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Should You Follow Neil Woodford And Buy Centrica PLC, Royal Mail PLC and Game Digital PLC

Buying good companies when they’re out of favour with the market can be highly profitable. Top fund manager Neil Woodford has been doing this successfully for more than a quarter of a century.

Centrica (LSE: CNA), Royal Mail (LSE: RMG) and Game Digital (LSE: GMD) are among Woodford’s most contrarian bets, and he has been pumping more money into them recently. Following the master investor into these three companies could prove to be a smart move.

Centrica

Centrica, the owner of British Gas and other assets in the energy chain, has been spurned by plenty of City analysts and many investors. Woodford and his team have summed up the contrarian investment case as follows:

“Centrica has been hit by a combination of factors recently (US and UK weather conditions, the oil price collapse, political and regulatory pressure) but as these abate, its long-term valuation attractions will become much more apparent”.

As such, Woodford has been buying Centrica shares with a vengeance in recent months.

The company looks good value to me on a forward price-to-earnings (P/E) ratio of 15. Compare this with water companies, which are the current market darlings in the utilities sector: United Utilities and Severn Trent trade on P/Es of well above 20. Also, despite rebasing its dividend 30% lower, Centrica still boasts an attractive 4.5% yield; fashionable United Utilities and Severn Trent offer 4% and 3.8%, respectively.

Royal Mail

Near the start of 2014, Royal Mail’s shares traded at over 600p, but ended the year at 430p amidst analyst and investor concerns about competition within the industry.

Woodford and his team see Royal Mail as “fundamentally a very attractive, cash generative business”. Their contrarian position is that:

“the challenging competitive environment may mean that it takes longer than previously anticipated for the company to reach its 8% EBIT margin target … [but] we remain confident in the long-term investment case”.

Royal Mail’s shares have recovered some ground of late — helped by encouraging results last month — but Woodford has continued to increase his stake in the company. The government sold half its remaining 30% holding in Royal Mail last week at 500p a share, and Woodford was a buyer.

For a business well-placed to generate long-term sustainable shareholder value, the current P/E of 15 and 4.3% yield look attractive to me.

Game Digital

Shares of video games retailer Game Digital collapsed in January when the company issued a profit warning, following fierce competition during the Christmas period. Woodford, who had bought shares in Game at higher prices last year, has massively increased his holding since the profit warning. His most recently reported trade (4 June) took his stake in the company to over 18%.

Woodford and his team acknowledged the profit warning was disappointing, but took the view that “one poor trading update does not undermine what we see as a strong long-term investment case”. Indeed, they have relished the opportunity to buy what they believe is “long-term value, at a hugely discounted price”.

Game is the leading specialist retailer of video games in both its territories — the UK and Spain — with a market share of over 30% in each. I think this dominance makes the company’s forward P/E of 12.6 (for its financial year ending July 2016) and super-chunky 5.8% yield highly attractive.

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