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3 contrarian retail shares with outsized upside potential

Forecasting is a notoriously difficult task. It is almost impossible to know with certainty what the future of any given business will be.

As such, value investors typically seek to buy businesses where the range of possible future outcomes means that there is significantly greater upside potential for the share price than downside potential. That is, the price that you pay has enough pessimism built in that even a slight reversal of fortunes will pay off.

One area of particular pessimism has been traditional bricks-and-mortar retail. The threat of Amazon Inc and Australian businesses such as Kogan.com Ltd (ASX: KGN) has seen pessimism take over. While it may be justified, the real question is whether there is sufficient pessimism built into the price of traditional retailers that the potential upside is far greater than the potential downside.

I am inclined to believe so. Here are three small cap retailers that I’d buy today on their upside potential.

Adairs Ltd (ASX: ADH)

Adairs is a retailer of manchester and homewares. The company has over 160 stores across Australia in five physical store formats, comprising Adairs, Adairs Homemaker, Adairs Kids, UHR and Adairs Outlets. Adairs currently trades at a price to earrings multiple (PE) of 15.5.

Nick Scali Limited (ASX: NCK)

Nick Scali retails and imports household furniture and accessories including lounges, dining chairs, dining and coffee tables, cabinets, rugs, and entertainment units. The company currently trades at a PE of 15.

Super Retail Group Ltd (ASX: SUL)

Super Retail Group own and operate a number of Australian retail brands including Rebel Sport, Supercheap Auto, Ray’s, and Boating Camping and Fishing (BCF). Combined, Super Retail Group operates over 630 stores across Australia, New Zealand and China. Shares trade at a PE of 8.6.

Foolish takeaway

Certainty is impossible in investing. Stacking the odds in your favour is therefore very important. Adairs, Nick Scali, and Super Retail Group are businesses that I believe can stack the odds in your favour at today’s share prices.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Stewart Vella owns shares of Amazon. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends Amazon. The Motley Fool Australia owns shares of Super Retail Group Limited. The Motley Fool Australia has recommended Amazon and Kogan.com ltd. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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