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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 67 buy and sell stock opinions recently issued on CNBC's Mad Money (2.13.2012 to 2.17.2012), two sell calls and four buy calls can be challenged on a valuation basis. Fortinet Inc. (FTNT), Michael Kors Holdings (KORS), Cerner Corporation (CERN), and Continental Resources (CLR) are too richly valued to be buy picks. Conversely, Activision Blizzard, Inc. (ATVI) and Halliburton Company (HAL) are too cheaply valued to be sell picks.

These picks are summarized below:

Ticker

Cramer's Call

Airdate

P/E

P/B

P/S

(FTNT)

2.14.2012

Buy

69.24

11.34

9.35

(ATVI)

2.14.2012

Sell

13.46

1.35

3.01

(HAL)

2.14.2012

Sell

10.93

2.49

1.32

(KORS)

2.15.2012

Buy

93.89

26.74

7.97

(CERN)

2.15.2012

Buy

40.9

5.28

5.54

(CLR)

2.16.2012

Buy

32.9

6.63

9.85

After reviewing the price multiples of FTNT, KORS, CERN and CLR, it is clear that these stocks are richly valued according to static valuation metrics. Sadly, even pleasant 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

FTNT

Buy

38.4%

19.7%

26.1

-13.3%

KORS

Buy

0.0%

28.2%

44.5

-27.5%

CERN

Buy

21.3%

19.6%

22.9

-9.5%

CLR

Buy

-4.1%

12.8%

23.0

-9.5%

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

Alternatively, ATVI and HAL 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

ATVI

Sell

8.5%

13.4%

10.6

-1.3%

HAL

Sell

9.6%

28.0%

8.3

6.7%

Even after tough scenarios, these stocks reward investors for buying HAL at attractive valuations. Though ATVI does see a loss in a terrible scenario, it is a small loss based on low future valuations and low growth. Buying ATVI is worth risking this scenario, and buying HAL is a no-brainer, based on its current low price multiples.

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.

Read the article disclaimer.

Source: Valuation-Based Contrarian Picks