If you're like most people, there are certain companies that you wouldn't be caught dead owning. These companies aren't necessarily the controversial ones. While there are plenty of people who hate how Altria (NYSE: MO ) makes money (the author most emphatically not included), there are also people who just as strongly defend these firms.
No, I'm talking about Blockbuster (NYSE: BBI ) . Airlines. Auto manufacturers and auto parts makers. Chicken companies. These companies have the taint of something bad having happened, or the aura that something bad is about to happen. I'm also talking about companies that the primary investor of most families -- who is even in this day and age generally male -- gets the ookies when he thinks about. Imagine if you will Tim Allen's Neanderthal-ish Home Improvement character admitting to his beer buddies that he held Playtex (NYSE: PYX ) or Claire's (NYSE: CLE ) in his portfolio, which sell, um, feminine products and teeny-bopper accessories, respectively.
He wouldn't do it. And do you know why? Because these companies aren't cool. Which is precisely why I'm interested in them; because when everyone thinks the same thing, then nobody is thinking very much. And that's exactly the point when I become interested.
See through prejudice
There are a few reasons why companies are totally hated, but three such reasons reign supreme: a poor competitive position, poor apparent operating measures, or a poor industry.
"Wait, what was it that you said about being interested in companies like this?" Well, it's pretty simple. In a lot of situations, out-of-favor industries and bad operating performance actually mask pretty good companies. And if no one is interested in buying these companies, then guess what? That's right -- they tend to be cheap.
Cheap is cheap
I'll give you an example. In 2003, my colleague Tom Jacobs recommended funeral home operator Alderwoods (Nasdaq: AWGI ) to subscribers of our Hidden Gems small-cap newsletter. The funeral home business isn't exactly the hap-hap-happy industry that you might expect. People don't want to think about it. What's more, Alderwoods was coming out of a bankruptcy. Yeeesh. What's happened since then? Well, we've recommended the stock twice, and it's up 139% and 89%, respectively.
In 2003, Alderwoods was un-ownable, according to the general market's opinion. The market was wrong. Really wrong. And how about Denny's (Nasdaq: DENN ) ? In 2003, it fell as low as $0.29 per share. What was possibly lovable about Denny's? After all, it's about as fashionable as a comb-over. Well, one thing that was lovable about Denny's was its real estate, which could be sold or used as collateral for financing. You didn't even have to catch this company at its most hopeless to do extraordinarily well. This year the stock has been as high as $5 per share.
The Foolish bottom line
Of course, being a contrarian doesn't mean that you simply bet against the market. When Delta careened toward bankruptcy, it would have been a poor time to step in the way with your hard-earned money. But looking at companies that others hate is a tried and true way to improve your chances for outperforming the market. It requires keeping your skeptic's hat on. When the world hates Deluxe (NYSE: DLX ) -- because, after all, checks are going the way of the dodo bird, right? -- you might want to step up and take a look. Well-run companies in bad industries can spin off obscene levels of cash flows for many, many years.
Bill Mann is co-advisor of the Motley Fool Hidden Gems newsletter service. To see his latest ignored, unloved stock idea, subscribe to Hidden Gems today. Since inception, the newsletter's picks are outperforming the market at large by an average of 25 percentage points. The Fool's money-back guarantee stands behind the offer.
Bill owns shares in Denny's. The Fool has a strict disclosure policy.