Is this cheap small-cap stock a perfect contrarian buy?

This fashion retailer has been battered in recent times, but Paul Summers thinks its stock is now temptingly cheap.

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Contrarian investing can be a hugely profitable endearvour, but only if you’re sufficiently skilled/lucky enough to pick stocks that are temporarily under pressure over those that are nothing more than value traps. For my part, here are two stocks I think look oversold and could bounce back to form in time. 

Harshly treated

Go back roughly 18 months and fashion/lifestyle retailer Ted Baker (LSE: TED) saw its share price riding high. Since then, a perfect storm of consumer jitters, bad weather, product issues and allegations of ‘forced hugging’ made against (and vehemently denied by) founder and former CEO Ray Kelvin have sent the value of the company crashing. At the close last Friday, the very same shares that were trading around 3,000p back in March 2018 could be yours for just 952p.

I still think the market has been a little too harsh on the company. Ted Baker remains a great brand with solid growth potential overseas and a history of generating high returns on the capital it invests. The recent product licence agreement reached with FTSE 100 clothing stalwart Next is another positive that many seem to have quickly forgotten about. 

That’s not to say I’d throw caution to the wind just yet. Ted reports to the market this Thursday. If there’s more bad news on trading (we’ve already had two profit warnings since February) the share price will likely continue its journey southwards for a while yet. Of course, any glimmer of recovery and the stock could soar.

Should the former be the case, I think this would only increase the likelihood of the company being taken back into private hands, possibly involving Kelvin himself. In the meantime, Ted starts the week valued at just 10 times earnings and yielding 5%. 

Woodford-inspired sell-off

Another small-cap that could turn out to be a great contrarian buy is doorstep lender Morses Club (LSE: MCL). Like Ted Baker, the market minnow’s shares have been on a downward trajectory for a while now, falling by a third in value since March. 

Why the big fall? At least some of this can surely be attributed to Neil Woodford’s decision to offload a proportion of his £13m holding in the company in an effort to raise cash to cope with the huge number of redemptions his flagship Equity Income fund will surely receive when it returns from suspension.

Such is the way the market works, a number of other investors are likely to have followed his lead in order to preserve their capital and not because there’s anything wrong with Morses per se. Indeed, this month’s update stated the company is trading in line with expectations and “continues to make strong progress” on the strategy of diversifying its product portfolio.

On a positive note, this surely gives prospective investors an ideal entry point. The business is now valued at nine times forecast FY20 earnings and has a price-to-earnings-growth (PEG) ratio of 0.5 — far below the 1.0 threshold legendary growth investor Jim Slater said investors should be looking for. The balance sheet looks solid and the stock comes with a massive 6.8% yield.

With concerns the UK economy may slip into recession in the near future, and the consequences this could have for our finances, Morses Club could suddenly find itself in something of a purple patch. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended Ted Baker. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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