One of the secrets of billionaire investor Warren Buffett’s early success was his willingness to buy stakes in companies that were out of favour with most other investors.
I try to take this contrarian approach with my own investing. I look for troubled companies that I believe have good underlying businesses. In this article, I’m going to take a look at two unpopular FTSE 100 stocks that I believe could beat expectations in 2017.
Shopping for a bargain
J Sainsbury (LSE: SBRY) seems to be firmly out of favour at the moment. Investors weren’t excited by the supermarket’s decision to buy Argos owner Home Retail Group. The shares seem likely to end the year in the red.
I think this gloomy outlook may be short-sighted. The Argos deal has the potential to solve most of Sainsbury’s problems. By relocating Argos stores into nearby supermarkets, property and transport costs should fall. Trading intensity — sales per square foot — should rise, boosting the group’s operating profits.
Another key driver of growth for Sainsbury is financial services. Sainsbury’s Bank delivered an underlying operating profit of £65m last year — almost 10% of the group’s total. The acquisition of Argos Financial Services added a valuable £600m loan book to the bank’s assets and a move into mortgage lending is planned for 2017.
The final attraction is that Sainsbury’s current valuation provides plenty of upside potential, if earnings do start to rise. With a forecast P/E of 12 and a prospective dividend yield of 4.1%, the shares look cheap to me. I believe significant gains are possible from current levels.
This contrarian bet could pay off in 2017
Investing in Royal Bank of Scotland Group (LSE: RBS) has been a painful and frustrating experience in recent years. I’ve stayed away so far, but recently decided to invest. I believe there are several reasons to think that 2017 could be a turning point for the UK’s most battered and bailed out bank.
The first of these is that RBS is probably getting close to resolving the last of its big misconduct issues. Analysts are predicting a fine of as much as $12bn relating to mis-selling allegations in the US. This potential liability seems to be the main reason why it failed the recent Bank of England stress tests. Once this is out of the way, RBS should have a relatively clean sheet.
The second attraction is that although RBS is still weighed down with bad assets, the bank’s figures suggest to me that its core operations are profitable and attractive. It reported an adjusted return on equity of 12% for its core operations last year. To put this in context, the equivalent figure for the whole group was -0.6%.
Chief executive Ross McEwan seems to be making steady progress. I believe he will eventually reach a point where investors are willing to look at the bank’s future potential, rather than its past problems.
RBS shares currently trade at a discount of about 35% to their tangible net asset value, with a 2017 forecast P/E of 13.8. Consensus earnings forecasts have risen over the last two months. For investors who are willing to take a longer view, I believe RBS could be a profitable buy at current levels.
