The other day I stumbled on a fantastic Bloomberg article.
Although it was intended to add to the argument for investing in small cap value, I found this statistic to be much more meaningful:
Large-company analysts have failed to add value throughout the bull market that began in March 2009. Through Dec. 31, the most-favored S&P 500 stocks posted average gains of 73 percent, compared with 165 percent for their least favorite.
That is astonishing. When analysts put their neck out there and put a SELL rating on a company, it often outperforms. To me this supports the position of being a large cap contrarian. We should look to outperform by capitalizing on the historical inaccuracy of analysts predictions. That being said, how do you mitigate the risk of “catching a falling knife”, or in other words - buying sinking ships.
Comparing a company's EPS growth over the past 5 years to analysts' predictions for the next 5 years can often produce some ideal contrarian candidates. If your homework suggests the company’s future prospects are okay, then this is usually a good sign that analysts are far too bearish. Using this as part of a more comprehensive screening system should find good companies with bad stocks. Below is a list of 3 contrarian ideas based on this approach:
Cooper Tire & Rubber Company (NYSE:CTB)
Manufactures and markets replacement tires primarily in North America and internationally. Founded in 1913.
- P/S = 0.35
- P/E = 10.38
- YTD performance = -15.58%
EPS Past 5 Years = 26.82%
EPS Next 5 Years = 5.40%
Oshkosh Corporation (NYSE:OSK)
Designs, manufactures, and markets a range of access equipment, specialty vehicles, and vehicle bodies worldwide. Founded in 1917
- P/S = 0.3
- P/E = 4.79
- YTD performance = -26.36%
EPS Past 5 Years = 31.99%
EPS Next 5 Years = 1.82%
Hewlett-Packard Company (NYSE:HPQ)
Offers various products, technologies, software, solutions, and services to individual consumers and small and medium-sized businesses, as well as to the government, health, and education sectors worldwide. Founded in 1939.
- P/S = 0.60
- P/E = 8.64
- YTD performance = -16.11%
EPS Past 5 Years = 34.98%
EPS Next 5 Years = 8.85%
All of these companies fit the bill of a Ken Fisher/Ben Graham value investment. Combining significantly negative YTD returns and extremely bearish forward EPS estimates (relative to the previous track record) with cheap value metrics (PSR, P/E, and P/FCF if relevant) is a well thought out system.
To increase your margin of safety, make sure that there is a wide enough margin between past performance and future estimates. I set 25% EPS growth over the past 5 years as my minimum and 10% EPS over the next 5 years as my maximum so I always get a minimum 15% discrepancy between what the company has done and what the analysts say it will do.
Of the three, I have to rule out CTB and OSK as investment opportunities as they do not fit the requirement of being a large-cap (10B+) investment.
In the past this method has helped me identify great companies with crappy stocks across all industries. It showed me EBAY at $20, SOHU at $40, SBUX at $21.50 and many others. I believe it is most effective in either a recession or recovery when Buffett and other value investors make the bulk of their investments and analysts get the most bearish.
Disclosure: I am long HPQ.