This article attempts to uncover the least favoured stocks in the UK market. The idea is to identify contrarian investment ideas which have the potential for a strong rebound when sentiment improves.

Betting against the crowd when they are wrong is a sure-fire way to make money in the stock market, but it’s much easier said than done.

Picking individual stocks is hard to get right. Even the professionals find it difficult to outperform the market and they have far greater resources and access to companies than the average investor. It also takes nerves of steel to buy when everyone is saying you should do the opposite.

MOST LOVED AND MOST HATED

Investment analysts generate in-depth reports and give opinions on which stocks to buy and which to avoid. Conflicts of interest due to corporate relationships tend to result in more buys than sells. 

AJ Bell investment director Russ Mould has analysed the most and least favoured FTSE 100 stocks as recommended by brokers over the last few years. He concludes: ‘The bad news is the analysts’ top picks failed to beat the FTSE 100 index in 2015, 2016, 2017, 2018, 2020, 2021 and now 2022, despite all their diligence. Only two of the 10 most popular names generated positive total returns and beat the index for good measure.’

That said, the least favoured also did badly with an aggregate total return of minus 20.5% against the positive 4.7% provided by the benchmark index.

‘Knowing which names to avoid can be every bit as valuable as knowing which names to buy.

‘You can argue it is the picks when analysts go against the crowd that come with greater conviction and thus may be worthy of greater attention,’ added Mould.

Building on the same theme we have used Stockopedia software to isolate UK companies with a market capitalisation above £500 million where ‘sell’ and ‘underperform’ recommendations represent more than a third of views.

BEATEN-UP HOUSEBUILDERS

A few trends jump out from the data. The housebuilding sector remains deeply unloved and one of the few industries where share prices remain significantly below pre-pandemic levels.

‘Sell’ and ‘underperform’ ratings make up 35% of all at Persimmon (PSN).

Analysts have slashed their 2023 earnings estimates for Persimmon by 63% over the last 18 months, reflecting concerns over slowing demand, higher mortgage costs and rising raw material inflation.

On 1 March the shares slumped 10% after chief executive Dean Finch warned completions, margins and profits would be ‘down markedly’ due to the sharp slowdown in the new-build market.

Reduced volumes, together with greater sales incentives and marketing costs, could further impact operating margins by around 8%.

Although mortgage rates have subsided from the spike seen after the disastrous mini-Budget last year, which saw two-year swap rates spike close to 6%, the latter remain a headwind for borrowers at around 4.7% compared with below 1% two years ago. This is relevant because UK mortgages are generally priced off two-year swap rates.

With share prices on the floor, could most, if not all, of the bad news already be discounted? That seems to be the view of analysts at HSBC who recently raised their rating on housebuilders (13 April) and increased share price targets by an average of 29% across the sector.

INSURANCE WOES

Insurers initially benefited from lockdowns as traffic disappeared from roads which in turn suppressed claims and increased profitability.

Since the reopening of the economy the combination of rampant car repairs inflation, extreme weather, and higher interest rates (which lowers the value of bond portfolios) has impacted the sector.

Insurer Admiral (ADM) has seen its shares fall over 35% in the last 18 months as post pandemic claims inflation and rising interest rates have impacted profitability.

On 8 March the company cut its final dividend by 28% to 52p per share, taking the total 2022 dividend including specials down 40% to 112p per share.

The company observed an increase in average claims cost in double digits and said the frequency of accidents had increased coming out of the pandemic. The home insurance arm was hit by bad weather.

Fellow insurer Direct Line (DLG) shocked investors on 11 January after passing on its final dividend entirely to restore the balance sheet.

The news was unexpected in part because historically Direct Line has been a prodigious payer in regular and special dividends since 2013.

The company appears to have been hit by the perfect storm of weather-related costs combined with continued claims inflation. In addition, the firm’s investment property portfolio has suffered a worse than expected 15% drop in value. A few weeks later the fiasco led to CEO Penny James agreeing to part ways with the company.

GO BIG OR GO NICHE

Generalist mid-sized fund managers have been attacked on all sides in recent times, from competing lower cost exchange-traded-funds which continue to grab market share, to specialist boutique fund managers offering investors more focused exposure to investment themes.

Asset manager Abrdn (ABRDN) stands out as the most despised stock in the UK with 73% of analysts tagging it with a ‘sell’ or ‘underperform’ rating.

Consensus earnings estimates have been revised down by nearly 40% over the last 18 months.

The company is not alone in attracting ‘sell’ recommendations from analysts. Quilter (QLT), Ninety One (N91) and Jupiter Fund Management (JUP) are also out of favour.

Just like the insurance sector, fund managers have suffered from a perfect storm with both stocks and bond prices falling in tandem last year, leaving investors nursing losses.

Abrdn has been particularly hard-hit which resulted in the shares being demoted from the FTSE 100 in 2022. The company has been cutting costs and streamlining its offering by closing or merging around 120 of the funds in its range.

Analyst David McCann at Numis believes the company would add more value by splitting the business up and returning capital to shareholders. The stock market seems to reward managers who have achieved greater scale or the specialists which means those occupying the middle ground may continue to struggle.

SHARES’ TOP CONTRARIAN PICKS

Admiral (ADM) £22.64

Famed investor Warren Buffett is keen on saying that he prefers to buy stocks like he buys his favourite groceries, in other words, when they are on offer.

We believe investors have thrown the baby out with the bathwater in the case of car and home insurer Admiral, presenting an attractive risk to reward contrarian buying opportunity.

The company has proven to be one of the best operators in the sector and has consistently generated an underwriting profit, 2022 notwithstanding.

Its capital light business model and keen cost focus means it generates plenty of cash and regularly pays out special dividends.

Admiral has an outstanding track record of providing strong shareholder returns. Total returns (share price appreciation and reinvested dividends) have increased 10-fold since 2005 representing a compound annual return of 14.4% a year.

The perfect storm impacting the sector in 2022 has probably done its worst, opening the potential for a strong recovery in profitability. Jefferies notes that car insurance pricing is improving at pace with premiums up 39% year-on-year in March.

Meanwhile, claims inflation is subsiding and second-hand car values are around 4.5% lower than last year. All the evidence suggests downward revisions to earnings have reached a trough.

PERSIMMON (PSN) £12.43

Arguably, investor sentiment couldn’t get much worse for the UK housebuilders with the removal of Help to Buy scheme the final piece of bad news. Persimmon’s shares languish around 60% below pre-pandemic levels.

According to an analysis of cyclically-adjusted earnings the price to earnings ratio is around six times, which is on a par with the depths of the banking crisis in 2008.

Meanwhile earnings have fallen back to their long-term trend line. Therefore, unless investors believe the downturn in the sector is likely to eclipse the worst on record, the risk to reward ratio looks very attractive at current levels.

As discussed, HSBC analysts appear to have come to the same conclusion. Having downgraded the sector in autumn 2022, they are now more constructive, arguing that valuations reflect the worst of the downturn.

‘We now have greater visibility about the shape of the current housing market downturn for the housebuilders’ profits and cash flows and their recovery from it, which we believe to be more than priced-in to share prices.’

That’s not to say the near term isn’t likely to see further contraction in housing activity. The bank’s analysts are forecasting 20% fewer completions in 2024 compared with 2022 and new build prices falling by around 5%.

Disclaimer: Financial services company AJ Bell referenced in this article owns Shares magazine. The author (Martin Gamble) and the editor (Tom Sieber) of this article own shares in AJ Bell.

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