Finding Profits In The Trash

10/31/2016


In a popular episode of Seinfeld, George Costanza, the stingy and opportunistic friend of Jerry Seinfeld, gets caught eating an éclair he had fished out of a trash can. "It wasn't down in, it was on top," says George. "Above the rim." Jerry doesn't buy the argument, concluding, "Adjacent to refuse is refuse."

Contrarian investors must be willing to suffer some ridicule when they buy a stock discarded by analysts or other investors. Contrarian investing is not for the impatient or insecure.

But if you consider the strategy from the perspective of supply and demand, unloved stocks have a bigger crowd of potential buyers sitting on the sidelines to eventually drive up their prices when the stocks gain popularity. Consider that the stocks most owned by mutual fund managers are on pace to underperform the least-popular stocks for the third straight year, according to The Wall Street Journal. This trend may be partly explained by the forced selling at mutual funds as more investors embrace passively managed funds.

Among the tools we use to measure sentiment for particular stocks are average analyst ratings and short interest.

A consensus rank of 1 equates to analysts rating a stock a Strong Buy, followed by 2 for a Buy, 3 for a Hold, and 4 for a Sell, and 5 for a Strong Sell. Most stocks receive favorable ratings (the typical S&P 500 stock averages an analyst rating of 2.3), in part because analysts tend not to cover stocks they don't like. Think of it as rejection by omission. For instance, the worst-rated stock in the S&P 500 is People's United Financial ($16; PBCT), which has an average analyst rank of 3.8. Just five analysts cover People's United, while 19 cover the average stock in the index.

Short selling occurs when an investor sells shares borrowed from a broker in the hope of buying the shares back at a later time at a lower price. The number of trading days needed to cover outstanding short positions is called the short interest ratio. A high ratio indicates the likelihood for a short squeeze, which happens when shorted stocks begin to rally, forcing short sellers to scramble and buy to cover their positions, pushing the stock even higher.

You may need to hold your nose, but consider buying the stocks in the table below, especially the ones in bold.

UNLOVED BUT NOT FORGOTTEN
Company (Price; Ticker)
Consensus
Rank
Short
Interest
As % Of
Float
Short
Ratio
(Days To
Cover)
Total
Return,
Past 3
Months
(%)
Quadrix
Overall
Score
52-Week
Price Range
Unloved by analysts
Aflac ($70; AFL)
3.1
1.9
4.7
(4)
83
75
-
55
F5 Networks ($120; FFIV)
2.7
6.2
6.7
(3)
86
127
- 
86
Ford Motor ($12; F)
2.8
3.8
4.3
(13)
88
15
- 
11
Toyota Motor ($116; TM)
3.3
0.1
5.7
4
99
127
-
98
Unloved by short sellers
Alaska Air Group ($71; ALK)
1.8
6.8
6.6
5
96
87
- 
55
Foot Locker ($69; FL)
1.7
9.7
7.0
16
96
70
-
51
Lam Research ($98; LRCX)
1.7
14.1
8.5
7
92
102
-
63
VMware ($73; VMW)
2.5
18.7
9.9
1
97
77
-
43
Unloved by analysts, short sellers, and investors
AmerisourceBergen ($79; ABC)
2.5
8.6
10.1
(7)
82
106
- 
73
Citrix Systems ($84; CTXS)
2.6
5.5
6.1
(5)
95
90
- 
61
Express Scripts ($70; ESRX)
2.6
4.2
7.8
(9)
90
89
- 
66
Owens Corning ($50; OC)
2.7
4.7
4.6
(5)
97
59
- 
39
S&P 500 Index average
2.3
3.9
4.4
(1)
60
Notes: Stocks in bold are recommended for purchase. Quadrix scores are percentile ranks, with 100 the best.

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