10 blue-chip shares for contrarian investors

Stockopedia’s Ben Hobson takes a contrarian approach to British large-caps, seeing scope to pinpoint unloved stocks that might bounce back.

Eighty years ago, an investor called John Templeton made a series of trades that eventually helped to cement his status as one of the world’s most-respected value investing ‘contrarians’.

With America just emerging from the Great Depression, Templeton (who was only in his late 20s at the time) sensed an opportunity. He bought $100 of every stock trading below $1 on the New York and American stock exchanges, paying around $10,400 for stakes in 104 companies. Four years later, 34 of those companies had gone bust but he had still made four times his money.

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Templeton went on to build a career as an investor who was prepared to look almost anywhere in the world to find value. His strategy marked him out as a contrarian, which was summed up in one of his best-known quotes: “Bull markets are born in pessimism, grow on skepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.”

Back to the present day, markets have been broadly bullish this year, and even this week’s fall in prices now looks like a momentary blip. But that doesn’t mean that contrarian value opportunities aren’t out there...

The makings of a contrarian

Contrarian investors go against the herd. They take the psychologically difficult route of buying stocks that most of us won’t touch. These are the investors who target unloved, perhaps even distressed companies, on the basis that a change in conditions will likely see them recover. It was contrarians who made serious money in the early months and years of recovery after the dotcom crash and the financial crisis.

Evidence shows that human nature is likely to have us run for cover in the face of danger. That’s why contrarianism is so counter-intuitive to many investors, even though it can work well over time.

In his book Contrarian Investment Strategies, David Dreman, another value-focused contrarian investor, wrote that “favored stocks underperform the market, while out-of-favor companies outperform the market, but the reappraisal often happens slowly, even glacially”.

Yet despite the challenges faced by contrarians, Dreman insists it’s worth the wait. He says that the re-evaluation process, which is heavily influenced by investor behaviour, is the key to large and consistent profits in the marketplace. “As long as investors believe they can pinpoint the future of favored and out-of-favor stocks, you should be able to make good returns on contrarian strategies.”

Hunting for unloved shares

With this in mind, we’ve taken a contrarian approach to British large-caps this week. As the market continues to recover from the disruption of Covid, there could be scope to pinpoint unloved stocks that might bounce back.

The screening rules use Stockopedia’s Quality & Value ranking measures to find large-caps with the strongest combinations of appealing valuation and high quality (where zero is poor and 100 is excellent). We’ve added the 0-9 Piotroski F-Score as a score of financial strength, as well as the forward PE ratios (as a measure of valuation) on these stocks. While these rules will highlight companies that have hit setbacks, the idea is that their quality could be enough to support a recovery over time.

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Royal Mail (LSE:RMG) - a long-time value stock that has performed well over the past 18 months - leads the list of large-cap contrarians. Among the others, it’s joined by mining shares such as Ferrexpo (LSE:FXPO), Rio Tinto (LSE:RIO) and Polymetal (LSE:POLY) and out-of-favour tobacco stocks such as Imperial Brands (LSE:IMB) and British American Tobacco (LSE:BATS).

Whether it’s an embattled stock or sector, a broader market dip or even a bear market, contrarian investors love moving away from the herd. This value-focused strategy looks for good-quality shares at relatively cheap prices, but it takes mental strength and relies on the key rule of value investing that, over time, the market will price fundamentals correctly.

Over the past 18 months, we’ve seen how quickly the market can change its view of previously unloved shares and out-of-favour industries and sectors. These rapid changes can lead to very strong performances - and that’s something we may continue to see as the next phase of Covid (and its impact on the economy) plays out.

As Sir John Templeton said: “If you want to have a better performance than the crowd, you must do things differently from the crowd.”

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