Valuation-Based Contrarian Picks

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Includes: CERN, CMG, HFC, HPQ, MNST, PNRA, TEF
by: Value Research

How can a consensus be identified when everyone claims to be different? Who isn't a contrarian or a value investor today?

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 130 buy and sell stock opinions recently issued on CNBC's Mad Money (3.12.2012 to 3.16.2012), three sell calls and four buy calls can be challenged on a valuation basis. Chipotle Mexican Grill (NYSE:CMG), Monster Beverage Corporation (NASDAQ:MNST), Cerner Corporation (NASDAQ:CERN) and Panera Bread (NASDAQ:PNRA) are too richly valued to be buy picks. Hewlett-Packard (NYSE:HPQ), Telefonica (NYSE:TEF) and HollyFrontier Corporation (NYSE:HFC) 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

(HPQ)

Sell

3.12.2012

8.65

1.24

0.39

54.9%

(CMG)

Buy

3.13.2012

60.79

12.3

5.66

-3.8%

(TEF)

Sell

3.13.2012

3.57

0.88

0.93

0.0%

(MNST)

Buy

3.14.2012

38.92

10.61

6.09

-12.3%

(CERN)

Buy

3.15.2012

43.71

5.65

5.92

-1.0%

(PNRA)

Buy

3.15.2012

35.48

7.31

2.81

-4.3%

(HFC)

Sell

3.16.2012

5.86

1.45

0.48

14.4%

Click to enlarge

After reviewing the price multiples of CMG, MNST, CERN and PNRA, it is clear that these stocks are richly valued according to static valuation metrics. Net insider selling is also discouraging for these stocks.

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

CMG

Buy

39.6%

23.8%

22.3

-8.7%

MNST

Buy

25.3%

14.5%

19.8

-4.9%

CERN

Buy

21.3%

19.7%

24.5

-11.5%

PNRA

Buy

21.6%

18.3%

19.8

-4.9%

Click to enlarge

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

Alternatively, HPQ, TEF, and HFC 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

HPQ

Sell

8.9%

5.5%

7.4

11.4%

TEF

Sell

4.3%

-1.6%

3.7

44.4%

HFC

Sell

24.8%

22.2%

3.2

46.6%

Click to enlarge

The attractive valuations of HPQ, TEF and HFC protect investors from tough scenarios like these, providing them with positive returns.

These projected returns flip the script on these seven 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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