More Growth Shares at a Reasonable Price: Part 1


This is the first of a two-part transcript in which's David Kuo chats with fund manager Jane Coffey about GARP investing. Jane, who is head of equities at the Royal London UK Equity Fund, revisits five stock picks for Money Talk listeners from last year that have delivered an average return of more than 20%. Read on for this year's selection of shares from Jane that could also offer "growth at a reasonable price!"

(You can read the second part of this transcript here. You can listen to or download the full podcast here.)

David Kuo: This is Money Talk, the weekly investing podcast from The Motley Fool. I am David Kuo, and today I am delighted to welcome someone back into the studio who shares my passion for top-down investing. My guest is head of equities, and she manages the Royal London UK Equity Fund, and is no stranger to us here at The Motley Fool, and I'll explain why she is no stranger to us here at The Motley Fool in a minute. She is, of course, Jane Coffey, and she is with me now. Welcome back to Money Talk, Jane.

Jane Coffey: Good afternoon.

David: It is a beautiful day today -- I don't know when this podcast goes out, whether it'll still be a beautiful day, but it is certainly very sunny today.

Jane: And the equity markets are up, so it's unusual all round!

David: That's right -- sunny on the London Stock Exchange, and also sunny outside here in London. Now, tell me a little bit about the Royal London UK Equity Fund, Jane.

Jane: This is a fund that's designed to be a core U.K. equity fund for investors. It's a 370 million pound equity open-ended investment company, and I run it with an investment philosophy based on growth at a reasonable price.

David: So you are still keen on GARP investing, then?

Jane: Very much so. It's an investment style that I've been using for 20 years, so I'm unlikely to change it now. At the moment, growth has very much been a style that has been in vogue, and I think over the next few years it is going stay that way, apart from maybe the odd one or two months where you get a sort of big rally in value stocks. The reason that I believe that is that, in this environment that we're in, a very low nominal GDP growth in a sort of slow economy, it's very difficult for companies to grow their top line across the board. So those companies that do have some kind of structural growth, and a good market position, are going to be valued more highly by the market.

David: So how does that differ from income investing? Because I mean, that is the other passion at the moment among investors. They're all going for high-yielding shares. So how does GARP differ from income investing?

Jane: Well, I'm certainly not against income investing. However, what I feel is that it's actually the growth in that income that drives the valuation ...

David: The share price over the long term, yeah.

Jane: ... over the long term, so yes, you can have a company that is yielding 6%, 7%, but it is only yielding 6% or 7% each year. That's likely to be your total return for the year, because why would the share rerate over time if its profits are not going up, or its dividend stream is not going up. However, if you're looking at growth, you're wanting to see longer-term growth in the actual earnings stream, and in therefore their ability to pay dividends, and that is likely to get you some kind of capital gain, as well as your dividend.

David: OK, now when you were here the last time, it was about a year ago, you brought to us five shares that you were particularly interested in. Do you want to know how those shares have done over the last year?

Jane: Of course I do.

David: OK, now, they have generated on average a return of over 20% over that year. That is quite an achievement, isn't it?

Jane: Well, as I say, I think good-quality growth companies have actually been the place to be in this very tricky environment, and these companies that I chose all have managed to deliver on their earnings growth, and so thankfully we've also seen that reflected in their share price.

David: OK, so can we have a look at some of these companies in particular, and can you explain to us why they have done well? The first one is Compass Group (ISE: CPG.L) -- why has Compass Group done well? I know at the time I made fun of Compass Group, because I said it was just a giant sandwich maker, but you said otherwise?

Jane: Yeah, well in fact Compass is a contract caterer.

David: Sandwich maker?

Jane: A sandwich maker. They do a lot of catering in corporations, government offices, and they are pretty international. In fact, they have 68% of their revenue in North America and the fast-growing emerging markets, and that's one of the reasons why I still like this company at the moment, because those are areas of the world that are growing top line more, so growing GDP, and in fact Compass expands as GDP expands really, because they can go out, and as companies employ more and more people, their turnover goes up in their canteen. That's the simple answer behind that. But one of the other key things about Compass is that they're very cash-generative, and so they started with a very good balance sheet. They're also generating 750 million pounds of free cash flow every year, and they're using that to make acquisitions that complement their existing presence in the markets that they're not in at the moment to get themselves better scale advantages. Plus, they're buying back stock, so reducing the number of equities that you actually have to share that profit with, and they're also paying a 3.5% dividend yield, so all in all, it's a pretty good story.

David: So doesn't the fact that it goes up by making acquisitions -- does that not worry you a little? As a fund manager, don't you get a little bit worried when management says, "I'm going to be going out and spending this free cash flow on new purchases"?

Jane: It depends very much on two things. One is how much they pay, and secondly, whether they're doing it just for size, rather than for actually getting advantages of scale and strategic advantage. So the good thing about Compass is that they've just been doing bolt-on acquisitions, which they've been getting at relatively good value. Usually they're paying the same or less multiples than they trade on themselves, plus they then can take out quite a lot of the central costs for that and bulk it up with their overall business, and usually they can also increase the margin, because they have a best-in-class margin. So whereas you might see them paying 13 times for a company, actually by the time they've stripped out that cost, to them it's only really seven times.

David: OK, so that is Compass out the way. What about Spirent (ISE: SPT.L) ? That was another company that you brought to us, and Spirent shares have gone up 27% since you were here the last time.

Jane: Indeed, Spirent has really benefited from the secular growth in smartphone as one of its core areas. Now, it does not make smartphones. What it does is it actually tests smartphones and their interconnection onto the networks. So all the smartphone manufacturers have to buy Spirent kit to check both backwards compatibility and across different networks and across different ranges. So this whole big growth in smartphones has led to an awful lot more testing, because you have to be able to interconnect on much more than just simple voice. What we've seen as well is that 4G, which is the next generation of mobile telephony, the ramp-up in that has been even faster than the ramp-up in 3G was. So this area of the business is growing about 30% per moment. They also are a beneficiary of the cloud and the big data centers, because interconnection and testing on that side is key, and again, that's growing quite quickly -- that's growing about 20%. They have two other smaller divisions which are not growing quite so much at the moment, and they're currently looking to potentially divest them, or just cut costs within them, and sort of downgrade them somewhat, but overall I still think this is a company that's giving you mid-teens earnings growth. Another company with a very strong balance sheet and a growing cash pile -- I mean they've got 21% of their market cap in cash, so it is possible they might make an acquisition, but at the moment the management have been pretty keen that they will return cash to shareholders as and when they have it, so again another company doing buybacks.

David: So you still like Spirent at the moment?

Jane: So I still like Spirent, even at this price.

David: OK, so you like Spirent, and you also like Compass Group?

Jane: Uhum.

David: OK, so IMI (ISE: IMI.L) , and this was another company that I made fun of. I said they just made optics that you find behind the bars when you go and get a shot of whisky. This company has gone up 23% since you came in, so another great tip from you. Why has IMI done so well?

Jane: Well, IMI has managed to again deliver on its earnings, so it's seen an uplift in earnings of more than 15% over the past year. In fact, its optics division is a division that's pretty much non-core now; although it's still there, it's very much not part of their core business. The other areas in their business are exposed really to industrial growth, and despite the recession, actually industrials across the globe have been doing reasonably well. So Spirent has ...

David: IMI, you mean?

Jane: IMI, sorry, has got a very good position within that, and they have continued to deliver. Again, the stock's still on 11 times earnings, so despite its 23% return in the share price, it hasn't rerated, because it has seen that good earnings growth, and this is the benefit of investing in growth stocks.

David: So just wait for the rerating to come, yeah? Is that right?

Jane: Yeah, now we'd like to see the rerating! There are grounds for it to be rerated, because in fact its core business has an 18% margin, and usually that would lead to a 1.8 times book value -- it's currently trading on 1.3 times.

David: OK, now then -- Holidaybreak (ISE: HBR.L) -- this was another company. This company, according to my calculations, has gone up 60% since you came in the last time. What happened there, what happened at Holidaybreak?

Jane: Well, Holidaybreak was a good little company that was transforming itself from being the old Eurocamp into an education holidays company. It bought PGL, which did the adventure holidays and the activity holidays in the U.K. for children, and therefore it was getting a much better stream of earnings, a much more visible stream of earnings, because these things are booked year after year by the same schools. It was therefore seen as attractive by a competitor, and Cox & Kings came in and bought it at a 30% premium on the day, but obviously at a bigger premium over the time that we were talking, because it had already gone up into the deal.

David: Now, there is always one boy in the choir who sings out of tune, Jane, right? We've looked at one, two, three, four companies that have done exceedingly well, and this boy that is not singing in tune with the rest of the choir is IG Group (ISE: IGG.L) . What has gone wrong at IG Group? It's only down about 8%, I have to say.

Jane: Yeah, IG Group has, in fact, been quite disappointing in its performance, but I still actually like IG Group, and it still has a place in my portfolio. What happened over last year is that, over the summer, earnings were being downgraded. Actually, bizarrely, it was when the market was going up that initially the earnings started being downgraded, because volatility in the market decreased, and as volatility decreased, the amount that each client would bet with IG Group became less. There was less excitement for the private investor to speculate on changes in share prices as volatility went down. So although their actual long-term growth is backed by the number of new clients, which continue to go up, as each new client was trading a bit less, it led to flat earnings instead of the expected growth that we were hoping for. However, this is a great stock.

David: There's always a "however", isn't there?

Jane: Yeah -- however, this is a good stock, if you think that there is going to be increased volatility in the market. So when markets actually fell dramatically at the end of last year, the stock started to outperform a bit into that environment, and I think now you've got a company that's trading, again still on 11 times, so still a reasonable price, and it's still got 8%, 9% expected growth over the next few years as it expands internationally.

David: And it also pays a dividend, doesn't it?

Jane: And it pays a 5% yield.

David: Yeah, so that's not too bad. I mean, getting 5% just to wait for the company to turn around isn't such a bad deal, is it?

Jane: No, absolutely not, and it's not that it's a company that's losing money or having any problems with its cash flow at all. This is a company that's still growing, it just has stuttered in its growth last year, but I believe we're back on track now.

That was the first of a two-part transcript in which's David Kuo chatted with fund manager Jane Coffey about GARP investing. In the second part of the transcript, Jane, who is Head of Equities at the Royal London UK Equity Fund, gives her latest selection of shares that could offer "growth at a reasonable price!" Just click here to continue reading.

David Kuo challenged his Motley Fool analysts to pinpoint the attractive sectors of 2012 -- and they delivered! Discover the industries they selected in this new Motley Fool guide -- "Top Sectors for 2012" -- while it's still free!

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