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Ben Yearsley: For the bargain-hunters, it's a numbers game


We all would like to acquire things for less than their worth. Whether it's houses, antiques, cars or groceries it's always nice to secure a bargain. What makes Henry Dixon and George Godber of Matterley Undervalued Assets Fund excited is their quest to find cheap companies, wherever they may be in the UK market.

Cheap is of course a very subjective word and clearly has to be used in the right context. Some cheap items aren't worth paying up for and you have to be selective. As Warren Buffett put it, "Price is what you pay, value is what you get". The Matterley managers are therefore looking for two specific features when considering cheap or undervalued shares. First, they identify companies where the share price doesn't fully reflect the value of the assets; ie the company is trading at below its replacement cost. Second, they hope to find businesses whose profit streams have been underestimated by the wider market. In other words the return the firm can generate from its assets is not fully appreciated.

Naturally, these criteria tend to filter out a disparate range of businesses large and small, so this fund could certainly not be accused of being a closet tracker hugging a benchmark. The 40 to 60 stocks in the portfolio enter it based on merit, rather than simply being large constituents of the FTSE100.

Understandably, Messrs Dixon and Godber spend a long time analysing reports and accounts from companies, as well as trading updates as soon as they are announced. This fundamental analysis leads them to construct a valuation matrix that places companies in one of three groups, undervalued assets, undervalued returns or overvalued. Looking at the FTSE100, they currently estimate that about 25 per cent of companies are overvalued, 25 per cent are in the undervalued assets camp and 50 per cent are in the undervalued returns camp. Their database covers almost 800 companies and it is interesting to compare the numbers now to, say, 18 months ago, when they believed that more than 55 per cent of companies in the FTSE100 were overvalued. This focus on the balance sheet and future cash-flows helps them avoid the value traps, companies that look cheap but are fundamentally in decline.

One company they are excited about is Sainsbury's, where they think the market capitalisation of the company is way below replacement cost. The market capitalisation is about the £5.5bn mark, but it would cost, in Matterley's opinion, approximately £14bn to replace their retail space. In other words, for every £1 you invest in Sainsbury's, you are in theory buying far more in physical assets.

And, since the present CEO, Justin King, arrived in 2004, sales have risen by 50 per cent, profits have increased and the dividend has doubled, yet the share price has basically gone nowhere. A more recent addition to the portfolio is Cairn Energy, where Matterley believe that the company has approximately £1.5bn more in cash in the bank than the market capitalisation.

It often takes time for the market to recognise undervalued companies, so this is definitely a fund to buy and tuck away for the long term. Although Matterley is probably a fund management company you have never heard of (it is actually owned by the more widely known Charles Stanley Group), in my view Mr Dixon and Mr Godber are a management team worth following closely.

Ben Yearsley is investment manager at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.h-l.co.uk/independent