Should you follow Neil Woodford into recent fallers BATS, CPI and LRE?

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Neil Woodford

The latest monthly update from Neil Woodford's flagship equity income fund shows the master investor has been going against the market by adding to several out-of-favour stocks.

Should you follow Woodford's contrarian lead and buy into these recent fallers?

Strategic and financial sense

At 4,350p, shares of FTSE 100 giant British American Tobacco(LSE: BATS) are 14% down from a high of 5,042p in early October. The bulk of the fall has come since the company announced a proposed merger with Reynolds American on 21 October.

BAT already owns 42.2% of the US firm and the proposal would see it acquire the remaining 57.8% for a total consideration of $47bn in a mixture of cash ($20bn) and shares ($27bn).

Woodford's fund update tells us: "Our view is that this deal was inevitable and, although it has happened earlier than we thought, makes a lot of strategic and financial sense. We will be voting in favour of the transaction".

Reynolds' shares spiked to an all-time high on the news and Woodford took advantage of the positive reaction to sell his Reynolds holding and buy more shares in BAT (and also Imperial Brands).

Of course, the deal may or may not go ahead. But I agreed with Woodford that the recent weakness in BAT's shares presents a good buying opportunity. The consensus P/E of 17.7 for calendar 2016 falls to 15.3 next year on the back of forecast 15% earnings growth and there's an attractive dividend yield of 3.8% rising to 4.1%.

Disproportionate market reaction

Shares of fellow FTSE 100 firm Capita(LSE: CPI) were trading at over 1,000p in early September but crashed dramatically when the company issued a profit warning towards the end of the month.

Having met management, Woodford and his team came away reassured that the outsourcing specialist is doing the right things "to restore the business to a healthier growth trajectory" and that the dividend is safe. Woodford added to his holding on the basis that "the market's reaction looks disproportionate" and his latest fund update tells us he's further increased his stake in the company.

At a share price of 577p, Capita is 55% down from its 52-week high. The market's reaction does indeed look disproportionate. On downgraded forecasts, the P/E for calendar 2016 is a mere 8.8, falling to 8.5 for 2017, while a dividend maintained at last year's level would give a juicy yield of 5.5%. This makes Capita an attractive buy to my eye.

Skills and discipline

Woodford has also upped his stake in FTSE 250 insurer Lancashire (LSE: LRE). The shares are currently trading at 641p -- down 15% from a high of 758p on 3 November when the company released its Q3 results and announced a juicy special dividend. Part of the reason for the fall is that the shares have gone ex-dividend.

Woodford and his team have previously praised Lancashire's "strong underwriting skills and capital discipline" and dividends are contributing significantly to shareholder returns. Analysts have pencilled in a payout of 46p for 2017 giving a terrific yield of 7.2%, while the P/E is a reasonable 14.6. Again, the shares of this one also look very buyable to me.

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G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended Imperial Brands. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.