Valuation-Based Contrarian Picks

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 |  Includes: CLR, CMG, DE, WBA, WFM
by: Value Research

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 104 buy and sell stock opinions recently issued on CNBC's Mad Money (Feb.6, 2012 to Feb. 10, 2012), two sell calls and three buy calls can be challenged on a valuation basis. Continental Resources Inc. (NYSE:CLR), Whole Foods Market, Inc. (NASDAQ:WFM), and Chipotle Mexican Grill, Inc. (NYSE:CMG) are too richly valued to be buy picks. Conversely, Walgreen Co. (WAG) and Deere & Company (NYSE:DE) 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

WAG

Sell

2.08.2012

11.71

2.06

0.41

42.7%

CLR

Buy

2.09.2012

28.39

5.72

8.5

0.2%

WFM

Buy

2.09.2012

42.29

4.88

1.46

-86.8%

CMG

Buy

2.10.2012

55.69

11.27

5.19

-13.4%

DE

Sell

2.10.2012

13.21

5.23

1.1

2.4%

Click to enlarge

After reviewing the price multiples of CLR, CMG, and WFM it is clear that these stocks are richly valued according to static valuation metrics. Moreover, CMG and WFM 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 3-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 ratios, 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

CLR

Buy

-4.1%

12.8%

19.8

-5.1%

WFM

Buy

6.6%

16.2%

27.0

-12.6%

CMG

Buy

39.6%

23.5%

20.5

-11.8%

Click to enlarge

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

Alternatively, WAG and DE were discovered as contrarian buy picks with attractive valuations by sifting through the 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

WAG

Sell

2.6%

11.3%

8.8

5.3%

DE

Sell

1.9%

16.6%

9.3

3.1%

Click to enlarge

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 while using 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.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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