Ken Wotton, manager of Strategic Equity Capital (SEC), reveals how he chooses which stocks to invest in and how he continually reviews his portfolio to ensure it is suited to market conditions. 

Importantly, and by design, the businesses in our portfolios share certain characteristics centred around financial quality and mitigating downside risk.

They have very low levels of leverage or none at all, they enjoy higher profit margins, their earnings streams are stronger and more robust, and they have an operating model that is fit for purpose, even in more challenging times.

In addition, we look for businesses set to benefit from structural themes that offer attractive long-term tailwinds. That could be the increasing trend towards digital transformation, for example, or the rise of the sustainability agenda. These themes are typically non-cyclical, providing insulation from the macro backdrop.

Our portfolio review process also considers the valuation of each business compared to its sector peers – and compared to any relevant M&A or private equity transaction valuation multiples. We want to hold businesses where the current valuation provides a margin of safety.

XPS Pensions (XPS)

One good example of an investment that meets all of those tests is our holding in the specialist pensions consultancy and administration provider XPS Pensions (XPS).

First, XPS operates in a large and structurally attractive market providing specialist advice to defined benefit occupational pension schemes; demand is robust and growing because of regulatory drivers and the increased complexity of running these schemes.

In addition, XPS enjoys an attractive market position and competitive advantage: as a leading independent consultant; it is one of the leading mid-tier providers of advice and consultancy in the UK pensions market, but it is also a pure-play provider; by contrast, several of its rivals are businesses owned by larger multinational groups with disparate operations.

Importantly, XPS has excellent earnings visibility – working as a retained adviser by many of its customers, a significant proportion of the business’s revenues are recurring in nature, often as part of inflation-linked contractual arrangements.

It also operates with a business model that does not require significant capital; XPS boasts attractive profit margins and has the cash generation potential to support a high and sustainable dividend yield.

The final piece in the jigsaw is XPS’s attractive valuation. On a high single-digit multiple of enterprise value to EBITDA (earnings before interest, taxes, depreciation and amortisation), it trades at a discount to its peers as well as to the multiples seen in M&A activity in the sector.

Hostelworld (HSW)

Sector specialists that are leaders in their field can build strong brand recognition and boost customer retention over the long term, better insulating them against macroeconomic headwinds.

Hostelworld (HSW), for example, is a leading online travel agent globally, focused exclusively on the hostel segment.

Having specialised in hosteling for more than two decades, the company has collected an immense amount of long-term data around the unique preferences of its user base.

This has enabled the company to refine its customer experience and value proposition far more effectively than generalist competitors – such as online travel giant Booking.com – cementing its position as market leader in this space.

While the looming global recession will likely result in reduced consumer spend on travel, the hosteling segment is relatively low cost.

This should enable Hostelworld to deliver more resilient returns than rivals targeting the broader travel industry, whose revenues will likely be dented by reduced take-up.

Inspired (INSE:AIM)

Inspired (INSE:AIM) is a good example of the way in which we have sought to exploit the increased dislocation between share prices and business fundamentals.

We invested in Inspired, which provides energy advisory and sustainability services to more than 2,900 UK businesses, having identified the opportunity through our investment platform.

The business case is clearly attractive. Inspired helps its clients rise to the growing imperative to operate more sustainably – requirements that will only become more demanding – but also to manage their energy consumption more efficiently.

This is crucial to clients given the elevated levels of energy prices. It also provides Inspired with counter-cyclical qualities – businesses will be especially focused on cost reduction during a difficult period of trading.

Importantly, Inspired has secured a high-quality management team that has extensive experience of building and exiting from businesses in this sector.

It also has an attractive financial profile – its model features high margins, low capital intensity, and growing revenue and profits; it also cash-generative with an attractive and growing dividend per share

Looking forward, there is every prospect of active consolidation in the marketplace, providing Inspired with an opportunity to grow through acquisition, as well as the potential to attract trade or private equity buyers.

In the meantime, the company’s valuation provides a generous margin of safety; its shares trade at a significant discount to those of its peers, and to recent M&A transaction multiples in the sector – as well as to the company’s own historical rating.

Our investment in Inspired is a good example of how the platform and capabilities we have developed to conduct such thorough risk management reviews of existing holdings can also be leveraged to deploy further capital into existing investments.

It provides a means through which to really get under the skin of potential investments – to really understand whether an apparent valuation anomaly stands up.

‹ Previous2023-04-06Next ›