Take the long view

05/07/2010

Investors should be focusing on sensibly priced companies offering good long-term growth prospects, says Baillie Gifford’s smaller companies manager, Douglas Brodie

Over the past 18 months we have witnessed the near collapse of the global financial system followed by a sharp economic slowdown. Douglas Brodie, manager of Baillie Gifford’s British Smaller Companies fund, believes that the speed with which markets have ‘moved on’ and embraced recovery seems out of kilter with the magnitude of these events.

‘While we readily acknowledge that the world is on a firmer footing than it was a year ago,’ he says, ‘it remains unclear as to how self-sustaining a recovery we will see over the coming years. With specific regard to the UK, the combination of ongoing de-leveraging of the private and consumer sectors, mounting debt levels in the public sector and normalisation of monetary policy is likely to be a powerful headwind.’

Corporate viewpoint

Brodie adheres to Baillie Gifford’s firm-wide investment process, which looks for stocks with the potential to offer sustainable long-term earnings growth.

‘I focus on companies that can deliver returns higher than the market average through a clear and sustainable advantage,’ he explains. ‘By this, I mean things like a cost advantage or barriers to entry in a respective industry.’

He favours firms with strong free cash flows and working capital reserves that are able to finance growth internally. ‘P/e ratios and asset replacement values are important in finding a company’s fundamental value,’ says Brodie, ‘and I use them to ascertain the price I will be willing to pay for the future long-term earnings growth.’

His bias towards picking well-managed, soundly financed companies with good long-term prospects typically becomes out of favour when markets detect economic recovery, with investors chasing higher-risk stocks, distressed companies or recovery plays. However, Brodie believes that ‘current market enthusiasm for pricing in a return towards peak cyclical profitability is misplaced and our more fundamental approach will return to favour in due course.’

The fund Brodie manages is overweight in industrials and financials, but he highlights stocks that have been held in the portfolio for some time, such as translation services business SDL.

‘Its purpose is to help corporations drive global brand consistency and accelerate time-to-market by providing software and services to manage the delivery of all corporate information into different languages,’ Brodie says. He strongly believes that, as SDL continues to invest heavily in its valuable, niche technology, the company could become a bid target.

Accounting for 3.8 per cent of the fund (its biggest holding) is chemical manufacturer Victrex, floated on the London Stock Exchange in 1995 and whose shares have since reached 1,104p. Brodie says, ‘Victrex increased underlying revenue by more than a third in the six months to March, while underlying pre-tax profit improved from £21.1 million to £31.8 million. It is a good, solid growth stock.’

Consumer focus

One theme, however, that is exciting the manager is the challenge facing the UK consumer. ‘Considering the growing pressure on UK government finances and a likely anaemic UK economic recovery, those companies that position themselves well for economic recovery will be the ones that have a strong niche market position and a growth bias.’

One such counter is property website Rightmove, set to benefit from the return of buyers to the UK housing market. Over half of all UK estate agents advertise their properties on its website, which enables users to see homes for sale or letting all over the UK.

But overall, Brodie remains confident that his long-term approach to stockpicking will pay off. ‘Things got really cheap in 2008/09 and are now looking much more like they should. However, the market is still concerned about many macro issues, and I am confident that, over the longer term, the companies within the portfolio will experience significant growth.’

Companies: SDL International , Victrex , Rightmove

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