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Should you follow Neil Woodford into these 3 stocks?

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Neil Woodford is widely believed to be the UK’s best fund manager. One of the reasons why he’s been able to lay claim to this title is thanks to his desire to invest where others are afraid to tread. 

One such opportunity is power station owner Drax (LSE: DRX)

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Contrarian buy 

In a recent interview, Woodford admitted that his fund added to its existing position in Drax during February, after the company’s recent stock declines. 

Following a number of profit warnings, Drax has fallen out of favour with the wider market during the past two years. The company, which runs the UK’s largest wood pellet-fired power station, has been hit hard by the government’s flip-flopping on energy policy and the removal of green energy subsidies. As a result of these changes, Drax’s earnings per share have slumped by 90% from 52p per share in 2012 to 5p for 2016. 

As earnings have crashed, so has the company’s share price. Since the beginning of 2014, shares in Drax have declined by 60%. But it seems Woodford senses value here. Drax is currently trying to reduce its dependence on power generation and recently acquired a business energy supplier. Thanks to this acquisition, City analysts have pencilled-in earnings per share growth of 160% to 13p this year and a further 45% to 18.9p for 2018. These are impressive growth rates, but even if the firm hits these high targets, the shares will still look expensive. 

Earnings per share of 18.9p suggest a forward P/E multiple of 17.3 for 2018. Considering Drax’s past, it does not seem wise to pay such a high multiple for the shares. 

Blue-sky buy 

Alongside Drax, Woodford also revealed in the interview that he had been buying shares in Mercia Technologies (LSE: MERC) and Homeserve (LSE: HSV) over the past two months. 

Mercia is an investment company with the goal of generating capital growth for shareholders in the creation, funding, incubation and development of technology businesses. It is a venture capital business, working on behalf of investors in businesses it believes have the potential to change the markets they operate within. 

This operation, which is similar to many of Woodford’s other venture capital style-businesses, recently won two contracts to manage funds associated with the UK government’s Northern Powerhouse scheme. The contracts include a £57.5m equity fund and £51m debt fund under the control of the state-owned British Business Bank. 

These deals show that Mercia is clearly an important business with connections in all the right places. If you have a high risk-tolerance, this could be a share for you. 

Growth buy 

Meanwhile, year-to-date shares in Homeserve have lost nearly 10% of their value. However, even after these losses, the shares look expensive trading at a forward P/E of 21.5 for the year ending 31 March 2017. Next year City analysts have pencilled-in earnings per share growth of 18% to 30.5. If the company can keep this growth up, it could be a solid long-term growth buy. The shares support a dividend yield of 2.6% while you wait. 

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

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