Investment Themes: The first step in finding a great stock.

Some stock pickers start with a screen.  I start with a concept:  Look for the hated!

I search for investment themes that are decidely contrarian.  That means that few like the concept, the sector or the stock.  The themes must meet several important critera:

  • Negative sentiment and/or polling
  • Analyst skepticism
  • Modest valuations

and most importantly — hatred.

I am going to list some themes and you probably will not like them.  That is the point.

My mission here is to provide some specific ideas as well as suggestions about how the individual investor can search for and find profitable investments.

Contrarian Concepts

One problem is determining what most people believe.  That is the only way to find the contrarian (and possibly undervalued) side of the trade.  I want to encourage a free-wheeling discussion that will be helpful to all, but let me suggest two rules:

  1. Nothing political.  I understand that you may think that Europe is in a socialist decline or be offended by Romney, but that is not the point.  This is about investments, not political philosophy.  We can predict political outcomes, but the purpose is to find investments.
  2. The time frame must be reasonable.  I personally screen using three to six months.

Theme Ideas

Here are a number of themes that  I nominate for consideration.

The Economy

This is an easy choice.  Even the most optimistic economic forecasters only look for growth of 2.5% or so.  There are many recession callers including many/most pundits (especially non-economists) and the ECRI.  The recession forecasters have influenced earnings forecasts, now showing little growth in 2012, and stock prices.

Time frame:  uncertain.  The recessionistas started making their forecasts last Spring at the time of the Japanese earthquake.  Q3 economic growth did not support the theory.  Perhaps another strong quarter will move attitudes.

Stocks:  Cyclicals and Tech.  Caterpillar (CAT) and Oracle (ORCL) are contenders, but the nominations are open.

Europe Crisis

This is open to some debate.  The credit market has not shown any recognition of improved prospects.  Some think that stocks have recently been "euphoric" but it could also be a reaction to the good earnings season.

Time frame:  week to week, but some specific tests within two months.  I think the verdict (for US investors) will be in within eight months, although the social issues may linger.

Investments:  Greek bonds, Italian bonds, credit default swaps, European banks, the dollar/euro spread, US banks, US stock market — listed in order of declining risk and reward.  My own play is lightly long US banks via JP Morgan (JPM).  Those taking either side should declare a time frame and also what would make them change opinions.

Value Trap Stocks

There are many stocks that nearly everyone agrees are cheap on a P/E basis.  The stocks remain "cheap" because of a general consensus that they will not appreciate no matter what happens.  The popular descriptive but unhelpful term is a "value trap."  It is supposedly a silly mistake to be invested in these names.

Time frame:  this quarter or next.  Many names in this category have continued to improve in value.  At some point this will be recognized.  Catalysts might be technical breakouts above key moving averages, changes in leadership, or an exceptional earnings quarter.

Investments:  Cisco (CSCO) and Microsoft (MSFT) come to mind.  Nominations welcome!

Obama Re-election

This seems like a toss-up, mostly because the Republicans are floundering in the search for an opponent.  Key factors in the race will be the economy and employment, reductions in troop commitment, and the qualifications of the GOP candidate.

Time frame:  the stock effect could occur well before the election, depending upon changes in the factors listed.

Investments:  Health care stocks lead this list, since every Republican is committed to unwinding ObamaCare.  There are many candidates, including insurance companies like United Health Care (UNH) and Wellpoint (WLP) and ETFs like XLV.  Many other drug stocks and device makers are also worth consideration.

The Supercommittee

This is my favorite current theme.  There is a lot of skepticism about progress and ultimate success.  The uncertainty has cast a pall over the sectors destined for cuts in the absence of a successful outcome — mostly health care and defense stocks.

Time Frame:  the committee action is due  by November 23rd and an extension seems unlikely.  Congress and the President will need to approve, but the first hurdle is imminent.  Check out my preview from August.

Investments:  The health stocks are good candidates here as well, but so are defense names.  United Technologies (UTX), and Boeing (BA) are leading choices.

Please Join In

Do you like this approach?  The ideas here are a work in progress.  New themes and stock ideas are encouraged in the comments.

In addition, you can participate in a real-time discussion.  I have recently joined a group of investment experts at Wall Street All-Stars.  I am writing about investment ideas and responding to questions in a daily investment diary.  I invite readers to check this out and also to consider the free trial (just email our office:  main at newarc dot com).   There is also free content and other diaries on various subjects.  It is worth checking out.

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18 comments

  • Proteus November 8, 2011  

    Wow, what an opportunity!
    Economy – I’ll second your ORCL choice, and nominate INTC. No reason other than I like them.
    Europe – John Hempton (Bronte Capital) bought Credit Agricole but had to sell; I’ll steal his idea and say French (and German) banks are reviled, as well as cheap, if they survive. I like and own JPM, but my suggestion is one you mentioned a while ago and got hate mail: Goldman Sachs. A friend’s daughter works there and says the culture is incredibly polite and customer focussed. I think GS is a bargain somewhere below $100. Holding time for both is over two years. Bonus: Citi in 5+ years.
    Health care – I prefer Aetna to UNH. Call them up as a customer and Aetna blows UNH away, plus AET has been pretty tough on hospital cost negotiations.
    Supercommittee – Defense seems to run in long cycles. Have to go with my ex-employer Lockheed Martin. After years of bloated management finally starting to cut some of the overhead. Low P/E and a nice dividend are pluses.

  • Angel Martin November 8, 2011  

    Jeff, the corollary to buying something everyone hates; is to short something everyone loves.
    Here’s my contrary idea on europe, short bunds. My thinking on this is that the guys who made the most money shorting subprime were the ones (as documented in The Big Short) who shorted the highest rated tranches.
    If europe blows up, my contrarian view is that Germany goes with it and bunds tank.
    Time frame: now to the end of dec, and again starting in march to june.

  • pacioli November 8, 2011  

    Angel –
    You are right on. But I have a question on mechanics.
    Are you shorting actual bunds, and ETF, options?
    How do you play it?

  • Proteus November 8, 2011  

    I like your thinking. Junk bonds can always improve credit quality (if they don’t go belly up), but AAA bonds can only go one way – down.

  • Angel Martin November 8, 2011  

    Pacioli, I currently don’t have this trade on, it’s the kind i like to do with options rather than, say, shorting BUND or BUNL.
    Unfortunately, as far as i know, there is no Bund reference ETF that currently has options… anyone know of one ?
    You could also go into the futures market for options on bunds.

  • Ann November 8, 2011  

    How do you see Nat gas as a contrarian play? Everyone seems to think it is too abundantly available to be a good investment yet they run oil and gold to the moon. I feel like I’d rather own natural gas than gold, because it actually fulfills a need in our lives. Jeffrey Gundlach has mentioned it as a sleeper investment idea as well.

  • oldprof November 8, 2011  

    Proteus — Thanks for the suggestions!
    Jeff

  • oldprof November 8, 2011  

    Angel — I absolutely agree that a contrarian play can and should go both ways. I am still searching for anyone other than David Goldman who sees a positive outcome in Europe.
    Deciding which side is the contrarian play is part of the problem.
    You have another point in your favor: Shorting bonds of any sort should eventually work, even if your thesis does not play out.
    Jeff

  • oldprof November 8, 2011  

    Ann — I agree. I should have mentioned energy as another theme. I have some Nat Gas holdings in client accounts.
    Thanks!
    Jeff

  • Paul in Kansas City November 8, 2011  

    the canadian oil sands; cash generated may be close to 18% before cap ex; unhedged syncrude production and almost net debt free; in my opinion the current quote is more appropriate at $75 WTI; i think this can be viewed as an easy short (and perhaps a consequence of selling the canadian dollar against the US dollar) versus trying to sell WTI or Brent short. this company is much less complex than E&P or inegrated oil companies.

  • Michael M November 9, 2011  

    Well I have to add that ‘short’ Long Term US Treasuries surely have to be a candidate for massive contempt. Whenever I look at my (held for many months) TBT holding I would say that “hate” is getting close! However, I still have them for some reason. Ummmmm…look what happened to Italy today with rates going over critical mass of 7%…Supposedly that could happen to the good old USA some day. Seems to be taking forever, so mega “hate” seems inevitable.
    MM

  • Angel Martin November 10, 2011  

    Michael M, I don’t agree with you that short TLT is contrarian. It seems that almost everyone since mid 2009 has been calling for higher treasury rates, and they keep going in the opposite direction.
    that said, i agree with you that if the US political system does not get its act together, then what is happening in europe now is a preview of coming attractions…

  • Mike C November 10, 2011  

    Cullen Roche over at pragcap.com has written extensively on these issues. Most everyone operating under the notion of much higher U.S. Treasury rates anytime soon and that Greece/Italy are equal to the U.S. is operating under a whole host of false assumptions about how the monetary and banking system operates, and what drives long-term interest rates in the U.S. which is a sovereign issuer of its own currency that is debts are denonimated in (not the case for Greece and Italy).
    In short, as long as the Fed keeps ST rates at zero, there isn’t much likelihood of higher LT rates anytime soon. So far the Fed has remained committed to ZIRP even with higher CPI numbers.

  • mac26d November 10, 2011  

    I’d like to nominate Toyota(TM) and BP.
    Both stocks with lots of negative sentiment.
    BP possibly on weakness to the trendline (or b/o above) and TM is coming down to long term support.

  • Angel Martin November 10, 2011  

    Jeff, I also question how “contrarian” it is to believe that europe might not be a total wreck.
    Yes, almost all of the bloggers, pundits and talking heads talk a negative game on europe. But if “the end of europe” was widely believed, why is the euro still at 1.35-1.36 ?
    When Ireland got into trouble in Dec 2010, the euro was 1.32-1.34. I think if you told people in late 2010 that by nov 2011, Greece would have been bailed out twice with a 50% haircut for bondholders, Portugal and Ireland would be bailed out and Italy would be in a political crisis with 2 year yields at 6.4%; investors back in late 2010 would be surprised that the euro would be at 1.35+
    I don’t think the current level of the euro is consistent with a consensus view that “europe is doomed”…

  • Proteus November 10, 2011  

    Jeff, this thread just keeps on going and going. Good idea for the original post.
    OK, my final suggestion. I promise 🙂
    Olympus. Talk about a hated, contrarian play. I have had mixed success buying stocks with corporate accounting issues. But the Cassandra Does Tokyo post on Tuesday (I find the anonymous author particularly astute) comes up with a valuation of $5B to $6.5B, against a current valuation of about $1.6B, assuming I didn’t mess up the conversions. 70% discount. Might be worth a shot.

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  • Cassandra August 16, 2013  

    Dear Proteus
    I wish they all worked out like that one….;)