In the case of banks, which have been hit by various scandals and poorly executed expansion strategies, Mr Jennings notes that a reputational shift from pillars of the community to national liabilities pushed valuations in the sector to their lowest level since 2011.
Like asset managers all over the world, it's his job to spot cases where companies appear to have been excessively punished by a whirlwind of negative sentiment towards a peer group. Above all, he reckons shares in Lloyds have been marked down too heavily, as the market failed to appreciate its transition away from riskier ventures, stronger balance sheet and return to a more conservative management culture.
How are today's fund managers finding value?
James Henderson: No pain no gain
Fund: Lowland Investment Company / Henderson UK Equity Income & Growth / Henderson Opportunities Trust / Law Debenture Corporation
Lowland's biggest holdings: Royal Dutch Shell, Hiscox and Senior
James Henderson, who is widely considered to be one of the greatest stockpickers of his generation, reacted to a dearth of attractively valued quality stocks by focusing on out-of-favour ones deep in the doldrums. In short, his strategy involves pursuing victims of difficult end markets once they show signs of starting to get their act together.
"Companies that are operationally challenged are forced to change," he says. "They are forced into rediscovering what they are good at and to re-find their discipline. When costs are lowered, operating profit will surprise analysts on the upside. With a reduced cost base a recovery is generally forthcoming, as analysts find themselves getting to grips with improvements."
This rationale has mainly led Mr Henderson into industrials, financials and basic materials, sectors that have been on the receiving end of poor sentiment as the global economy stalls and commodity prices plummet. One of his unloved favourites is mining group Anglo-American (AAL), which he applauded for admitting its mistakes and selling a large chunk of underperforming assets.
Mr Henderson is similarly impressed with the potential of downtrodden shares in pump specialist Weir (WEIR) and engine maker Rolls-Royce (RR.) to spring back into life. Driving his faith in both is the possibility of cost reductions delivering much-needed cash and a product portfolio that he believes is capable of excelling again once the downturn eases.
Of course, backing companies after multiple profit warnings is a far riskier strategy than building stakes in the type of companies identified by Peter Lynch. While they can end up becoming a lucrative call and candidate for bargain of the century, there's an equally good chance that they may be cheap for a reason. With this in mind, Mr Henderson holds a fairly big pool of stocks and is very meticulous in identifying and slowly topping up his latest holdings.
Moreover, plenty of emphasis is placed on not cutting too much fat out of the business as this could threaten its ability to bounce back when trading conditions improve. And he's equally big on riding the wave of initial share price volatility, claiming that it's pivotal to be patient while the share register changes hands to reflect the latest developments.
Laura Foll: Cheap and quality can coexist
Fund: Henderson UK Equity Income & Growth
Biggest holdings: Hiscox, BP, Phoenix Group
While the current environment doesn't always permit it, Laura Foll, a relatively new face to the industry having joined Henderson's graduate scheme in 2009, endeavours to locate attractively valued stocks backed by strong leadership and tough barriers to entry. Like Peter Lynch, she's very persistent about meeting with companies to better establish what they do and is particularly keen on sectors such as aerospace, where contracts tend to be long and not many have the resources to compete.
Companies with these traits must then pass the valuation test to be added to the portfolio. Metrics used include enterprise-value-to-sales (EV/sales), which compares the market value of a company's equity and debt to total sales, and price-to-book, which is employed to compare market price to book value. While the second approach prompted her to dump a large portion of the fund's holdings in housebuilders, Ms Foll credits EV/sales for its ability to monitor the health of the all-important balance sheet.
As can be expected, not many companies emerge from this screen with flying colours, save for a handful in the generally overlooked small-cap space. However, Ms Foll reckons that developments and themes in some sectors mean a number of bigger names have recently been undervalued by the market.
One example is banks. While Henderson seldom looked at them in the past due to "a lack of real earnings growth", a flurry of negative sentiment and subsequent strategic changes suddenly forced it to have a change of heart. A key catalyst was the appointment of Jes Staley at Barclays (BARC). Ms Foll commended the former American banker for putting the emphasis back on areas where it historically excelled, such as retail and corporate banking. She's also been impressed with how Virgin Money (VM.) is taking share in mortgages, is confident that it can continue this trend when interest rates rise and likes that its lack of branches means it doesn't have a big legacy cost base.
Outside of banks, she's keen to cash in on the impact Hillary Clinton's threats of cracking down on drug pricing in North America has had on sentiment in pharmaceutical companies. And she continues to see value in misunderstood and unglamorous industrials, noting that recent reassurances from the likes of GKN (GKN) and Senior (SNR) have yet to be factored into their downtrodden share prices.
Ben Whitmore: The cheaper the better
Fund: Jupiter UK Special Situations / Jupiter Income Trust
UK Special Situations biggest holdings: BP. Imperial Tobacco, BAE Systems
Like Mr Henderson, Ms Foll and value investors in general, Jupiter's Ben Whitmore prefers to focus on specific stocks rather than get caught up in sectors and the direction of the general economy. His strategy as manager of two Jupiter funds is to buy out-of-favour companies that are either not exciting enough to attract attention, or have been excessively punished for their struggles.
"We invest in lowly valued securities… because all the evidence shows that it's the price you pay for a security that is the primary determinant of future returns," he says. "If you pay a low price, future returns are likely to be high."
"We aim to hold out-of-favour and lowly priced shares in companies which are, in our view, well run (or have the potential to be) and have a sound balance sheet. The search for value is… opportunistic, so we have no preset size or sector bias, investing wherever we see value, although we tend to focus our attention on larger UK companies."
In order to fit Mr Whitmore's definition of well run, candidates must be "strong franchises" that generate lots of cash and prioritise paying dividends over making expensive acquisitions. Given the barrage of recent high-profile cuts, and growing speculation that plenty more will follow, a lot of attention is paid to the sustainability of income.
Once all of these stringent boxes are ticked, he admits it's rare for the company in question to make the grade just for not being exciting. Halfords (HFD) or Clydesdale Banking Group (CYBG) aside, most of the candidates are cheap because investors have lost patience with a whirlwind of highly publicised issues.
But while the majority have lost hope in the likes of Tesco (TSCO) and Standard Chartered (STAN), Mr Whitmore is confident they can significantly outperform the FTSE All-Share benchmark over the long term. He also has big positions in BP (BP.), BAE (BA.), Aviva (AV.) and Centrica (CNA) and recently added South 32, Antofagasta (ANTO), HSBC (HSBA), Ashmore (ASHM) and CYBG (CYBG).
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