The First Step In Finding A Great Stock

by: Jeff Miller

Some stock pickers start with a screen. I start with a concept: Look for the hated!

I search for investment themes that are decidely contrarian. That means that few like the concept, the sector or the stock. The themes must meet several important critera:

  • Negative sentiment and/or polling
  • Analyst skepticism
  • Modest valuations

and most importantly -- hatred.

I am going to list some themes and you probably will not like them. That is the point.

My mission here is to provide some specific ideas as well as suggestions about how the individual investor can search for and find profitable investments.

Contrarian Concepts

One problem is determining what most people believe. That is the only way to find the contrarian (and possibly undervalued) side of the trade. I want to encourage a free-wheeling discussion that will be helpful to all, but let me suggest two rules:

  1. Nothing political. I understand that you may think that Europe is in a socialist decline or be offended by Romney, but that is not the point. This is about investments, not political philosophy. We can predict political outcomes, but the purpose is to find investments.
  2. The time frame must be reasonable. I personally screen using three to six months.

Theme Ideas

Here are a number of themes that I nominate for consideration.

The Economy

This is an easy choice. Even the most optimistic economic forecasters only look for growth of 2.5% or so. There are many recession callers including many/most pundits (especially non-economists) and the ECRI. The recession forecasters have influenced earnings forecasts, now showing little growth in 2012, and stock prices.

Time frame: uncertain. The recessionistas started making their forecasts last Spring at the time of the Japanese earthquake. Q3 economic growth did not support the theory. Perhaps another strong quarter will move attitudes.

Stocks: Cyclicals and Tech. Caterpillar (NYSE:CAT) and Oracle (NASDAQ:ORCL) are contenders, but the nominations are open.

Europe Crisis

This is open to some debate. The credit market has not shown any recognition of improved prospects. Some think that stocks have recently been "euphoric" but it could also be a reaction to the good earnings season.

Time frame: week to week, but some specific tests within two months. I think the verdict (for US investors) will be in within eight months, although the social issues may linger.

Investments: Greek bonds, Italian bonds, credit default swaps, European banks, the dollar/euro spread, US banks, US stock market -- listed in order of declining risk and reward. My own play is lightly long US banks via JP Morgan (NYSE:JPM). Those taking either side should declare a time frame and also what would make them change opinions.

Value Trap Stocks

There are many stocks that nearly everyone agrees are cheap on a P/E basis. The stocks remain "cheap" because of a general consensus that they will not appreciate no matter what happens. The popular descriptive but unhelpful term is a "value trap." It is supposedly a silly mistake to be invested in these names.

Time frame: this quarter or next. Many names in this category have continued to improve in value. At some point this will be recognized. Catalysts might be technical breakouts above key moving averages, changes in leadership, or an exceptional earnings quarter.

Investments: Cisco (NASDAQ:CSCO) and Microsoft (NASDAQ:MSFT) come to mind. Nominations welcome!

Obama Re-election

This seems like a toss-up, mostly because the Republicans are floundering in the search for an opponent. Key factors in the race will be the economy and employment, reductions in troop commitment, and the qualifications of the GOP candidate.

Time frame: the stock effect could occur well before the election, depending upon changes in the factors listed.

Investments: Health care stocks lead this list, since every Republican is committed to unwinding ObamaCare. There are many candidates, including insurance companies like United Health Care (NYSE:UNH) and Wellpoint (WLP) and ETFs like XLV. Many other drug stocks and device makers are also worth consideration.

The Supercommittee

This is my favorite current theme. There is a lot of skepticism about progress and ultimate success. The uncertainty has cast a pall over the sectors destined for cuts in the absence of a successful outcome -- mostly health care and defense stocks.

Time Frame: the committee action is due by November 23rd and an extension seems unlikely. Congress and the President will need to approve, but the first hurdle is imminent. Check out my preview from August.

Investments: The health stocks are good candidates here as well, but so are defense names. United Technologies (NYSE:UTX), and Boeing (NYSE:BA) are leading choices.

Disclosure: None