Mark Slater: UK growth companies are now ‘value’ shares

Slater Growth manager Mark Slater sits down with ii's Sam Benstead to discuss the opportunities in the UK stock market.

He speaks about his investment approach, which uses both quantitative and qualitative techniques, and gives examples of companies that fit his strict criteria. He says that UK growth companies are now very cheap, making this an opportune moment to invest. Slater is the founder of Slater Investments and has been managing Slater Growth since 2005.

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Sam Benstead, deputy collectives editor, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Mark Slater, manager of the Slater Growth fund. Mark, thank you very much for coming in.

Mark Slater, manager of the Slater Growth fund: A great pleasure.

Sam Benstead: You are a growth investor investing in the UK. Is that a contradiction?

Mark Slater: Growth is something that means different things to different people, in the same way that value does. These are very poorly defined terms. Some people take the idea that growth is extreme momentum, very high prices, often no profit at all. Our version of growth is double-digit earnings growth. We only invest in profitable businesses, and we obviously want that to be sustained over a long period of time. So, it's a very attainable target of double-digit growth. It's still meaningful.

Obviously, sometimes we find companies which are growing quite a lot faster than 10%. And the risk profile, obviously, for the type of growth we're looking for is much, much lower. The UK gets a bad rap and it has now for some time. But Schroders did some very interesting research on this. The probability they found over a 10-year period of finding a 10-bagger, a company that goes up tenfold, is significantly higher in the UK than it is in the US. The instance over a decade, I think, was something like 6% in the UK versus 4.7% in the US. So, the UK is an awful lot better as a hunting ground than people think.

Sam Benstead: So, you're looking for fast-growing companies, double-digits' annual earnings growth. Where are you finding opportunities that meet that criteria?

Mark Slater: At the wide end of the funnel, we're looking for that, for growth, forecast growth. We're also looking for the ability to buy that growth cheaply, and our primary measure of the price of growth is the price/earnings-to-growth (PEG) ratio. So, we're comparing the price to earnings (P/E) with the growth rate on a prospective basis. And the other really important criterion is cash flow, and that is a really good sanity test on the degree to which profit is real.

Those three primary focuses give us a shortlist of roughly 5% of the market. So, we eliminate 95% very, very quickly. And from there on in, our focus goes from being quantitative to entirely qualitative. In other words, if a business is, on the face of it, growing, and it's relatively cheap, and it's generating cash, then all you're really interested in at that point is whether it's going to continue. The degree to which it's reliable. So that really becomes our focus once we have our shortlist.

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Sam Benstead: So, assessing that future growth, what questions are you asking company management? What signs are you looking for that a company's in a good position to keep growing?

Mark Slater: Well, a lot of the analysis is about the sector. The type of business you're looking at, that obviously is very important. Its position in its sector, its competitive position, as well. Its scope for growth. When we meet management teams, we're trying to understand their long-range plans, and that's much more interesting because you can then get away from all the restrictions around the current year.

It's quite difficult for management teams to talk about what's happening in the next few months. We're not that interested in the next few months. So, once you get into the three/five-year outlook and what the obstacles might be, what the risks are, what the opportunities are, it's a much more interesting conversation. It's a much freer conversation. But it's very subjective. There are very few objective hallmarks that guide you as to whether a company is going to grow on a multi-year basis. So, a lot of it is experience, really, and a lot of it's common sense.

Sam Benstead: Are there any companies that you've bought recently that you're particularly excited about?

Mark Slater: Well, I would say, unlike a couple of years ago, right now, pretty well all growth companies are valued as value companies. In other words, they're all very lowly rated. So, it's a very interesting environment now for growth, or for any type of investing in the UK I think, but particularly for us.

So, the kind of businesses we've been buying recently, Franchise Brands (LSE:FRAN) is a business that we bought relatively recently, which we think is a first-class business, it has the best management team in the franchise industry. It's the team [where] the chief executive or the chair is the person who built Dominos in the UK into a very successful business from nothing. And it's a primarily business-to-business franchise operation across a number of brands. But that business is growing 15-20% per annum in terms of earnings. They're trading on around 12.5 times after tax profit, P/E, so it's very lowly rated for that kind of business, which is very resilient. And with one of the best management teams in the country, or probably in the world, actually. So that's the sort of thing.

We've also been buying shares in Loungers (LSE:LGRS), which I think is the best leisure operator in the UK. They have the best like-for-like sales growth record of any business of their type. It's trading well below its IPO price of many years ago. And the business has got a runway to treble its size. It can finance everything internally. So, businesses of that kind, I mean, they're all different. But businesses that can grow over a multi-year period significantly, which we can buy cheaply.

Sam Benstead: And are you generally finding the best opportunities in smaller companies, and do you invest in the AIM market as well?

Mark Slater: We do. So, the first part of your question is yes, I would say we have a bias between mid and small-cap. We don't exclude large-cap and we do invest in larger companies, but not many large companies are growing at double-digit rates. So, there have been times over a long period of time, there have been a few occasions, where we've had a lot more in large-cap, but that isn't the case today.

So, I think small and mid-cap has been beaten up much more than any other part of the market. It's very cheap, that part of the market. So that's our focus today. AIM is something we're interested in, and we don't really make a distinction between AIM and full list. In terms of liquidity, it's the same. Quite a lot of the businesses we own on AIM are capitalized [in the] hundreds of millions if not billions, and they're not tiny companies. I think it's right that AIM comes with a health warning because I think 80% of AIM is uninvestable, but the 20% that's good is often very good.

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Sam Benstead: And in that 20%, could you give us some examples of companies that you own there?

Mark Slater: Well, Franchise Brands is one. I think Loungers is also on AIM, but we don't make a distinction. So, I almost have to think about it quite hard to know where they are. But, we have plenty of companies on AIM. We have CVS Group (LSE:CVSG), the veterinary surgery business, it's a decent-sized business, that's on AIM. You can find quite large companies there. So, we have no prejudice against AIM at all. The only risk with AIM is if some of the tax advantages were removed, but right now, there is no premium for that at all.

Sam Benstead: You said before that smaller companies are very cheap at the moment, so what is the discount to large companies, if there is one, and why is there a discount there at the moment?

Mark Slater:I think a lot of it's fashion. I think we're in a phase now where the UK is deeply out of fashion. That has been the case for a little while, but it's become very extreme in the last year or two. And you can see it in the press, it's fashionable for people to think the UK is a disastrous economy. The facts don't support that. But it's fashionable to beat up on everything that's to do with the UK. And I think mid and small-cap are more vulnerable, mainly for liquidity reasons.

If people are selling, and in bear markets people sell, there's a lot of selling, they're more vulnerable to selling pressure. There's a bigger reaction to it. And then that becomes self-fulfilling. So, if a fund has redemptions, they then have to sell some stocks. That drives shares down, that means performance is worse, they have to have more redemptions. So, there's a bit of that going on, which is more impactful in the mid and small-cap space than it would be in the larger companies’ space. I don't have a number off the top of my head for what the exact discount is, but it's wider than normal, much wider than normal.

Sam Benstead: Tesco (LSE:TSCO) and Prudential (LSE:PRU) are large companies that don't scream growth to me, but they make it into the top 10 of your portfolio. Why do they make the grade?

Mark Slater: Well, we're happy with double-digit growth. So, they're not super-dynamic, but they're growing, in our view, at around 10%. I mean, Prudential had numbers today where they were producing much higher numbers than that. But there's an element of recovery there because of the Chinese business being shut down during Covid.

But, we would expect 10% per annum-plus from Prudential. They're aiming for much bigger numbers than that on the five-year plan, they're aiming for 15-20%. Similarly, Tesco is very cheaply rated, chucking out lots of cash. Its competitive position is probably the best it's been in years. Two of their major competitors are hobbled with a lot of debt. The discounters are becoming big, and so that's going to have some effects on them too. And they're also, in our view, going to deliver around 10%. The first half of the current year, the retail business in the UK delivered 14% profit growth. So, they're not in the category of, for instance, a Franchise Brands. That's growing a lot quicker. But they're very attractive.

Sam Benstead: And are there any sectors that you avoid because of the lack of growth there?

Mark Slater: We look at everything, at the wide end of the funnel, we look at everything. There are certain types of operation we're less likely to be keen on. Businesses that guzzle capital, we're less likely to be keen on because we're focused on cash flow. Because we want to get some reassurance that growth will continue on a multi-year basis, we're trying to avoid more cyclical businesses, but we cast the net wide initially.

Sam Benstead: Mark, thanks for coming in.

Mark Slater: Thank you. 

Sam Benstead: And that's all we've got time for. You can check out more Insider Interviews on our YouTube channel where you can like, comment and subscribe. See you next time.