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In the wake of past asset bubbles many of today's investors describe themselves as contrarians. Can a majority of investors really have minority views? How can a consensus be identified when everyone claims to be different?

Even though Jim Cramer's trades are not long-term recommendations, his picks can be a very useful barometer of investor and media attitudes. Contrarians can use his picks as an indicator of current market sentiment to selectively counter.

Of Cramer's 90 buy and sell stock opinions recently issued on CNBC's Mad Money (January 30,2012 to February 3, 2012), two sell calls and three buy calls can be challenged on a valuation basis. Allergan Inc. (NYSE:AGN), Chipotle Mexican Grill (NYSE:CMG), and Whole Foods Market (NASDAQ:WFM) are too richly valued to be buy picks. Conversely, YPF S.A. (NYSE:YPF) and Peabody Energy (NYSE:BTU) are too cheaply valued to be sell picks. These picks are summarized below:

Ticker

Cramer's Call

Airdate

P/E

P/B

P/S

Insider Transactions

YPF

Sell

1.31.2012

9.6

2.64

1.02

0.0%

AGN

Buy

2.02.2012

29.1

5.15

4.93

-7.6%

CMG

Buy

2.02.2012

58.0

11.66

5.41

-5.3%

BTU

Sell

2.02.2012

10.1

1.87

1.29

63.9%

WFM

Buy

2.03.2012

39.5

4.56

1.36

-87.3%

After reviewing the price multiples of AGN, CMG, and WFM it is clear that these stocks are richly valued according to static valuation metrics. Moreover, insiders are selling their positions in these stocks more than they are buying.

Future growth scenarios are not much consolation for such richly valued stocks. What could an investor expect from these picks?

Total returns were calculated over a three-year holding period for each of these stocks. (I use a three-year holding period since above-average growth estimates are not reliable further out.) Giving these buy recommendations the benefit of the doubt, each stock is assumed to be sold at a generous growth stock price-to-earnings multiple of 17 and the maximum of historical and analyst estimate values for earnings growth are assumed. These assumptions are used to project an annualized total return over the next three years and a terminal price-to-earnings ratio, that is, price paid today divided by earnings at the end of the holding period for each stock:

3 Years Growth

Ticker

Cramer

g (past)

g (future)

Terminal P/E

Annualized Return

AGN

Buy

-73.6%

13.5%

19.9

-5.1%

CMG

Buy

31.6%

23.5%

25.4

-12.6%

WFM

Buy

6.6%

16.6%

24.9

-11.8%

Even when incorporating fantastic earnings growth, these stocks are just too expensive.

Alternatively, YPF and BTU were discovered as contrarian buy picks with attractive valuations by sifting through this week's sell recommendations. These contrarian buy candidates were evaluated using conservative assumptions. A bargain value stock price-to-earnings multiple of 10 and the lesser of historical and analyst estimates values for earnings growth are assumed. These assumptions are used to project an annualized total return over the next three years and a terminal price-to-earnings ratio, that is, price paid today divided by earnings at the end of the holding period for each stock:

3 Years Growth

Ticker

Cramer

g (past)

g (future)

Terminal P/E

Annualized Return

YPF

Sell

-1.8%

13.7%

10.2

2.8%

BTU

Sell

12.3%

22.5%

7.1

12.4%

Even after tough scenarios these stocks reward investors for buying them at attractive valuations.

These projected returns flip the script on these five stock calls. They ignore stories and current sentiment, and use valuation and math to demonstrate how buying expensive stocks can cost investors dearly.

Bear in mind that challenging the consensus requires guts of steel. Contrarians have to shut out the allure of stories, interviews in the financial media, and other distractions in order to focus on valuation. This is quite difficult.

Read the article disclaimer.

Source: Valuation-Based Contrarian Picks