There's at least a kernel of contrarian thinking behind most stock trades. Any convinced buyer takes the shares of a seller who is just as convinced. True contrarian investors, however, go rummaging through deeply unloved shares for ones that are misunderstood, or are on the verge of a turnaround, or are for other reasons undeservedly cheap.
One downside to that approach is that price momentum matters. Stocks that have plunged over the past six months to a year are more likely than not to continue doing so in the coming six months to a year, studies show.
Below are listed the results of a search for contrarian stocks with recent signs of hope. Each has lost 20% of its value over the past year. Considering that the large-company S&P 500 index has gained 16% over the past year and its sibling index of small companies has gained far more, these three stocks are dogs, indeed. But each stock has rebounded 5% over the past four weeks, and each company topped Wall Street's earnings forecast in its most recent quarter, suggesting the pessimism is overdone.
Dean Foods (DF) is the nation's largest seller of fresh milk. Despite yearly sales of more than $12 billion, the company is valued at barely $2 billion. That's because margins on milk are meager. Dean turns less than four cents of each sales dollar into operating profit. That could change soon. BMO Capital Markets analyst Amit Sharma initiated coverage of the stock last month with an "outperform" rating, and in a note to clients pointed out some promising signs. With wholesale milk prices rising, grocers are becoming less willing to discount it to lure customers. Dairies are becoming more willing to sacrifice volumes to preserve profits. And although Dean's supply contracts are expected to crimp profits in the near-term, they will expire in coming quarters, lifting margins again. A recent debt offering buys the company three years to turn things around in its fresh milk division. Specialty products, like Horizon organic milk and Silk soy milk, are already plenty profitable.
The death of Circuit City in 2008 gave rival Best Buy (BBY) a short-term boost, but should have also served as a warning. Electronics stores have been going bust for a reason. Many sell the same brands, which keeps pricing power weak, and large store formats that have spread through the industry come with high operating costs. Meanwhile, Wal-Mart (WMT) and online sellers are grabbing market share. Best Buy is growing, but barely. Management recently outlined a plan to fix what's ailing the company. It will reduce big-box store space by 10% and reduce the number of in-store items while increasing online ones. It will also focus on expanding what's working: video games (including lucrative used ones), cell phones (including contract initiation), tablets and electronics in China. The strategy could carry increased marketing expenses and has no guarantee of success, but then, shares sell for just nine times earnings, a discount of more than one-third to the broad market.
House prices fell again last month. They're down more than 30% nationwide, and more with inflation, since I warned readers in April 2007 that renting had come to make more financial sense than buying. Some markets are now cheap enough but most are not, based on valuation measures like the ratio of prices to comparable rents and area incomes, and on near-term price pressures. These include a high rate of foreclosures, a glut of inventory, high unemployment, finicky lending and the looming reverse of the Federal Reserve efforts to keep mortgage rates unnaturally low. It's early, then, to make a bet on homebuilders like D.R. Horton (DHI), but consider a few bright signs. The damage seems done: Sales have plunged from more than $14 billion in 2006 to a yearly pace of around $4 billion, and the stock is down more than 70% from its summer 2005 peak. The company has modest debt, positive cash flow and a high number of closings relative to peers. The stock also comes with a 1.2% dividend. Investors who have a cheerier outlook for housing than mine -- and a strong contrarian side -- might want to have a look.