UK Edition
Questor: Brooks Macdonald is that rare thing, a promising stock that isn’t at a pricey valuation
“I can show you loads of great businesses but they are all trading at 23 times earnings.”
This lament, from one of Britain’s most successful fund managers, reflects a widely held frustration among investors over what some call the “everything bubble”. But the manager, Anthony Cross of Liontrust, went on to offer Questor some consolation.
He said Brooks Macdonald, the Aim-quoted wealth management firm, had many attractive aspects and its shares were far from expensively valued at a price-to-earnings ratio of 13, based on expected profits for the year to June 2019.
“That valuation makes the stock much more interesting from a risk/reward point of view,” he said. He holds Brooks in his firm’s Special Situations fund, co-managed with Julian Fosh.
Brooks Macdonald is a “private client” money manager, so it differs from, say, Liontrust in that it has a direct relationship with its customers, who include wealthy individuals, as well as charities and financial advisers.
Private client firms tend to operate via offices in towns and cities across the country so that they can meet customers in person, and Brooks has been extending its network of branches, currently 11 strong.
Other drivers of organic growth, Cross said, have been good investment performance and the company’s relationships with financial advisers, who will often outsource the management of their own clients’ investments to firms such as Brooks.
In recent years it has had to spend considerable sums on complying with new rules, upgrading its computer systems and meeting costs arising from its troublesome acquisition of a Channel Islands firm. But once it is through this phase it should start to reap the benefits of what fund managers call “operational gearing”: the tendency for profits to take off when an increase in revenues combines with a relatively fixed cost base.
It already runs about £12.5bn for its clients and, while its charges have fallen as a result of competitive trends in the industry, it remains a high-margin business. There is relatively little need for ongoing investment so returns on capital are decent and conversion of profits into cash is good, Cross said.
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“It’s a nice clean business,” he added. “Another point in its favour is that the average age of its clients is lower than at some rivals and it has a good record of attracting new ones. There is also a very strong culture and the firm has won awards for being a good place to work, which is important in what is a people business.”
Although the yield is a relatively modest 2.2pc the company has increased its dividend every year since its flotation in 2005.
“If Brooks can put the period of extra expenditure and the problematic acquisition behind it the shares could do quite nicely – we could see a 20pc rise over the next two years,” Cross said.
“But if it remains too cheap for too long, someone will notice. There is always consolidation going on in this sector; good franchises such as Brooks don’t come along all the time. However, we don’t want it to be taken over, we want it to keep chugging away.”
Questor says: buy
Ticker: BRK
Share price at close: £18.70
Update: Gamma Communications
Anthony Cross also holds Gamma Communications, first tipped by Questor in November 2016. The shares have risen by 82.6pc since then so we asked him if he was still comfortable owning the stock.
“We are still holders,” he said. “Yes, it now has a highish valuation, as do lots of small companies. However, Gamma is a business that often beats earnings expectations, which makes the true valuation not as high as the headline figure may suggest.”
He acknowledged that any slowing of this momentum could see the shares retreat but added: “We look for quality companies with strong barriers to competition, then we roll with fluctuations in valuation and allow compounding to do its work over the long term. We have no worries about the underlying business.”