Value style investing has been out of favour for most of the past decade. But that hasn't been detrimental to contrarian value investor Alex Wright, who over the past 10 years has delivered a cumulative return of 453.2 per cent against 155.5 per cent for a composite of his peer group, according to FE Trustnet. Mr Wright has run Fidelity UK Smaller Companies Fund (GB00B7VNMB18) for 10 years, and more recently taken on Fidelity Special Situations Fund (GB00B88V3X40), and Fidelity Special Values (FSV).
And in the UK over the past 18 months value has been making a comeback, so now could be one of the best times to find UK stocks that are cheap on an absolute, as well as a relative, basis, argues Mr Wright.
One reason for the changing market is the UK's forthcoming withdrawal from the European Union and the economic uncertainty as a result of this.
"If you look at the UK market in terms of UK earners compared with international earners, they are at a clear discount," says Mr Wright. "Look at Lloyds Banking (LLOY) versus [Belgian bank] KBC (KBC:BRU) or BT (BT.A) versus Deutsche Telekom (DTEX.N:GER) – they are at dramatically lower valuations. That shows international equity owners are worried about the Brexit process and they don't understand it. So when they've got the whole globe to invest in, and something that has never happened before and is difficult to analyse [is affecting the UK], they've decided it's easier to steer clear."
Mr Wright is finding more value in domestic-facing UK companies than internationally exposed ones. Fidelity Special Situations Fund has 37 per cent of its assets in UK-facing companies, which is 7 per cent more than their representation in the FTSE All-Share index, where international companies dominate.
"The reason we're not at 50 or 60 per cent [domestics] is because the UK is growing more slowly than its European neighbours, and consumers are in a tough spot with inflation picking up and real wages below that," explains Mr Wright.
But he generally tries to spend as little time as possible thinking about macro issues, including Brexit. Instead, he analyses stocks' individual attributes, aiming to find companies on low valuations with improving fundamentals. He typically looks for businesses he believes are entering a period of positive change not yet recognised by the market, for example, because they have a new management or approach.
"When we buy cheap, if we get it wrong, we don't lose that much," says Mr Wright. "But if we get it right, because these stocks are so undervalued and the prospects are so misunderstood, the potential for real outsized returns is significant."
PayPoint (PAY) is an example of a stock he thinks has good potential for a change in fortunes. It offers payment services for consumers in shops such as newsagents and is yielding about 11 per cent because its business is perceived as an area in decline. But PayPoint has recently launched a new product to help newsagents and convenience stores manage functions such as transactions, card payments and stock re-orders. When deciding whether to invest in PayPoint, Fidelity surveyed 500 independent newsagents about its offering, and found two-thirds of them were either already using PayPoint's new product or planning to.
"PayPoint more or less has a monopoly in this business, with the only competitor offering an inferior product," says Mr Wright. "Newsagents said they would lose a huge amount of footfall if they moved from PayPoint to the competitor."
Mr Wright is also finding opportunities among defence companies such as Meggitt (MGGT) and Chemring (CHG) which he bought in the past three months. And he has added to Fidelity Special Situations' existing position in Ultra Electronics (ULE). The increase in bond yields from around 0.5 per cent in mid 2016 to around 1.5 per cent today has led to a drop in demand for shares like these, making them attractively valued. And an increase in the US government's defence budget – the largest military budget in the world – could also be positive for defence companies.
But Mr Wright is staying clear of companies that have been prized for their defensive qualities such as Unilever (ULVR), Diageo (DGE), Imperial Brands (IMB) and British American Tobacco (BATS).
"Even after the large underperformance from some of those names, they are still not looking that cheap," explains Mr Wright. "Balance sheets have deteriorated, particularly in the tobacco sector, with Imperial down about 40 per cent and British American Tobacco down 30 per cent since peaks in 2016. But they still don't look amazing value on an earnings before interest, taxes, depreciation, and amortisation (EBITDA), sales or price to book basis."
However, Mr Wright is bullish on educational publisher Pearson (PSON) which accounts for 3.3 per cent of Fidelity Special Situations' assets. It is unusual in being a reverse cyclical company – when the economy is doing well demand for its services fall. In the US, where most of its business is based, the strong economy has been a headwind. Another factor that has been weighing on its share price is the company's transition from a print to digital model.
"There are a lot of digital-only businesses within Pearson, for example, its vocational testing in the US and globally, and its remote university and schools businesses," explains Mr Wright. "But these tend to be glossed over as its key business of higher education is 50 per cent text book and 50 per cent digital based, and that means it has the problem of supporting two different infrastructures."
But its higher education business is projected to be 80 per cent digital based by 2020.
"This is no longer a textbook with a syllabus but a tool that's helping to run the classes," says Mr Wright. "Pearson will increasingly be seen as a tech company rather than a book company, and the change in multiple that could follow could be very dramatic."
Alex Wright CV
Alex Wright is manager of the Fidelity Special Situations and Fidelity UK Smaller Companies funds, and Fidelity Special Values investment trust. He joined Fidelity in 2001 as a research analyst and has covered various industry sectors across the market capitalisation spectrum.
Mr Wright has a first-class honours degree in Economics from Warwick University and is a CFA charterholder.
