Effectively, contrarian investing involves "zigging," when other investors are "zagging."
2013 saw stock prices run up some 30%, leaving far fewer "bargains" out there than a year ago. A few brave investors approach 2014 armed with an investment strategy that includes accumulating shares of out-of-favor companies in 2013. This approach isn't for the squeamish.
Separating sound contrarian stocks from value traps takes a combination of thorough research, fortitude, and a certain element of good fortune. Some stocks are cheap for a reason.
It's not too difficult to get started. Generate a list of "most hated" stocks. These are trumpeted throughout the media and panned by investment experts.
Picking through the rubble of shunned stocks is like being a prospector sifting through yards of rock and sand to find a single gold nugget. Adding to the challenge, nuggets are oft mixed in with pyrite, or "fool's gold." It's caveat emptor when you're a contrarian investor.
Nonetheless, here are three contrarian stocks for your consideration.
Caterpillar (NYSE:CAT) -- This just may be the most hated stock on the NYSE.
2013 marked a period when just about everything that could go wrong did: four missed earnings reports, revenue declines in all business lines, especially heavy mining equipment, and little prospective enthusiasm for 2014 from either management or the Street.
Caterpillar is expected to earn only $5.50 per share this year, a whopping 38% decline versus 2012. Yet the stock has risen 6% since an abysmal third-quarter earnings release in October. When shares refuse to stay down despite all kinds of bad news, the offering just might be one of those gold nuggets.
Stock sleuths may also note Caterpillar shares have experienced lower-than-average volume for months: Average weekly volume has been above the norm only five times since August.Have the sellers exhausted themselves? Historically, heavy machinery sales can turnaround quickly, and Caterpillar remains the best manufacturer of construction equipment, mining equipment, and industrial engines in the business.
Caterpillar stock price, 3 months:
Intel (NASDAQ:INTC) -- Some investors argue that Intel will never recover from the dot-com bust over a decade ago.
Management has been oft-maligned for slow entry to the handset device / tablet markets, instead relying too heavily on PC chipset sales.
Intel changed CEOs in 2013, marking an end of one era and the start of another. Like a new coach on a football team, sometimes a fresh leader becomes a catalyst for a company and its stock. Intel has a pristine balance sheet, the dividend yield is greater than most utility sector stocks, and margins remain high.
Intel's stock quietly garnered favorable 2013 total returns, thereby making its inclusion as a contrarian play questionable. However, retail investors as gauged by TD Ameritrade remain decidedly bearish on the name, and the short interest ratio is 7.1, meaning it would take about 7 days for Intel short-sellers to cover their bets that the stock is headed for the dog pound. A short interest ratio above 4 days is considered high.
Annaly Capital Management (NYSE:NLY) -- Possibly, this stock is hated as much as Caterpillar. Year-end tax-loss selling exacerbated an already dismal 2013 stock performance. The shares dropped nearly as much as the S&P 500 rose, and the dividend was cut three times. Ouch.
Investors bailed on Annaly in droves after interest rates spiked in May and their fixed-income investment ticked lower. The stock trades about 20% below net book value, and the divergence between the stock price and yield spread between 2-year and 10-year Treasury notes is at an all-time high. Nevertheless, many investors continue to view Annaly shares with disdain.
Early in 2013, investors fretted that mREIT net interest margins were too low. Later in the year, many feared that as long as interest rates rose, this mREIT stock remained in dire straits; even as the short-long spread widened, thereby increasing net interest margins.
Despite long-standing experience, management's ability to hedge interest rates, leverage capital deployed, and diversify into commercial mortgages is discounted.
Some of these problems are real. But some are temporary, and sometimes, investors can make money by looking where others are not.
Raymond Merola owns shares of Caterpillar, Intel, Annaly Capital Management, and NLY-D. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.