Twenty stocks for value-focused contrarian investors

Most people intuitively understand the idea of concentration risk. You know the line: don’t put all your eggs in one basket. Or even just five. Spread those risks, diversify, build in redundancy and have a back-up plan.

But why don’t we ever hear about ‘concentration reward’? Perhaps we do: one pithy idiom holds that investors should “concentrate to get rich, diversify to stay rich”. And maybe, deep down, we are all drawn to the idea of betting the farm on one huge positive outcome. Without such instincts, Las Vegas doesn’t exist.

Then again, nor would charts like the one below. It shows the performance of our Contrarian Value stock screen, whose selections have been refreshed each year since 2011. Unlike many of the screens we follow, this is measured in two ways: via a well-diversified 20-stock version, and a super-concentrated five-share one.

Our screens are intended as prompts for further research, not off-the-shelf portfolios. But clearly, anyone who stuck with a concentrated version of the screen (the yellow line) would be better off than the alternatives. After 14 years, the cumulative total return stands at 452 per cent, equal to a 13 per cent compound annual return, and more than double the all-time performance of both the 20-stock version and the screen’s benchmark, the FTSE All-Share index. Even if we add a 1 per cent annual charge to reflect notional dealing costs, the return amounts to a very handy 380 per cent.

What’s also clear is the price: a lot more volatility, including a protracted drawdown starting in mid-2021, from which it took three years to recover.

But volatility can also be a good thing. And for the Contrarian Value screen, there have been two powerful episodes of “concentration reward”, for want of a better phrase.

The most recent has been going since the end of November 2023. Despite April’s tariff shock blip, an investment in the screen’s top five holdings has yielded a 166 per cent total return, just under double the return from the 20-stock version (whose own performance owes much to those five stocks). The other episode began at the screen’s inception and lasted around 32 months, during which time the top five stocks generated a 177 per cent total return, versus 77 per cent from the diversified version and 32 per cent from the benchmark.

There are a couple of ways to interpret this. First is that when this screen works, it really works. Another is that its stewardship is guilty of survivorship bias: after such a stellar early run, its subsequent annual results could afford to be pedestrian or lacklustre, because the all-time returns would still look strong.

Does that charge hold up? Until a year ago the top five version had beaten both benchmark and diversified screen in eight of 13 outings. Whenever it lagged one, it also lagged the other. That’s a decent hit rate, notwithstanding the occasional hefty drawdown that you’d expect from an eggs-in-just-five-baskets approach.

Over the past 12 months, however, something original happened. The concentrated screen posted a 14.6 per cent total return, smashing the diversified screen by 5.4 percentage points. Alas, it was not enough to match the rally in the FTSE All-Share, whose ‘value’ credentials have suddenly become apparent to an international investor audience in the past few years.

Given how close we came, we shouldn’t be too aggrieved. Nor should we shrink from that top five performance, given we have long argued that it is only these results that are of serious interest to the contrarian investor, as these stocks have the lowest enterprise value (EV) to sales ratios of the bunch.

A table of this year’s Contrarian Value stocks is included below, as well as a larger downloadable spreadsheet with much more information on every stock. Half are returnees. The five that saw their EV/sales multiples expand in the past year (see table) all posted positive gains, suggesting re-ratings were at least partly responsible for their performance.

By contrast, shares whose multiples contracted tended to struggle in price terms, even though their collective consensus forward earnings forecasts grew by 7.2 per cent over 12 months and 3.9 per cent over the last quarter. Does this mean it’ll be second time lucky for this batch? Will the market finally start to recognise the apparent cheapness of Rathbones (RAT) or electronics group RS (RS1)? We’ll know more in a year’s time.

Download documents (.xlsx)