Slow-burning recovery stocks can lift your portfolio from the ashes

Although economic gloom is everywhere and President Trump is causing a rumpus with his ‘America first’ approach, the UK stock market remains unfazed. 

Despite a few wobbles last week – and more to come as Trump rattles international cages – both the FTSE100 and wider FTSE All-Share indices have been resilient.

Both are more than 13 per cent higher than this time last year – and close to record highs. 

Against this backdrop of economic uncertainty, Trump rhetoric and near-market highs, it’s hard to believe that any outstanding UK investment opportunities for patient investors exist – so called ‘recovery’ situations, where there is potential for the share price of specific companies to rise like a phoenix from the ashes.

But a band of fund managers is specialising in this contrarian form of investing: buying undervalued companies in the expectation that over time the market will reflect their true worth.

This undervaluation may result from poor management leading to business mistakes; an unfriendly economic and financial backdrop; or wider issues in the industry in which they operate.

Yet, the fund managers who buy these shares believe the ‘problems’ are solvable, although it might take up to five years (occasionally less) for the results to be reflected in far higher share prices. Sometimes, to their dismay, the problems prove unsolvable.

Max King spent 30 years in the City as an investment manager with the likes of J O Hambro Capital Management and Investec. He says investing for recovery is high risk, requires patience, a disregard for consensus investment thinking – and nerves of steel.

He also believes it has become crowded out by both the expansion in low-cost passive funds which track specific stock market indices – and the popularity of growth investing, built around the success of the big tech stocks in the US.

Yet he insists that recovery investing is far from dead.

Last year, King says numerous UK recovery stocks made shareholders stunning returns – including banks NatWest and Barclays (still recovering from the 2008 global financial crisis) and aerospace and defence giant Rolls-Royce Holdings (booming again after the impact of the 2020 pandemic lockdown). They generated respective returns for shareholders of 83, 74 and 90 per cent.

Some shares, says King, have more to offer investors as they progress from recovery to growth. ‘Recovery investors often buy too early,’ he says, ‘then they get bored and sell too early.’

But more importantly, he believes that new recovery opportunities always present themselves, even in a rising stock market. For brave investors who buy shares in these recovery situations, stellar returns can lie at the end of the rainbow.

With that in mind, Wealth asked four leading fund managers to identify the most compelling UK recovery opportunities.

They are Ian Lance, manager of investment trust Temple Bar and Alex Wright who runs fund Fidelity Special Situations and trust Fidelity Special Values. These two managers embrace the recovery investment thesis 100 per cent.

Completing the quartet are Laura Foll, who with James Henderson runs the investment portfolio of trust Law Debenture, and Imran Sattar of investment trust Edinburgh.

These two managers buy recovery stocks when the investment case is compelling, but only as part of broader portfolios.

‘Recovery stocks are in our DNA,’ says Lance who runs the £800 million Temple Bar with Nick Purves. ‘The logic is simple. A company makes a strategic mistake – for example, a bad acquisition – and their share price gets cratered. We buy the shares and then wait for a catalyst – for example, a change in management or business strategy – which will transform the company’s fortunes.

‘Part of this process is talking to the company. But as an investor, you must be patient.’

Recent success stories for Temple include Marks & Spencer which it has owned for the past five years and whose shares are up 44 per cent over the past year, 91 per cent over the past five.

Fidelity’s Wright says buying recovery shares is what he does for a living. ‘We buy unloved companies and then hold them while they hopefully undergo positive change,’ he explains.

‘Typically, any recovery in the share price takes between three and five years to come through, although occasionally, as happened with insurer Direct Line, the recovery can come quicker.’

Last year, Direct Line’s board accepted a takeover offer from rival Aviva, valuing its shares at £2.75. As a result, its shares rose more than 60 per cent.

Foll says recovery stocks ‘are often big drivers of portfolio performance’. The best UK ones, she says, are to be found among underperforming mid-cap stocks with a domestic business focus.

Sattar says Edinburgh’s portfolio is ‘diverse’ and ‘all weather’ with an emphasis on high-quality firms – it’s awash with FTSE100 stocks. 

So, recovery stocks are only a slivver of its assets. 

‘For us to buy a recovery stock, it must be first and foremost a good business.’ 

So, here are our investment experts’ top picks. As Lance and Wright have said, they may take a while to make decent returns – and nothing is guaranteed in investing, especially if Labour continues to make a pig’s ear of stimulating economic growth.

But your patience could be well rewarded for embracing ‘recovery’ as part of your long-term investment portfolio.

> Search for the stocks below, latest performance, yield and more in This is Money’s share centre  

WINNERS IN A POSSIBLE HOME BUILDING BOOM

Marshalls is the country’s leading supplier of building, landscaping, and roofing products – buying roofing specialist Marley three years ago. 

Yet it has struggled to grow revenue against the backdrop of ‘challenging markets’ – last month it said its revenue had fallen £52million to £619 million in 2024.

The share price has gone nowhere, falling 10 and 25 per cent over the past one and two years.

Yet, lower interest rates – a 0.25 per cent cut was announced by the Ban>k of England last Thursday – and the meeting of an annual housebuilding target of 300,000 set by Chancellor Rachel Reeves may help ignite Marshalls’ share price.

Law Debenture’s Foll says any pick-up in housebuilding should result in a demand surge for Marshalls’ products, flowing through to higher profits. ‘Shareholders could enjoy attractive total returns,’ she says, ‘although it might take a while for them to come through.’ Edinburgh’s Sattar also likes Marshalls although, unlike Foll who already holds the company’s shares in Law Debenture’s portfolio, it is only on his ‘radar’.

He says: ‘Its sales volumes are still below pre-pandemic levels. If the Chancellor does her bit to re-

ignite housebuilding, then it should be a beneficiary as a supplier of materials to new homes.’

Sattar also has an eye on builders’ merchant Travis Perkins which he has owned in the past. ‘It has fresh management on board [a new chairman and chief executive] and I have a meeting with them shortly,’ he says.

‘From an investment point of view, it’s a picks and shovels approach to benefiting from any expansion in the housing market which I prefer to buying shares in individual housebuilders.’

Like Marshalls, Travis Perkins’ shares have gone nowhere, falling by 7, 33 and 50 per cent over one, two and three years.

Another beneficiary of a possible housebuilding boom is brick manufacturer Ibstock. ‘The company has big fixed costs as a result of heating the huge kilns required to make bricks,’ says Foll.

‘Any uptick in housebuilding will increase brick production and sales, having an exaggerated benefit on its operating costs.’

Lower interest rates, she adds, should also be a positive for Ibstock. Although its shares are 14 per cent up over the past year, they are up a meagre 0.3 per cent over two years, and down 11 and 42 per cent over three and five years.

Fidelity’s Wright has also been buying shares in two companies which would benefit from an improvement in the housing market – kitchen supplier Howden Joinery Group and retailer DFS Furniture.

Both companies, he says, are benefiting from struggling competitors. In Howden’s case, rival Magnet has been closing showrooms, while DFS competitor SCS was bought by Italy’s Poltronesofa, which then closed many SCS stores for refurbishment.

DFS, a Midas pick last month, has seen its share price rise by 17 per cent over the past year, but is still down 41 per cent over three years. Howden, a constituent of the FTSE 100, has made gains of 6 per cent over both one and three years.

FUND MANAGER WORTH MORE THAN ITS PARTS

Temple Bar’s Lance doesn’t mince his words when talking about FTSE250-listed fund manager Abdrn. ‘People are right when they describe it as a rather struggling fund management company,’ he says.

‘Yet what they often don’t realise is that it also owns a successful investment platform in Interactive Investor and an adviser business that, combined, justify its market capitalisation. In effect, the market is putting little value on its fund management business.’

Add in a pension fund surplus, a big multi-million-pound stake in insurer Phoenix – and Lance says shares in Abrdn have ‘great recovery potential’.

Temple Bar took a stake in the business at the tail end of last year. Lance is enthused by the company’s new management team which is intent on trimming costs.

Over the past one and three years, the shares are down 3 and 34 per cent, respectively.

OTHER RECOVERY POSSIBILITIES

Fidelity’s Wright says a recovery stock tends to go through three distinct phases.

First, a company embarks on positive change (stage one, when the shares are dirt cheap). Then, the stock market recognises that change is in progress (stage two, reflected by a rising share price), and finally the price fully reflects the changes made (stage three – and time to consider selling).

Among those shares he holds in the stage one bucket (the most exciting from an investor point of view) is advertising giant WPP. Wright bought WPP last year for Special Values and Special Situations. 

Over one, two and three years, its shares are respectively up by 1 per cent and down by 22 and 33 per cent.

‘WPP’s shares are cheap because of the difficult advertising backdrop and concerns over the possible disruptive impact of artificial intelligence (AI) on its revenues,’ he says. ‘But our analysis, based in part on talking to WPP customers, indicates that AI will not disrupt its business model.’

Other recovery stocks mentioned by our experts include engineering giant Spirax Group. Its shares are down 21 per cent over the past year, but Edinburgh’s Sattar says it is a ‘brilliant UK industrial business, global in reach’.

He is also a fan of pest control giant Rentokil Initial which has experienced repeated ‘hiccups’ over its expensive 2022 acquisition of US company Terminix.

Sattar holds both stocks in the £1.1 billion trust.