We recommended this stock in 1964 and we're buying it again today

Telegraph

4 days ago

Questor is The Telegraph's stock-picking column, helping you decode the markets and offering insights on where to invest
Investors are finally beginning to realise that the FTSE 100 is unjustifiably cheap. Its international focus amid a period of monetary policy easing across developed economies, plus several years of underperformance versus other major indexes, mean many of its members offer excellent value for money.
In Questor's view, it is now only a matter of time before investors similarly realise that the FTSE 250 offers significant long-term growth potential. It has produced even more disappointing returns over recent years than the large-cap index, having risen just 30pc in the past five years versus a 55pc gain for the grossly underperforming FTSE 100 index over the same period.
The mid-cap index's UK focus means it is set to be catalysed by the economic impact of the Bank of England's increasingly loose monetary policy, which leaves it well placed to move significantly beyond a record high that still stands 10pc above the index's current level.
As a result, the Mercantile investment trust becomes the latest addition to our wealth preserver portfolio. The company aims to achieve long-term capital growth by focusing on UK small and mid-cap stocks, such as those listed in the FTSE 250, and has produced an annualised capital gain of 7.6pc over the past decade. This compares favourably with a 4.9pc capital gain for its benchmark, which is the FTSE All-Share index excluding the FTSE 100 and investment trusts.
The company currently trades at an 8pc discount to net asset value (Nav). Although this is slightly narrower than the 10pc average discount recorded over the past year, it still suggests that investors can buy heavily discounted UK small and mid-cap stocks at a relatively attractive price. With a gearing ratio of 14pc, the company is well placed to capitalise on what this column believes will be a rising FTSE 250 index over the coming years.
Certainly, relatively high leverage suggests that the company's share price is likely to be volatile, but given this column's long-term focus, sharp short-term fluctuations in market value are not viewed as a major cause for concern. Additionally, with the trust's largest holdings dominated by high quality companies such as food producer Cranswick, housebuilder Bellway and retailer Dunelm, its long-term prospects appear to be upbeat.
The trust currently has noteworthy overweight exposure, compared with its benchmark, to the financials and consumer discretionary sectors. Given these are cyclical sectors whose performance is heavily influenced by the economy's prospects, this further suggests the company is positioned to benefit from an improving outlook for UK GDP growth amid a likely fall in inflation and further interest rate cuts.
Alongside its capital growth potential, the trust offers income investing appeal. Although it currently yields a rather modest 3.1pc, which is 20 basis points lower than the FTSE 250's yield, its dividend growth rate is likely to be catalysed by increasingly buoyant operating conditions for its holdings. It also has an excellent track record of shareholder payouts, with dividends either maintained or increased in each of the past 33 years.
While Mercantile has not featured in our wealth preserver portfolio until now, it has previously been tipped by Questor – in fact, it was recommended in our very first column. Since our more recent ''buy' recommendation in June 2023, it has produced a 24pc capital gain and outperformed the FTSE 250 index by nine percentage points. It has also risen by 6pc since being added to our income portfolio during August last year.
To make way for the company in our wealth preserver portfolio, Currys, Admiral and RWS will now be removed. They have produced total returns of -6pc, 30pc and -75pc, respectively, since being added to the portfolio during June 2021.
In Questor's view, using the capital raised from the removal of those three stocks to fund the notional purchase of Mercantile represents a logical long-term move. The trust's focus on UK small and mid-cap stocks means it should benefit from a period of sustained interest rate cuts that boosts earnings growth and prompts higher stock market valuations.
Given the company trades at a sizable discount to Nav and has an excellent track record of benchmark outperformance, it offers a favourable risk/reward opportunity on a long-term view.