Contrarian investing is for brave, long-term investors. It involves buying out-of-favour shares and waiting for the companies – or market conditions to improve. This can take a while and requires nerves to see out periods of volatility and underperformance.
Biting off more than it can chew
Technology group Micro Focus (LSE: MCRO) is one company that only a contrarian or value investor might consider investing in right now. Over the last year alone the shares have lost 60% of their value.
The biggest challenge the once high-flying group faces is integrating its huge $8.8bn 2017 acquisition of Hewlett Packard’s software business.
The difficulties it has faced has led to a succession of profit warnings and the loss of its executive chair. His replacement, Greg Lock, an industry veteran and ex-chair of Computacenter (CCC), took the reins in February. Investors will be hoping he has a better strategy for moving the group beyond this debacle.
One of the problems with a big acquisition – especially when it fails – is debt. Net debt at Micro Focus has ratcheted up to 3.2 times cash profits. And the group is still spending huge sums of money trying to make something out of the HP software.
Given how unloved the shares now are – and how well they were performing prior to 2017 – any improvement in the business or any takeover bid is likely to send the share rocketing.
Meanwhile, investors can bag themselves a yield of over 13%. There’s no doubt Micro Focus would be a very risky buy right now, but for a contrarian investor it also looks cheap.
Part of an industry slump
Chemicals group Elementis (LSE: ELM) is being hit by a double whammy of its own declining performance and general negativity about the chemicals industry. Shares in competitor Croda are down 7% over the last 12 months. Over the same timeframe, Elementis shares have plummeted by 40%.
Why the difference? Both are in the same industry, both have seen profits slump and both are likely to be negatively affected by the coronavirus.
In February, Croda said adjusted pretax profit for the year to the end of December declined 2.8% to £322.1m from a year earlier. Core sales slipped 0.2% to £1.27bn. Excluding currency movements, profit fell 3.7% and sales dropped 2.3%. Revenue from continuing operations was up 6% at $874m.
It seems like on a price-to-earnings ratio of just seven, versus a figure of 25 for Croda, and having experienced a much greater share price fall, Elementis shares are now looking cheap. On that basis I think if the market bounces back, and chemicals companies come back into favour, then it’s share price will rapidly recover.
I expect both these share prices could fall in the near term and will certainly be volatile. But for long-term contrarian investors, I think there’s an opportunity in the share prices of both these struggling companies.
