In a world where "Think Different" is a corporate motto and most business people believe they think "outside the box," is there such a thing as creativity or independent thinking? How can a consensus be identified when everyone claims to be different and innovative? 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 jumping off point for current market sentiment to selectively counter.
Of Cramer's 72 buy and sell stock opinions recently featured on CNBC's Mad Money (from April 2 to April 5), three sell calls and four buy calls can be challenged on a valuation basis. Cerner (CERN), IMAX (IMAX), Red Hat (RHT), and Plum Creek Timber (PCL) are too richly valued to be buy picks. On the other hand, Alliance Resource Partners (ARLP), Newfield Exploration (NFX), and Research In Motion (RIMM) 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 |
CERN | Buy | 4.02.2012 | 43.11 | 5.57 | 5.84 | -4.8% |
IMAX | Buy | 4.02.2012 | 102.52 | 7.97 | 6.53 | -17.0% |
RHT | Buy | 4.02.2012 | 81.27 | 8.47 | 10.37 | -9.9% |
ARLP | Sell | 4.02.2012 | 6.88 | 3.3 | 1.12 | 4.6% |
NFX | Sell | 4.03.2012 | 8.8 | 1.21 | 1.92 | 23.6% |
RIMM | Sell | 4.04.2012 | 5.71 | 0.66 | 0.36 | 0.0% |
PCL | Buy | 4.05.2012 | 34.92 | 5.31 | 5.75 | -1.6% |
After reviewing the price multiples of Cerner, IMAX, Red Hat, and Plum Creek Timber, it is clear that these stocks are richly valued according to static valuation metrics. Net insider selling of these picks over the past six months is also discouraging.
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 names. (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 ratios; that is, the price paid today divided by earnings at the end of the holding period for each stock:
3 Years Of Growth | |||||
Ticker | Cramer | g (past) | g (future) | Terminal P/E | Annualized Return |
CERN | Buy | 21.3% | 19.4% | 24.2 | -11.1% |
IMAX | Buy | 39.9% | 27.0% | 37.4 | -23.1% |
RHT | Buy | 20.7% | 18.8% | 46.3 | -28.4% |
PCL | Buy | -7.3% | 4.6% | 30.5 | -16.6% |
Even after incorporating optimistic earnings growth, these stocks are just too expensive.
Alternatively, Alliance Resource Partners, Newfield Exploration, and Research In Motion 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 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, the price paid today divided by earnings at the end of the holding period for each stock:
3 Years Of Growth | |||||
Ticker | Cramer | g (past) | g (future) | Terminal P/E | Annualized Return |
ARLP | Sell | 15.1% | 10.7% | 5.1 | 28.3% |
NFX | Sell | -3.3% | 10.2% | 9.7 | 0.9% |
RIMM | Sell | 15.0% | 2.2% | 5.3 | 23.2% |
The attractive valuations of these stocks protect investors from tough scenarios, providing them with better odds for positive returns.
These projected returns ignore stories and current sentiment while using valuation and math to demonstrate how buying expensive stocks can cost investors dearly. They flip the script on these seven stock calls.
Challenging the consensus is quite difficult and 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.
Disclaimer: Please read the article disclaimer here.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
