12 stock ideas for brave bargain hunters

Cognitive biases can prove costly in the long run, not least by stopping investors benefiting from the recovery when it comes. Preferring a more contrarian approach, stock screening expert Ben Hobson sees this as a limited-duration stock market sale.

The stock market sell-off this year has been agony for investors used to years of calm conditions and positive price trends. But while many are currently rueing double-digit losses in what were popular go-go growth stocks, this new phase could present a rare moment of big potential upside. Periodic bear markets are part and parcel of long-term equity investing, and for the brave investor they can offer the chance to buy shares at bargain prices.

This year’s sharp pull-back has been a painful reminder that equities can be volatile at times. But that said, a glance at the blue-chip FTSE 100 index wouldn’t necessarily alert you that anything was wrong. Its stalwarts in the energy, mining, healthcare and finance sectors have propped things up pretty well.

To see the biggest declines, you need to look at the mid and small-caps of the FTSE 250, small-cap and AIM indices. Those index prices are down -17.6%, -14.9% and -25.7% respectively year-to-date. In terms of sectors, the worst pain has been felt in consumer discretionary (which includes retail and house construction) and technology.

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What makes this so jarring is that these areas of the market delivered stellar gains in the aftermath of the pandemic. So there’s no escaping the sense that this has been a painful sucker punch for investors.

Keeping a sense of perspective

Faced with falling prices day in, day out, investor psychology plays an increasingly vital role. Loss aversion is likely to have driven many out of the market. Regret aversion, which is the fear of making a bad decision, will likely keep them out of the market for fear of getting their timing wrong. Both cognitive biases can prove costly in the long run, not least by stopping investors from benefiting from the recovery when it comes.

A more contrarian approach is to see this as a limited-duration stock market sale. On this basis, it’s a hunting ground for stocks that have been sold off and now offer much more upside than they did just a few months ago. It’s a view shared by Warren Buffett, who once famously said that “whether we’re talking about socks or stocks, I like buying quality merchandise when it’s marked down”.

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A contrarian value approach in a bear market takes care and attention. While it’s true that good companies can get caught up in the selling during a panic, it is also the case that prices can always fall further. Companies themselves can also be hit by unpredictable problems in tough economic conditions. But there’s no harm in surveying for stocks whose new valuations make them much more attractive.

So how might you do that?

To avoid speculative or troubled companies, a few ‘quality’ foundations in this approach might include:

• Revenues that have grown at a compound rate of at least 5% over the past three years (capturing companies that are seeing top line growth)
• Gross profit margins of more than 35% (showing that companies are profitable after costs)
• Total debt/total capital less than 20% (ensuring that companies aren’t over-burdened by debt)
• Market capitalisation of more than £100million (avoiding the smallest companies)

Then we need to consider price performance, valuation and what the future might hold. Here you could look at:

• The year-to-date performance of the shares (looking for those that have sold off heavily)
• Share price as a percentage of the ’52-week low’ less than 150% (which looks for stocks trading close to new lows)
• Stocks where analysts are forecasting substantial upside from the current price

The screen below takes these ideas and applies them to the current market. The list is sorted by stocks that have suffered the sharpest sell-offs - with Hotel Chocolat (LSE:HOTC), the high street and online chocolate retailer, leading the list with a massive -73.2% price fall in 2022.

In this case you can see that the analyst consensus price target on the stock is 121.4% higher than the current price level.

One striking observation is how varied the companies are but also how sharp the sell-offs have been in previously popular, smaller-cap growth stocks such as BATM Advanced Communications (LSE:BVC), Strix (LSE:KETL), Water Intelligence (LSE:WATR) and XP Power (LSE:XPP). Even mid-to-large-caps such as Greggs (LSE:GRG) and insurance group Admiral (LSE:ADM) have been severely beaten down in the current conditions.

Making plans for better times

A natural instinct for many investors in markets such as these is to cling to safety. Seemingly relentless down days can be tough to take - and that’s not helped by continued uncertainty about what the near-term future holds for inflation and economic growth.

But with so many stock prices coming under pressure, it’s reasonable to think that some good-quality companies might be getting unfairly caught up in it all. And while prices may continue to fall, and some companies may encounter problems, a contrarian view is that we are witnessing a stock market sale for some stocks - which is the ideal hunting ground for the contrarian value investor.

Ben Hobson is a freelance contributor and not a direct employee of interactive investor.