The UK stockmarket’s still full of hidden gems: JEFF PRESTRIDGE on the dirt cheap potential winners

The UK stock market is on a roll. Despite all the gloom and doom on the employment front, and an inept government in charge of the nation’s tiller, the FTSE 100 Index – comprising the biggest listed companies in the country – is roaring away like a late winter fire.

With inflation creeping down towards 2 per cent and interest rates expected to ratchet down another quarter of a percentage point later this month, there seems every chance the FTSE 100 will break through 11,000 before spring is upon us.

Yet the boom in the equity market, which has seen the FTSE 100 shoot up by nearly a quarter over the past year, is far from over.

Financial experts believe that after a decade of being unloved, the UK stock market still holds plenty of attraction for both domestic and international investors.

Darius McDermott, managing director of fund scrutineer Chelsea Financial Services, describes the UK as a ‘value beacon in a global market full of bubbles’.

He says: ‘The reason British companies are being rerated is because valuations were too cheap to ignore – and are now drawing in global investors and takeover buyers. Indeed, rising merger and acquisition activity is revealing hidden value.

‘Corporate earnings are proving more resilient than expected, and, combined with high dividend yields and renewed overseas interest, this is shifting sentiment towards viewing the UK as a value opportunity.’

Chris Beauchamp, chief market analyst at investing trading platform IG, agrees. He says: ‘There are plenty of companies that trade at a discount to their five-year valuation, some substantially so. The list includes big names such as Legal & General, Sainsbury’s and even silver miner Fresnillo.’

In other words, although the UK stock market, as measured by the FTSE 100 and FTSE All-Share indices, has delivered a barnstorming performance over the past 12 months, it has been far from uniform.

As a result, there are hidden gems lurking out there which have the potential to make shrewd investors some tidy returns in the months and years ahead.

‘Share price gains over the past year have been concentrated in sectors such as defence, mining, banks and tobacco,’ explains Jason Hollands, managing director of investing platform Bestinvest.

‘Large swathes of the stock market, including many domestically focused businesses – have lagged behind. This disparity creates opportunities for investors with an eye for a deal – though it is important to be selective.’

He adds: ‘As fans of 1970s BBC series Fawlty Towers may well recall, when hotelier Basil defended his decision to hire a dubious plumber, the response of his wife Sybil was, “The reason he’s cheapish is he’s no bloody good!” ’

So, how do we identify some of the hidden gems of the UK stock market while side-stepping those companies whose shares have little chance of improving (which are known in the investment world as value traps)? Or are there investment funds which can do the heavy lifting for us?

Wealth sought the views of leading financial experts and fund managers. Some of these gems, as IG’s Beauchamp has already indicated, are to be found among mega UK stocks. 

But others lie lurking among the collection of mid, small and microcap-sized companies – the hunting ground for a number of specialist investment funds.

Although there are risks, Beauchamp says that ‘looking for possible bargains does go some way to providing that famed “margin of safety” for investors.’

Bargains among the large stocks 

A number of FTSE 100 stocks have taken a beating in recent weeks in response to growing concerns over the disruptive impact of artificial intelligence (AI) on their businesses.

They include the likes of Experian, London Stock Exchange (LSE), RELX and St James’s Place, whose shares fell sharply in the past month. RELX’s shares are down the most, by 11.9 per cent.

Yet some fund managers believe these price corrections are overdone, turning some of the companies’ shares into bargains.

Alan Dobbie, co-manager of Rathbone Income, has recently increased the fund’s exposure to analytics giant RELX while taking a stake in credit reporting agency Experian.

He says: ‘In both cases, we believe the market’s reaction has been kneejerk. RELX has invested heavily in AI-enabled legal tools and formed partnerships that position it well. Experian’s proprietary credit data is a powerful competitive moat that technology alone cannot replicate.’

Matt Britzman, senior equity analyst at investing platform Hargreaves Lansdown, also believes that the slide in RELX’s shares provides a chance for investors to ‘pick up a proven, resilient business at an unusually attractive valuation’. 

He adds: ‘While the pace of AI innovation is a genuine risk, the sell-off has raced well ahead of reality for a business that still looks far more like an AI winner than a casualty.’

Alex Wright, manager of funds Fidelity Special Values and Fidelity Special Situations, has used the market volatility caused by AI fears to buy more shares in wealth manager St James’s Place (SJP) at an opportunistic price. Wright does not believe AI will have any negative impact on SJP because of the personal nature of its business.

On a wider level, he describes the stock market as ‘an attractive hunting ground for contrarian investment opportunities’.

According to Dominic Younger, manager of investment trust CT UK Capital & Income, pest control business Rentokil represents ‘one of the most compelling hidden gem opportunities in the UK stock market’.

He explains: ‘After a period of challenges and issues following acquisitions, the market is struggling to price its cash flows with confidence. This uncertainty has left the shares looking undervalued relative to the long-term opportunity. For investors, this dislocation creates an attractive entry point.’

Alex Savvides, lead manager of investment fund Jupiter UK Dynamic Equity, says there are plenty of FTSE100 companies that are ‘trying to become better versions of themselves’.

They include the likes of Aviva, BP, Land Securities and Mony (owner of MoneySuperMarket) – companies that currently offer investors attractive dividend yields of between 5.1 (BP) and 7.4 per cent (Mony).

All are held in the Jupiter fund, where the dominant investment theme is buying businesses which are focused on changing for the better (see Fund Focus – Page 58). This might result from management change, the selling of business assets, cost savings – or a mix of them.

Hargreaves’ Britzman also believes shares in Marks & Spencer are trading at an attractive discount – a legacy, he says, of the operational issues it faced last year following a cyber attack.

He adds: ‘Underlying momentum in the business is encouraging, with gains in terms of market share for both food and fashion, home and beauty.’

Marks & Spencer and RELX are the only two UK shares to get on to the platform’s ‘five shares to watch’ list for this year.

Invest in specialist gem-hunting finds 

Investors can also reap the benefits from investment gems by investing in a fund set up to search them out.

Such funds come in all shapes and sizes, investing across the market – not just in FTSE 100 stocks. Some dig out bargains in the microcap space – smaller companies with market capitalisations of below £250 million.

Bestinvest’s Hollands says his company’s preferred funds in this space are Artemis UK Select, Fidelity Special Values and Temple Bar. ‘All operate within a broad value framework,’ he explains, ‘but each takes a distinct approach.’

Artemis UK Select targets businesses with strong growth potential that is not yet reflected in their share prices. Amongst its top-ten holdings are Marks & Spencer and SJP – stocks already identified by experts as bargains.

‘I like its focus on growth rather than simply targeting stocks that look optically cheap,’ says Hollands. ‘The managers also have the flexibility to take occasional short positions in shares they believe are overvalued and might fall in price.’

As already discussed, investment trust Fidelity Special Values is run by contrarian investor Alex Wright – assisted by Jonathan Winton. Their mission, says Hollands, is to invest in ‘unloved or misunderstood companies trading at a discount to their intrinsic value’.

But its distinguishing feature, he adds, is the managers’ willingness to invest across the market cap spectrum. Some 40 per cent of the portfolio is invested in FTSE 250 or FTSE Small Cap stocks.

In recent days, Wright has confirmed that he has increased exposure to recruitment businesses Page Group and Hays (both FTSE 250 listed) and SThree (part of the FTSE All-Share) in Fidelity Special Values and sister fund Special Situations.

‘Investors have viewed staffers [recruitment businesses] as vulnerable long before the emergence of AI,’ says Wright. ‘More recently, concerns about automation and job displacement have intensified those fears. However, we have yet to see clear evidence that AI has structurally impaired these businesses.’

Temple Bar, Hollands’ final gem-hunting pick, is run by Ian Lance and Nick Purves of asset manager Redwheel.

The managers focus on companies trading at significant discounts to their assessment of long-term earnings power.

Their top-ten holdings include FTSE 100 ‘bargains’ Aviva and Marks & Spencer.

Over the past year, these three funds have respectively delivered investor returns of 26.9, 42.5 and 40.7 per cent.

To put these numbers into perspective, they compare with the total return from the FTSE 100 of 28.6 per cent and 27.5 per cent from the FTSE All-Share.

Going forward, Hollands says that such a bargain-hunting investment approach should continue to ‘uncover opportunities the broader market has yet to fully recognise’.

Other similar funds that investors might want to take a look at include Jupiter UK Dynamic Equity and Schroder Recovery – picks made by Chelsea’s McDermott.

Ben Kumar, head of strategy for wealth, investment and public policy at Seven Investment Management, says his company’s ‘selection team’ like £2.3 billion investment fund Man Income.

‘The managers, Henry Dixon and Jack Barat, are really good at finding value opportunities outside of the FTSE 100,’ says Kumar.

‘Some of the gems they’ve been building large positions in include housebuilders Barratt Redrow, Bellway, and Taylor Wimpey – and insurers Lancashire Holdings and Beazley, subject to a bid from Zurich Insurance.

Respective one-year returns for the three funds are 25.5, 32.2, and 28.4 per cent.

… and don’t forget UK-focused firms

AJ Bell investment director Russ Mould says the areas of the UK stock market that ‘still feel unloved or are only addressed in dismissive terms’ are those exposed to the domestic economy. That means housebuilders such as Barratt Redrow and Bellway.

Laurence Hulse, manager of investment trust Onward Opportunities, believes there are plenty of gems to be found among the microcap stocks that he rummages around in.

He says that such companies are poorly covered by investment analysts, meaning great-value stocks are waiting to be discovered. ‘I see myself as a stock sleuth,’ says Laurence. 

‘Every month, with the help of my analyst, we do quantitative analysis on our universe looking at key financial numbers such as cash flow, gross margins and borrowings.

‘Alongside this, we use AI to scrape all the regulatory news announcements [commonly known as RNSs] looking for information that might be of interest – a change of chief executive, for example.

‘This allows us to strip out many companies, concentrating our effort on those that remain and which have an interesting thesis.’

Although Onward is just three years old and small at £42 million, it has delivered shareholders returns of 40 per cent – better than the 34 per cent gain from the average UK smaller companies trust over the same period.

Successful investments include Pebble Beach Systems, a broadcast software company which it bought in August 2024.

As a result of paying down debt and increasing margins, its shares are up more than 178 per cent over the past year.

With the recent winning of a big contract from a US streaming company, Hulse believes the shares remain mispriced. ‘It’s a real gem,’ he declares.

Other UK smaller companies’ funds with a successful track record of hunting down gems include Aberforth Smaller Companies, River UK Micro Cap and Rockwood Strategic.