Is Neil Woodford a fool to continue pumping money into Capita plc and AstraZeneca plc?

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Neil Woodford

The latest monthly update from Neil Woodford's flagship equity income fund was published this week and shows the master investor has been adding to several of his holdings.

Some of his trades will probably be seen as uncontentious in the eyes of most investors but some might question whether Woodford's a fool to continue pumping money into Capita(LSE: CPI) and AstraZeneca(LSE: AZN). After all, the former has issued two profit warnings in recent months, while thelatter has reported a decline in earnings every year since 2011.

Intrinsic value

Capita's shares crashed to a 10-year low early in December after a second profit warning in three months. City analysts now expect the FTSE 100 outsourcing giant to post a 12% drop in earnings for 2016, followed by a further decline of 6% for 2017.

Not a single City broker out of 19 covered by financial data webstite Digital Look currently rates the shares a 'buy'. But Woodford has done what contrarian investors seeking long-term value should always do in these circumstances. Not react emotionally to the disappointment of the share price fall, but calmly reappraise the long-term investment case for the company.

Having done so, he concluded that the market has over-reacted and "driven Capita's share price way below the intrinsic value of the business". At a current price of around 500p, it trades on just 8.5 times forecast 2017 earnings, giving scope for considerable upside over the longer term. In the meantime, the board having indicated it expects to maintain the dividend, the company will deliver a 6.3% annual yield.

I agree with Woodford that outsourcing will be an area of long-term growth. And with Capita's depressed earnings rating and juicy yield I also agree that the shares currently look an attractive buy.

Patience

AstraZeneca is Woodford's largest holding and an example of just how long he's prepared to be patient with a company he views as intrinsically undervalued. Earnings at the pharma group have suffered as a result of expiring patents on some of its top sellers and no improvement is expected to the bottom line until 2018.

However, the company has maintained its dividend through this difficult period and offers a 5% yield at a current share price of around 4,400p. The dividend is forecast to start rising with the resumption of earnings growth in 2018 as a result of Astra's reinvigorated drugs pipeline.

The company reported further positive pipeline and clinical developments during December and Woodford added to his holding at what he believes is a "very attractive" valuation. Again, I agree that this stock looks well worth buying for its long-term prospects.

Two of a different stripe

Finally, Woodford also added to his holdings in British American Tobacco and Drax. Both companies are in the process of making significant acquisitions that he believes make strategic and financial sense.

In contrast to Capita and AstraZeneca, BAT and Drax are set to increase their earnings for both 2017 and 2018, underpinning rising dividends. BAT's yield is forecast to rise from 3.8% to 4.1% and Drax's from 2.6% to 4.4%. These stocks also look very buyable to me with starting yields above inflation and rising payouts above inflation forecast.

Dividend focus

Here at the Motley Fool, we agree with Woodford that focusing on dividends is one of the surest ways to increase the value of your portfolio. With this in mind, our experts have unearthed a company they believe is a dividend growth champion in the making.

The company in question has gone unnoticed by many investors, but lifted last year's payout by 10%. This dividend was covered more than three times by earnings, and our analysts project it can march strongly higher in the coming years. They've published their research in a FREE report called A Top Income Share From The Motley Fool.

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