Many successful investors have followed a simple mantra – buy low and sell high.
It seems simple enough but sometimes stocks that look cheap are cheap for a reason.
There is no doubt the market is irrational at times and this can also work in the favour of savvy investors. Often the best time to buy high quality stocks is after the market has over-reacted to short term news and the share price gets beaten-down heavily.
Problems arise for investors when they fall into a value trap – buying a stock that looks cheap after a large drop in the share price, but in reality will struggle to recover as the underlying fundamentals have changed.
With this in mind, here are three stocks that are trading at a discount to the market and could appeal to some contrarian investors:
1. Genworth Mortgage Insurance Australia Limited (ASX: GMA) – Genworth is Australia's leading lenders' mortgage insurance (LMI) business with an impressive 44% market share. The share price dropped by more than 25% in February after Westpac Banking Corp (ASX: WBC) terminated a contract with Genworth that represented 14% of Genworth's gross written premiums in 2014.
Although National Australia Bank Ltd. (ASX: NAB) recently renewed its contract with Genworth, the market is still nervous about other lenders providing their own mortgage insurance and the shares have been trading in a narrow range for the past four months.
Trading at around 9x FY15 earnings, Genworth shares are probably undervalued at the moment but I think a new catalyst will be required for the share price to break out of the current range.
Investors should note that the current low interest rate environment coupled with low unemployment have created favourable conditions for Genworth but these conditions are not guaranteed to last.
2. Mineral Resources Limited (ASX: MIN) – The massive drop in the iron ore price over the last year has severely impacted the operations and profitability of Mineral Resources.
Although it is still providing mining and crushing services, Mineral Resources is now operating its own iron ore mines. As a relatively high cost producer, Mineral Resources is potentially in a loss-making position at the current iron ore price.
Its contracting and crushing services have also come under pressure recently as the major miners look to reduce their costs and delay new projects. The outlook for the sector remains difficult and Mineral Resources may struggle to win new contracts unless commodity prices rebound substantially.
Although the shares look cheap if valued on FY14 earnings, the company is potentially going to be in a loss-making position for the foreseeable future. I would suggest investors looking for exposure to the mining sector look at the lowest cost producers such as BHP Billiton Limited (ASX: BHP) or Rio Tinto Limited (ASX: RIO) .
3. AIR N.Z. FPO NZ (ASX: AIZ) – Air N.Z. is New Zealand's dominant airline with a market share of around 85%. The airline has delivered surprisingly good earnings stability over the past few years as management has been able reduce costs, increase capacity and focus on the most profitable routes.
Lower fuel costs have also been a tailwind for the airline more recently and management has confirmed that strong earnings momentum has continued in the second half of FY15.
The shares are trading at around 8x FY15 forecast earnings and analysts are expecting a dividend yield of around 6%. Although this appears attractive, the outlook for airlines can never be predicted with any certainty.
Competition in the domestic market will be increasing in December when Jetstar begins flying to regional destinations within New Zealand. The full impact of this is unknown at this stage but is expected to result in downward pressure on fares.
Amongst all the other uncertainties that airlines operate under, I think investors are better off looking for easier to understand businesses that have better earnings visibility.
