There are three principal reasons why we believe investment trust Merchants Trust (MRCH) is a great stock to own.

First, the recently published half-year results demonstrated the merits of manager Simon Gergel’s investment approach. This involves searching for attractively valued companies with strong fundamentals that are expected to pay a dividend yield above or in line with the market average.

Second, historically the trust has focused on the FTSE 100 but more recently it has adopted a more eclectic style, increasing its exposure to European and mid and small companies. That opens the door to a broader range of investment opportunities.

Third, the trust yields an attractive 5.1% which is one of the highest within its peer group, and the board is committed to a progressive dividend policy which can be funded through reserves.

IMPRESSIVE NUMBERS

Results for the six months to 30 July revealed net asset total returns of 19.8%, significantly ahead of 12.6% for the FTSE All-Share index.

The trust benefited from the rotation out of growth stocks and into value stocks following the announcement of the Covid-19 vaccine rollout in November. While growth stocks have subsequently been in fashion over recent months, there are some signs to suggest that investors are now taking profits and looking at value once again.

Merchants Trust’s latest results vindicate the approach adopted by Gergel who adopts a three-pronged strategy to stock selection. This involves assessing a company’s fundamentals, valuation and catalysts for change.

Fundamentals include the strength of a company’s competitive offering, its brands, the quality of management and their ability to allocate capital.

Gergel focuses on cash generation and divided yield when assessing a company’s valuation. He aims to buy good companies when they are trading below fair value.

Another facet of Gergel’s investment style involves finding companies that are benefiting from long term structural trends like demographics, or technological innovation and disruption. Conversely this involves avoiding companies that are facing structural challenges that put the business under long term threat.

WAITING FOR THE RIGHT MOMENT

Gergel invested in Vodafone (VOD) last year having previously believed it was a value trap. His view has become more positive partly because the group is taking out a significant amount of costs, and at the margin he believes consumer spending on mobile phones could stabilise.

This would remove pressure on the group’s revenue line and potentially be indicative of an inflection point in the company’s growth rate.

Moreover, the group has the largest mobile payments business in Africa, which is a rapidly growing business.

POSITIVE ON TOBACCO STOCKS

Gergel believes there is a potential transformation story emerging for the tobacco companies. This is predicated on their transition away from cigarettes to vaping and heat not-burn devices, that are potentially a lot less harmful.

As consumers make this transition to these less harmful products, the tobacco companies could move from being in structural decline to a position of stability or growth. This could act as a catalyst for a re-rating of the sector. Admittedly growth rates for these so-called next generation products have yet to meet expectations.

LOOKING FURTHER AFIELD

The trust now has 40% of its holdings that are outside the FTSE 100 index, either in mid-caps, small caps or European companies.

The trust has recently allowed an allocation of up to 10% of the portfolio in overseas-listed shares to the portfolio to provide greater diversification.

The initial focus has been to increase the exposure to European stocks. This makes sense given that there is in-house expertise at the trust’s asset manager Allianz, with a team focused on the European market based in Frankfurt.

Pharmaceuticals and reinsurance are the two areas where Gergel believes there are opportunities, the former offering greater diversity than the UK market and the latter benefiting from a marked resurgence in pricing power. This is reflected in the recent decision to add both Sanofi, and Swiss Re and Scor to the portfolio.

Gergel is also constructive on the outlook for mid-caps and his portfolio includes FTSE 250 housebuilders Redrow (RDW) and Bellway (BWY).

Merchants Trust pays dividends once a quarter and two payments totalling 13.6p have been declared so far this year. The board remains committed to raising the dividend for the full year, which would extend a track record that has already seen 39 consecutive years of increased dividend payments.

Past performance may not tell you what the trust will achieve in the future, but it does provide evidence of successful active fund management. Investors pay a fund manager to beat the market and that’s precisely what Merchants Trust has achieved.

BEATING THE MARKET

Over the past five years it has achieved a 67.9% total return which is the share price gains and dividends. That’s more than double the returns from the FTSE All-Share (31.7%), according to FE Fundinfo data.

Over the past decade, Merchants Trust has returned 150.4% versus 112.8% from the benchmark. It has a 0.61% ongoing charge.

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