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Contrarian investing sounds good in theory: buy high-quality companies at bargain prices when they are dumped on excessive negativity. But it is hard to in practice when share prices are falling and media reports imply a company is in turmoil.

Consider these five stocks: South32, Flight Centre, IOOF Holdings, Slater & Gordon and FlexiGroup. Each has a good record or, in South32’s case, solid prospects. And each has fallen in the past few weeks amid negative news reports or company announcements.

IOOF, for example, tumbled after Fairfax Media this week published a series of allegations over its internal compliance, systems and processes. Slater & Gordon, too, has fallen; other Fairfax reports suggest it is a target for short-sellers who are unhappy with the price of its UK acquisition, Quindells’ professional services division.

Flight Centre fell heavily this week after a modest earnings downgrade and company comments about a market-share loss that suggest a structural change as more people buy travel online rather than use agents.

The leasing company FlexiGroup, identified for The Bull, dropped about 10 per cent this month after the surprise announcement that managing director Tarek Robbiati would resign in the second half of this calendar year.

BHP Billiton spin-off South32 has also had its fair share of negative news reports and poor sentiment after listing on ASX last month. It has fallen from a brief high of $2.45 to $1.94 after flagging write-downs in its Australian and South African manganese operations – a poor start for a divestment with good long-term potential.

So what to make of these negative media stories and company announcements?

Experienced investors will argue it is better to avoid market “noise” and focus on the real game: company valuation. I disagree: it’s important to follow the news flow, without over-reacting.

Others will argue the sharp sell-off in these stocks is a buying opportunity. Maybe. But anchoring value expectations to past share prices is a dangerous strategy.

Of the five stocks, South32, IOOF Holdings and Slater & Gordon look most interesting. Flight Centre’s downgrade, for example, suggests significant structural headwinds for the business and I’m concerned it is losing too much ground to online rivals. FlexiGroup’s CEO resignation surprised; more work is needed to reaffirm my previous positive view.

South32

I have written previously that divestments have a habit of underperforming in the first year and outperforming after that. That could be the case with South32.

There have been huge volumes of stock in South32 traded by Australian and offshore exchange-traded funds that had to buy or sell to maintain their index exposure. And South32’s write-downs were hardly unexpected: plenty of new CEOs get as much bad news out as possible early in their tenure.

Morningstar has a $3 fair-value estimate on South32 and an accumulate recommendation (it is close to buy). Of 16 brokers that cover the stock, 11 have a buy or strong buy recommendation, and three have a buy, and at two have a hold. The mean price target is $2.10.  

Although it is approaching value territory, South32 will probably offer better value in the next few months as the market digests its listing, the share register stabilises, and sentiment towards resource stocks starts to improve in the back half of this year. More aggressive long-term investors could justify buying South32 now.

Chart 1: South32

 

IOOF Holdings

IOOF Holdings is challenging. Some brokers dismissed the media reports and quickly labelled the sell-off as a buying opportunity. I’m not so sure. The allegations, if proven, are wide-ranging, serious and go to the heart of IOOF’s compliance and governance.

That said, the allegations relate to a smaller part of the business and several of the problems, such as unit-price errors, can be fixed and should not be material to earnings. Macquarie Equities Research says IOOF’s current share price is factoring in “significant reputational damage, aligned adviser losses and fund outflows”.

Macquarie has a 12-month share-price target of $12.10 and an outperform recommendation.   IOOF’s current price is $9.24. It has been a good long-term performer, has a solid board and has moved quickly to review its internal structures after the media allegations.

Although it will take time for IOOF to restore its market reputation, the financial services company is trading at a significant discount to intrinsic value.

Chart 2: IOOF Holdings

 

Slater & Gordon

Report this week about historical accounting standards at the division drove Slater and Gordon almost 20 per cent lower. United Kingdom authorities are investing the division’s parent company, Quindell.

The listed law firm seems to have split the market in two: those who believe its valuation underestimates the long-term growth potential in the United Kingdom; and those who argue it paid far too much for Quindells’ professional services division and will be thumped by hedge funds and short-sellers.

I’m in the first camp – at the right price. The acquisition makes Slater & Gordon the leading personal-injury firm in the fast-growing UK personal-injury market, and creates a big market-share advantage over its largest competitors.

Also, watch for more leaks of rumours and trumped-up “bad news” stories as short-sellers try to create mischief and drive Slater & Gordon lower. I don’t care what proponents of short-selling say about its ability to improve price discovery: it is a blight on the market.

Consensus estimates show 11 brokers who cover Slater & Gordon seven have a buy or strong buy recommendation and one has a hold. The mean price target is $8.33, from about $5.

There’s enough value now for long-term investors who can withstand short-term price volatility. But Slater & Gordon will probably get cheaper in the next few weeks until there is more clarity on the reliability of the accounts at its $1.3 billion acquisition.

Chart 3: Slater & Gordon

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Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at June 25 2013.