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Why I’d buy Dignity plc over this other contrarian stock

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Contrarian investing — the strategy that seeks to exploit price anomalies by doing the opposite of what everyone else is doing —  requires considerable guts and confidence in your own research. It’s not easy, but that’s precisely why it can be so lucrative.

While it might be prudent to wait for the dust to settle following last week’s news, funeral services provider Dignity (LSE: DTY) is already shaping up to be a prime example of when it might be wise to go against the herd, at least in my opinion. 

To recap, the company announced last Friday that it would be making alterations to its funeral pricing strategy in response to stiffening competition over the last 18 months and “increasingly price-conscious” customers. As a result, it expects cheaper, simple funerals will represent around 20% of all ceremonies it performs in 2018. This development, combined with the need for an additional £2m for digital and promotional activities, goes some way to explaining why the Sutton Coldfield-based business now suspects profits for the new financial year will be “substantially below” previous expectations.

Clearly, this news was never going to be warmly received. Nevertheless, a 50% drop in Dignity’s share price feels excessive given that its response to a shift in the market looks both eminently sensible and decisive. Handled correctly, the overhaul of its online offering and overall branding could be a positive move, particularly as the acquisition-friendly £500m cap’s decision to allow its locations to continue using their local trading names does appear to have restricted the public’s awareness of the business to-date.  

Dignity’s reputation for excellent customer service also can’t be disregarded. While some may be concerned by the lack of barriers to entry, it must remembered that this is a market like no other. The suggestion that people will begin purchasing funeral packages in the same way that they buy insurance (with fairly limited attention paid to the provider) drastically underestimates the emotional aspect of the transaction.

These reasons, coupled with the fact that the strong performance of the company’s pre-arranged and crematoria divisions appears to have been overlooked, make me increasingly bullish on Dignity’s ability to recover.

Less appetising

While confident that Dignity will spring back to life in time, one contrarian ‘opportunity’ I’m more than prepared to pass on is Frankie and Benny’s owner Restaurant Group (LSE: RTN), particularly after today’s rather insipid trading update. Based on initial market reaction, it seems I’m not alone.

Despite making “solid progress” against its strategic initiatives — including re-establishing the competitiveness of its brands, improving the guest experience and growing its pubs and concessions businesses — like-for-like and total sales fell 3% and 1.8% respectively in the 52 weeks to the end of December. The fact that adjusted profit before tax for 2017 is likely to be in line with current market expectations also isn’t saying much given that the latter weren’t exactly high. 

Since January 2016, shares in Restaurant Group have lost just under 65% of their value and currently trade at 12 times forward earnings. Although some may sense value, I continue to be wary, particularly if the company is pushed to further reduce prices as a result of ever-present competition.

When it’s hard to come up with reasons for wanting to visit its sites or purchase its products yourself, a company’s shares are best avoided in my view.

For a smoother ride...

Acting in a contrarian manner often be rewarding but those with a low tolerance for capital risk need to tread carefully. Not all companies recover; not all shares bounce back.

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.