Ever looked at a major stock dip and thought it was an overreaction by the market? Have you been tempted to ignore the crowd and buy into it? Market sentiment is not always logical and often groups of investors overreact to negative or positive market news.

Contrarian investors ignore the crowd and herd mentality and make their own investment decisions, based on which stocks could provide the best long-term value. Often they buy into shares that have experienced significant drops, but that still offer long-term instrinsic value and wait for things at the company to recover.

However, this investment approach requires substantial research and patience, as it can often take several years for a company and its stock to turn around. It can also be high risk as some stock picks may not work out and investors will need to hold their nerve.

Warren Buffett is probably the world’s greatest proponent of contrarian investing. Other famous contrarians include John Templeton, Benjamin Graham and Peter Lynch. IG has a useful article here on market sentiment and how to trade it.

Here are three stocks which we think could be of interest this month to investors who prefer not to follow the herd.

PayPal – looking oversold

Tech stocks are firmly in the unpopular box at the moment as investors dump them in favour of more defensive sectors, such as tobacco, healthcare and consumer staples. Indeed, despite making a recovery this summer, the Nasdaq index is down over 20% this year.

As such, the contrarian investor can pick up some bargains, as long as they are prepared to wait for the stocks to recover. Some US technology stocks, such as Meta – the owner of Facebook – and Paypal have more than halved this year. Shares in digital publisher Buzzfeed are down by as much as 94%.

Contrarian investors could take a look at Paypal, which is currently trading at $92.70, having fallen in value by 66% this year. The fintech company, which provides online payment technology – most notably for eBay - has attracted the attentions of activist investor Elliott Management. The activist investment group has ploughed $2 billion into PayPal and persuaded management to return as much as $15 billion to investors.

Jesse Cohn, managing partner at Elliott Investment Management, said at the second-quarter results he “strongly believes in the value proposition at PayPal [as it] has an unmatched and industry-leading footprint across its payments businesses and a right to win over the near- and long term.” He said steps were “underway… to help realize the significant value opportunity” at the company.

Second-quarter results were solid, with net revenues up 9% to $6.8 billion, although the company made a net loss of $341 million due to an exceptional tax charge relating to intellectual property. Free cashflow increased by 22% to $1.3 billion during the period and $900 million of cost savings expected to be realised in 2022. However, operating margins fell 684 basis points to 11.2% during the period.

For the full-year, PayPal expects net revenues to reach $27.85 billion, up more than 10% on a spot basis. Total payment volume (TPV) is also anticipated to grow to by around 12% on a spot basis, while sales excluding eBay are forecast to increase by approximately 13.5% on a spot basis.

Analysts at Daiwa Capital recently upgraded the shares to outperform from neutral, setting a price target of $116, while those at Barclays think they could hit $131. The company is set to hold an investor day in early 2023, which could help boost the shares. Over the short term, a drop in consumer spending could hit revenues but over the longer term, prospects for PayPal look positive.

IAG – on the flightpath to recovery?

Shares in International Consolidated Airlines Group (IAG) have lost nearly a third of their value this year, and are down 34% to 108.48p. The company behind British Airways and Aer Lingus had a difficult time during the pandemic and has struggled with flight delays and reduced capacity this year.

However, it returned to profit in the second-quarter – for the first time since the Covid-19 pandemic - after seeing strong demand from passengers over the summer. It posted pre-tax profits of €133 million for the second-quarter compared with a loss of €981 million in the same period last year. Losses for the half-year were also cut to €654 million from €2 billion in the same period in 2021.

Going forward, IAG expects operating profit before exceptional items to be “significantly improved” in the third-quarter and positive for the full-year. Net cash flow is also forecast to be “significantly positive for the year,” assuming no further issues from the Covid-19 pandemic. In the second-quarter, passenger capacity levels hit 78% of 2019 levels, while according to May figures from the International Air Transport Association, international air traffic is up 326% compared to last year.

IAG has €11 billion of debt on its balance sheet and capacity restraints could continue, plus further Covid-19 lockdowns could hit the company hard. However, the recovery looks to be underway and analysts at UBS think the shares could hit 170p.

Persimmon – is housing market as gloomy as painted?

The prospects for the UK housing market look mixed with some experts saying that the bubble is set to burst. A perfect storm of the higher interest rates, spiralling inflation and the cost of living crisis is expected to hit demand and house prices.

However, things may not be quite as gloomy as some commentators suggest. Supply still remains low and demand high. While Rightmove says that reduced affordability and increased housing stock could see prices fall slightly in the second-half, it expects prices to end the year 5% higher than in 2021.

Rival Zoopla expects a smaller rise of 3%. Plus, while estate agents Savills forecasts that the property market will slow in 2023, it expects prices to drop by 1%, while Knight Frank anticipates an increase of 1%.

Shares in Persimmon are down 48% this year to 1497.5p and could be a recovery play. The housebuilder recently posted encouraging half-year results. Although revenues were down 8% due to strong comparative figures, selling prices were higher at £245,597 (compared to £236,199 in the first-half of 2021). What’s more the company’s forward order book is 90% sold with forward sales of 10,542 homes worth £2.32 billion.

A major issue besides a softening in the housing market is likely to be the ongoing issues around building cladding following the Grenfell Tower tragedy. However, the shares look oversold and could surprise on the upside. Analysts at Liberum Capital have a price target on the shares of 2630p, while those at Citigroup have a target of 1930p.

Piper Terrett | Financial writer, London
30 August 2022