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 73 buy and sell stock opinions recently issued on CNBC's Mad Money (2.21.2012 to 2.24.2012), two sell calls and four buy calls can be challenged on a valuation basis. Kinder Morgan Energy Partners (NYSE:KMP), Michael Kors Holdings (NYSE:KORS), MarkWest Energy Partners (NYSE:MWE), and Salesforce.com (NYSE:CRM) are too richly valued to be buy picks. Conversely, Hewlett-Packard Company (NYSE:HPQ) and AstraZeneca PLC (NYSE:AZN) are too cheaply valued to be sell picks.
These picks are summarized below:
After reviewing the price multiples of Salesforce.com, Kinder Morgan Energy Partners, Michael Kors Holding, and MarkWest Energy, 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
Even when incorporating fantastic earnings growth, these stocks are just too expensive.
Alternatively, HP and AstraZeneca 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
Even after tough scenarios, these stocks reward investors for buying HP and AstraZeneca at attractive valuations.
These projected returns flip the script on these six 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.
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