10 contrarian mid-cap shares for patient value investors

One of the big stockmarket stories of 2017 has been the spectacular performance of smaller, growth-oriented shares. The AIM All Share index has soared by more than 20% this year, casting a shadow over the usually solid mid - and large-cap sectors.

But while the excitement has focused on smaller companies, it's important to remember that market trends do shift on a regular basis. The essence of 'mean reversion' is that what's out of favour to day will be back in favour at some point down the line.

In fact, it's precisely the out-of-favour stocks that have forged the fortunes and reputations of some of the world's best known investors. For these value-focused contrarians, there's money to be made in shares that everyone else overlooks.

When markets slumped after the technology boom 15 years ago, many investors found themselves battered. The tech shares that had once been so adored were suddenly reviled. It was the same after the financial crisis of 2008, except then it was banking shares that no-one liked.

Even after the EU referendum, market swings saw defensive and commodity shares fly, while domestic cyclicals were heavily marked down.

In each of these market phases, the stocks and sectors that were once hated went on to recover. They ended up being a triumph for the contrarian value investors that bought them when they were cheap and went on to make a killing as they bounced back.

This approach is in the mould of successful investors like David Dreman and Sir John Templeton.

But while on paper their methods make perfect sense, the truth is that it takes a heck of a lot of discipline to be a contrarian. It's much more natural to move with the pack and buy what everyone else is buying - but that won't make you a fortune.

The key, according to the well-known investment analyst Michael Mauboussin, is to remember the single most important factor in value investing - to distinguish between the fundamentals of a stock and the expectations reflected in its share price.

In practice, this means that contrarian value investors should be looking for stocks that are priced too cheaply against their underlying value. In many cases, these shares will have hit major setbacks and will be shunned by the market.

Screening the market

From a practical point of view, you don't necessarily need sophisticated screeners to help you find potentially good quality companies that are unloved by the market. But you'll need to take the classic value investor's approach to digging around for shares that are simply being mispriced.

At Stockopedia, we measure and rank every stock in the market based on their value and quality - scoring each from zero (poor) to 100 (excellent). So we can get a quick view on shares that might fit the profile of contrarians. While these stocks might genuinely deserve to be marked down, it's a starting point in seeing what is currently out of favour.

These rules were applied to the £350 million - £2.5 billion mid-cap range, and the results offer a very diverse range. Petrofac, the oil services group has the strongest combination of high financial quality and attractive valuation - based on a range metrics.

But the top contrarians on the list also includes the pub group Greene King, transport group Go-Ahead and the electronics and telecoms retailer Dixons Carphone.

Interestingly, defence specialist Ultra Electronics, which recently issued a profit warning, also passes these rules. That reflects just how this investment strategy targets companies that are out of favour in the market.

Going where other fear to tread

2017 has been a strong year for certain parts of the market, but it's always the case that some stocks and sectors remain out of favour. They've either suffered setbacks or they've reached a low in the business cycle or they're simply not as popular as others.

Most investors don't find much appeal in these shares, but they are exactly what contrarian value investors are looking for.

Among the mid-caps, there is often the financial strength and management expertise to guide these companies back to prosperity over a period of time. For their patient contrarian investors, this can result in very impressive returns.

About Stockopedia

Interactive Investor's Stock Screening series is written by Ben Hobson ofStockopedia.com, the rules-based stockmarket investing website. You canclick here to read Richard Beddard's review of Stockopedia.com and learn more about the site.

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It's worth remembering that these and other investment articles on Interactive Investor are simply for generating ideas and if you are thinking of investing they should only ever be a starting point for your own in-depth research before making a decision.

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Ben Hobson is Investment Strategies Editor at Stockopedia.com. His background is in business analysis and journalism. Ben researches and writes regularly on investment strategy performance and screening ideas for Stockopedia.com. He is the author of several ebooks including "How to Make Money in Value Stocks" and "The Smart Money Playbook"

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.