Contrarian investing is about picking companies that have been oversold, firms that are out of favour, yet have the prospect of being turned around, or coming back into fashion. You need to differentiate these from firms whose share prices are falling because they're losing business and really are poor investments.
Contrarian investors such as Warren Buffett and Neil Woodford have shown that, if you get it right, it works, and it works in spades.
In this article I'm looking at three companies that have taken a battering in recent months. Will their share prices revive, and are they now contrarian buys?
HSBC(LSE: HSBA) is my top UK bank pick. My reasoning for this is that this is one of Britain's most profitable companies and in 2015 it made a net profit of £10.189bn. Its share price has fallen as the share prices of all the banks have fallen. But in the case of HSBC, I think the falls have been overdone, and this has created a buying opportunity.
In comparison, peers like Lloyds, Barclays and RBS are lossmaking or make far less money.
The fundamentals show just how cheap this company is. The 2016 P/E ratio is forecast to be just 9.05. And the dividend yield is a stonking 8.10%. This is a firm with a substantial stake in emerging markets such as China, that has the potential for growth, and is also a high-yield play. HSBC is one of the buys of the moment.
Rolls-Royce(LSE: RR) used to be a stock market star whose share price just kept on rising. But since its peak at the end of 2013, the stock has been tumbling.
A large part of Rolls-Royce's business is in the defence and oil and gas sectors. This was fine as global defence spending grew and the commodities boom rolled on. But the commodities crash has meant oil firms have been slashing spending, and cuts in defence budgets mean this is a sector that's also in decline. Yes, the civil aviation sector continues to do well, but this is out-weighed by these other factors.
The effect on Rolls' bottom line has been dramatic. A net profit of £1.323bn in 2013 has fallen to just £84m in 2015.
In cases like these, I like to see a clear return to profitability to buy back in. At this stage, I would recommend that investors keep a watching brief.
Standard Chartered(LSE: STAN) is another high-performing share that has had a dramatic fall from grace. And this fall has been even greater than that seen by Rolls-Royce. A net profit of £2.547bn in 2013 has turned to a loss of £1.482bn in 2015.
The slide in profitability is all the more surprising when you consider that this is an emerging market bank with businesses in China, India and Africa. Yet a money-laundering scandal has been followed by job cuts and a retrenchment in many of its markets.
I'm hopeful that this company will make a return to profitability. But I think it's too early to buy back in.
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Prabhat Sakya has no position in any shares mentioned. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.