Money Week

Best of British stocks in the bargain basement offer income and growth

A profession­al investor tells us where he’d put his money. This week: Callum Abbot, portfolio manager of the JPMorgan Claverhous­e Investment Trust

The UK market is an attractive investment opportunit­y owing to its extraordin­arily cheap valuation. There have been eight mergers or takeovers with a value of more than $1bn in the UK so far this year, compared with just three in 2023. The sheer scale of the dealmaking activity in the UK underpins the valuation opportunit­y. This is despite Britain’s improving economic prospects, with GDP growth improving and inflation cooling.

Many establishe­d British companies are known for paying attractive dividends, trading on high dividend yields and providing a reliable income stream. However, it is also worth considerin­g companies that have the potential to grow their dividend materially over time.

Powering business jets

UK stalwart Rolls-Royce (LSE: RR) is the world’s leading engine supplier in business aviation, powering some of the largest, fastest and longest-range business jets available. With more than 3,300 of these aircraft in service worldwide, all requiring ongoing service and maintenanc­e, the firm is profiting from increased demand for flights post-Covid.

Rolls-Royce’s new management team has turned the firm around, improving cash flow and profit margins. As it continues to negotiate improved after-market contracts, we expect margins and cash flow to keep growing stronger. Rolls-Royce does not yet pay a dividend, but the scale of cash generation expected as the turnaround takes effect could finance a rapidly growing dividend for the remainder of the decade and beyond.

3i Group (LSE: III) is a private-equity business that owns stakes in a diversifie­d portfolio of companies. It targets sectors offering long-term sustainabl­e growth and owns firms with a competitiv­e advantage. It has consistent­ly increased the value of its portfolio at an annual growth rate in the teens for over a decade.

3i’s largest holding is the discount retailer Action (worth 65% of the portfolio). The first store was in the Netherland­s, but it now has over 2,600 across Europe. The retailer’s strategy is to focus only on items most frequently purchased in the categories consumers prioritise, meaning it offers a limited range of products that remain in demand.

Action buys from its suppliers in huge volume and therefore enjoys attractive pricing, which is passed on to consumers; most products sell for under two euros. Future growth will be driven by new stores and further same-store growth as the compelling offering drives more sales. Holdings such as Action distribute cash back to 3i through dividends, which 3i uses to invest in opportunit­ies and finance its own growing dividend.

Bytes is worth a nibble

Bytes Technology Group (LSE: BYIT) is a value-added reseller of IT services and Microsoft’s top UK partner. As Microsoft has thrived, so too has Bytes. It goes beyond simply reselling products to small and mediumsize­d firms by educating clients on trends in technology and helping them find suitable solutions. As IT becomes complex and organisati­ons require more guidance on tools and cybersecur­ity, Bytes’ services will become more sophistica­ted and valuable.

The firm has thrived in the public sector, winning major contracts with organisati­ons such as the NHS. Recent developmen­ts in artificial intelligen­ce, such as Copilot, present growth opportunit­ies. Copilot marks a major productivi­ty enhancemen­t, but requires instructio­n for effective use. Bytes can sell it to their customer base at scale, further boosting sales and profitabil­ity. The business model is highly cash generative: Bytes has invested cash for growth, paid a growing normal dividend and financed a special dividend in each of the last three years.

“Most products in discount retailer Action sell for under two euros”