Being a contrarian requires challenging the consensus, which can be quite difficult. It requires guts of steel. Contrarians have to shut out the allure of stories, interviews in the financial media, and other distractions to focus on valuation.
Although Jim Cramer's trades are not long-term recommendations, his picks can be a 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 89 buy and sell stock opinions recently issued on CNBC's Mad Money (6.18.2012 to 6.22.2012), I challenge his four sell calls and three buy calls on a valuation basis. Crown Castle International (CCI), Starbucks Corporation (SBUX), and Hershey Co. (HSY) are too richly valued to be buy picks. On the other hand, Pitney Bowes Inc. (PBI), AstraZeneca (AZN), Caterpillar (CAT), and Research In Motion (RIMM) are too cheaply valued to be sell picks.
Cramer's picks are summarized below:
After reviewing the price multiples of CCI, SBUX, and HSY, it is clear that these stocks are richly valued according to static valuation metrics. Net insider selling of CCI and SBUX 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?
I calculated the total returns 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, I assumed each stock would be sold at a generous growth stock price-to-earnings multiple of 17. I am assumed the maximum of historical and analyst estimate values for earnings growth. These assumptions are used to project an annualized total return over the next three years and a terminal price to earnings ratios -- the price paid today divided by earnings at the end of the holding period for each stock:
3 Years Growth
Even after incorporating optimistic earnings growth, these stocks are just too expensive.
Alternatively, I discovered PBI, AZN, CAT, and RIMM as contrarian buy picks with attractive valuations by sifting through the week's sell recommendations. Then, I evaluated these contrarian buy candidates using conservative assumptions. A bargain value stock price to earnings multiple of 10 and the lesser of historical and analyst estimates values tearnings 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, again, the price paid today divided by earnings at the end of the holding period for each stock:
3 Years Growth
These stocks' attractive valuations 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 also flip the script on Cramer's seven stock calls.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.