When companies list shares on public markets, the offering is frequently accompanied by a fanfare from stockbrokers and bankers, whose aim is to create a huge sense of excitement about the company and sell it at the best (that is, highest) price they can achieve.
A contrarian investor is naturally wary of these high-profile IPOs because they often allow little room for disappointment. As a result, I usually leave most of these offers on the table, preferring to scour the market for stocks that have been left behind or forgotten by other investors.
However, somewhat unusually, the past few months have seen a few offerings that have met my bargain-hunting criteria. This is due in large part to the sheer volume of companies trying to list shares at the moment. The first week of April saw the biggest week of deals in the European IPO market since November 2006.
In this environment, only the most exciting stories made it to the top of the pile, with the less trendy businesses escaping the hype and attracting less capital.
I will give two instances of this type of situation below and, as always, these are intended as examples of my investment process in action rather than recommendations to buy.
McColls Retail runs convenience stores and newsagents across the country and as such is a stable and defensive business which should perform well throughout the economic cycle. Although it has low margins, the cash it generates can be invested at attractive rates of return, principally by buying out retiring shop owners and/or converting existing newsagents into higher-margin convenience formats. The cash it raised by listing shares allows it to accelerate this process, which should provide it with a fairly low-risk and steady growth platform over several years.
There have been a large number of offerings in the retail sector in the past couple of months but capital was drawn to the companies promising high growth and online opportunities, leaving little room at the table for an old-fashioned business like McColls. I, however, like these steady smaller companies.
Other investors often underestimate the extent to which they can grow earnings because their end-markets are not experiencing significant demand growth. What their analysis misses is the value that disciplined capital allocation in a stable end-market can create for investors over the years.
A similar idea applies to DX Group. This company’s background is in providing a courier service to the legal industry. I could buy shares in it at an attractive price because many investors were dismissive of the uninspiring total demand outlook for this market.
In fact, I think the growth prospects for this company are good with potential to leverage its existing delivery network and a recent acquisition into parcel delivery. With the logistical infrastructure already largely in place, the growth in demand for parcel delivery occurring as a result of e-commerce could be a very profitable opportunity for the company and one that the market seems to have missed.
As I mentioned, I think these opportunities have arisen because the large number of IPOs in the market has inevitably led to some getting left behind. It is worth dwelling for a moment on what this large volume tells us about current market conditions.
Indeed, some commentators have suggested that it may indicate an irrationally optimistic market and be predictive of troubles ahead.
At a recent discussion commemorating his retirement from fund management, Anthony Bolton, the first manager to run the Special Values portfolio, was asked whether he saw a dangerous bubble in equity markets.
His response was that although confidence has improved, we are not witnessing any of the strange behaviour typically associated with bubbles.
I think Bolton’s perspective is highly valuable as it is partly his stewardship through the undulations of the past 20 years that has made Special Values a rewarding investment for long-term clients.
I agree with his assessment. While the current market psychology is certainly capable of short bursts of over-confidence, a sense-check has (so far) never been far away.
Recent price activity has rewarded companies delivering but harshly punished those falling short of expectations.
This makes me constructive on the ability of stockpicking strategies to create value for shareholders over the coming months and years.
Alex Wright is portfolio manager of the Fidelity Special Situations fund, Fidelity Smaller Companies fund and Fidelity Special Values plc.