In How the Grinch Stole Christmas, Dr. Seuss titular fiend was convinced that the holiday was simply a bad idea. He believed that by getting rid of the presents, trees, and decorations that marked the season, he could make the whole celebration go away. That the Grinch was wrong on that particular point doesn't mean that all such contrarian thinkers are similarly off-base.
Contrarian thought is natural. Like the Grinch, contrarian thinkers believe that the rest of the world is on the wrong track, and that "conventional wisdom" and the "consensus opinion" simply result from crowd behavior. Like the Grinch, they derive great satisfaction from proving their case.
When it comes to picking stocks, I don't know anyone who's batting a thousand. Not even the greatest investors, such as Warren Buffett, chairman of Berkshire Hathaway (NYSE:BRK-A), get it right all the time. Behavioral finance has shown that financial markets are not completely efficient, that many investors simply follow the herd, and that stock values sometimes get out of whack. That's why it's a good idea to occasionally put on your contrarian hat and second-guess yourself about whether a company like Google (NASDAQ:GOOG) is really worth 53 times earnings.
Investors with a bad attitude
Being a contrarian doesn't necessarily mean that your heart is two sizes too small. It just allows you to read the signs differently than other investors, and it makes you willing to invest where other investors may not be looking.
I mostly follow retail stocks, and unless you've been living in a cave high above Whoville for the past year, you know that retail is having a dismal year. Consumers aren't spending, the economy is looking pretty shaky, and most of the retailers we've counted on for years to deliver consistent growth are giving us anything but.
The market isn't too keen on the retail industry, given the current environment. However, short-term setbacks like these present great opportunities for contrarian investors. We can dig up strong companies that have been overlooked because the market is avoiding the industry. In the long run, when the overall sector recovers, these companies may offer lucrative returns.
Losing the caffeine buzz?
Apparently, some investors have switched to decaf over the past year. Starbucks (NASDAQ:SBUX) has lost 42% of its value in the last 52 weeks, prompting downgrades from several analysts on Wall Street. It's a typical situation for a maturing growth stock, as investors begin to realize that the company's previous high growth rates and margins are no longer achievable.
Yet I still believe that the company has a loyal customer base and enormous potential to grow its worldwide store count. Many investors are worried about Starbucks' prospects for further growth, and its fortunes in the brewing coffee war with McDonald's (NYSE:MCD). I'm not.
I'm simply interested in how far the stock will reasonably fall before the market realizes that it has underestimated Starbucks' growth potential. Earlier in the year, I thought $25 was the magic number. The last two months have proven me painfully wrong.
At its current price around $21, Starbucks is valued at 17 times analysts' 2008 earnings estimate of $1.22 per share. Although I don't trust the analysts, the estimate appears reasonable, since it represents 18% earnings growth -- the same that Starbucks delivered this past year. A 16.5 forward P/E is in the average range for all S&P 500 companies, which strikes me as not hugely overvalued for a growth company.
I believe this stock is getting to a point where the Grinch might be right.
The housing crisis will end ... someday
The housing market has made several grave mistakes in the past few years, and the nation's homebuyers and sellers are now paying the price for their irrational exuberance. But the last time I checked, most of my friends lived in houses, and have every intention of continuing to do so.
People who own homes naturally need to fix or improve them (especially if they can't sell them), and the majority of that business will go to Lowe's (NYSE:LOW) or Home Depot (NYSE:HD). Both stocks are down substantially from their 52-week highs -- Lowe's is off 25%, Home Depot by 33%.
There really isn't another big player in this industry, and I don't see signs of an upstart moving in and knocking off either company. I've favored Lowe's for the past few years because of management consistency and what looks to me like better merchandising and store operations, but that may be personal preference. Both stocks are trading at trailing-12-month PE's of around 11, which again strikes me as a pretty fair valuation.
Don't bet the farm
These are just a few of the many downtrodden retail companies to catch contrarian investors' eyes. It's a great time to be looking around for solid companies whose current slumps mask significant potential once the economy begins to recover.
One word of advice, though. Market-timing is a dicey business at best. Even if you're right about a stock, don't assume the market will agree with you right away. Smart Grinches enjoy making money on contrarian picks, but they never bet the whole roast beast on them.
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