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Even though Jim Cramer's trades are not long-term recommendations, his picks can be a very useful barometer of investor and media attitudes. His endorsement can help identify a consensus when everyone claims to be different. This can be challenging in times when everyone self-identifies as a contrarian.

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 (6.04.2012 to 6.08.2012), three sell calls and four buy calls can be challenged on a valuation basis. The Hain Celestial Group (NASDAQ:HAIN), Whole Foods Market (NASDAQ:WFM), Diageo (NYSE:DEO), Ulta Salon, and Cosmetics & Fragrance (NASDAQ:ULTA) are too richly valued to be buy picks. On the other hand, Dell (NASDAQ:DELL), Caterpillar (NYSE:CAT), and Fluor Corporation (NYSE:FLR) 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

DELL

Sell

6.08.2012

6.93

2.28

0.34

36.4%

HAIN

Buy

6.08.2012

35.94

2.56

1.81

1.4%

WFM

Buy

6.08.2012

41.33

4.82

1.54

-68.7%

DEO

Buy

6.08.2012

23.99

7.76

3.85

0.0%

ULTA

Buy

6.06.2012

45.41

10.11

3.17

-83.7%

CAT

Sell

6.05.2012

11.06

3.82

0.9

7.9%

FLR

Sell

6.05.2012

13.75

2.31

0.33

8.4%

After reviewing the price-to-earnings multiples of HAIN, WFM, DEO, and ULTA it is clear that these stocks are richly valued. Other static valuation metrics confirm that ULTA and DEO are pricey, whereas price-to-sales ratios may cast doubt whether the valuations of WFM and HAIN are outlandish. To investigate further growth projections can be incorporated.

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 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

HAIN

Buy

5.7%

13.9%

24.3

-11.3%

WFM

Buy

6.6%

17.7%

25.4

-12.3%

DEO

Buy

2.6%

10.4%

17.8

-0.7%

ULTA

Buy

33.3%

25.3%

19.2

-3.9%

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

Alternatively, DELL, CAT, and FLR 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

DELL

Sell

6.3%

36.4%

5.8

20.1%

CAT

Sell

17.5%

7.9%

8.9

4.6%

FLR

Sell

11.4%

8.4%

10.0

0.6%

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.

Bear in mind that taking on these investments is not easy. 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.

Read the article disclaimer.

Source: Valuation-Based Contrarian Picks