Morningstar's 2007 Contrarian Portfolio
We've found 10 stocks for investors who aren't afraid to go against the crowd.
Stock Strategist
If your parents were like mine, you probably heard the following line many times growing up: "You wouldn't jump off a bridge just because everybody else was, would you?" As this bit of wisdom suggests, sometimes it makes sense to go against the crowd, because the crowd isn't always right. Contrarian investing follows this philosophy. Contrarians believe, in a variety of ways and for a variety of reasons, that the market often acts irrationally, thus leading to mispriced stocks. At Morningstar, we feel the same way, and for the past several years we have assembled a contrarian portfolio to test this theory.
Contrarian investing is a relatively broad term. There is no set-in-stone rule for exactly how to invest using this technique. Investopedia defines it as "An investment style that goes against prevailing market trends by buying assets that are performing poorly and then selling when they perform well." The thesis behind investing in these stocks is that, quite frequently, stock prices are beaten down for reasons that do not correspond with a firm's long-term earnings potential. However, we think that there is another potential stock universe for contrarian investing: stocks that are largely ignored by the market. Ignored stocks often represent a buying opportunity, because the market might not be paying enough attention to notice an attractive price.
At Morningstar, we have two proprietary pieces of data that we believe can help us identify contrarian winners. The first piece is our deep pool of more than 1,900 Analyst Reports and fair value estimates; our research ultimately results in Morningstar Ratings for each firm that we cover. Because Morningstar takes the long-term view when estimating a company's earnings potential, that makes our research a great fit for the contrarian investor. The second proprietary data source that we have at our disposal is our Morningstar.com page view rankings. By looking at which Analyst Reports our subscribers have read, and which they have not, we believe that we have a fairly representative sample for the popularity of the stocks in our coverage universe. Theoretically, we should be able to identify attractive contrarian portfolio candidates from among our "least popular" stocks.
Utilizing these resources, Morningstar has been creating contrarian portfolios since 2004. We ranked all of our 5-star stocks in order of page view rankings (popularity), and then selected the 10 "least-popular" stocks for the portfolio. As you can see below, our 2004 Contrarian Portfolio impressively beat the S&P 500, but subsequent iterations have proved a bit disappointing.
| 2004 Contrarian Portfolio | |||||
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| 2003 Page View Rank | 2004 Total Return | 2005 Total Return | 2006 Total Return | Three-Year Cumulative Return | |
| CarMax (KMX) | 163 | 0.4% | -10.9% | 93.8% | 73.4% |
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| Chicago Merc (CME) | 175 | 218.5% | 61.5% | 39.5% | 617.6% |
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| Accenture (ACN) | 215 | 2.6% | 8.0% | 29.3% | 43.3% |
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| AutoZone (AZO) | 226 | 7.2% | 0.5% | 26.0% | 35.7% |
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| Biogen IDEC (BIIB) | 247 | 81.5% | -32.0% | 8.6% | 34.0% |
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| Expeditors Intl. (EXPD) | 334 | 49.0% | 21.4% | 20.5% | 118.0% |
| Washington Post (WPO) | 385 | 25.2% | -21.4% | -1.5% | -3.1% |
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| Triad Guaranty (TGIC) | 513 | 20.1% | -27.3% | 24.7% | 8.9% |
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| TransCanada (TRP) | 515 | 20.4% | 31.2% | 15.1% | 81.8% |
| CH Robinson (CHRW) | 979 | 48.1% | 36.2% | 11.9% | 125.7% |
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| Average (equally weighted) | 47.3% | 6.7% | 26.8% | 99.3% | |
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| S&P 500 | 10.9% | 4.8% | 15.8% | 34.6% | |
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| Outperformance | 36.4% | 1.9% | 11.0% | 64.7% | |
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| 2005 Contrarian Portfolio | ||||
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| 2004 Page View Rank | 2005 Total Return | 2006 Total Return | Two-Year Cumulative Return | |
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| Federated Investors (FII) | 70 | 23.7% | -6.9% | 15.2% |
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| Fifth Third Bank (FITB) | 114 | -17.2% | 13.0% | -6.4% |
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| Allied Waste | 118 | -5.8% | 40.6% | 32.4% |
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| eSpeed | 131 | -37.7% | 13.2% | -29.4% |
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| DeVry (DV) | 178 | 15.2% | 40.3% | 61.6% |
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| Lear (LEA) | 187 | -51.7% | 4.9% | -49.3% |
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| Intersil | 212 | 49.9% | -3.1% | 45.3% |
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| Group 1 Auto (GPI) | 325 | -0.2% | 66.5% | 66.1% |
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| Millennium Phar. | 408 | -20.1% | 12.4% | -10.2% |
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| Micrel | 1,274 | 5.2% | -7.0% | -2.2% |
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| Average (equally weighted) | -3.9% | 17.4% | 12.8% | |
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| S&P 500 | 4.8% | 15.8% | 21.3% | |
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| Outperformance | -8.7% | 1.6% | -8.5% | |
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| 2006 Contrarian Portfolio | ||
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| 2005 Page View Rank | 2006 Total Return | |
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| Valeant Pharmaceuticals (VRX) | 180 | -3.4% |
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| Educate | 238 | -39.7% |
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| White Mountains Insurance (WTM) | 296 | 5.3% |
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| BT Group ADR | 321 | 63.6% |
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| Hewitt Associates | 293 | -8.1% |
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| Alleghany | 243 | 30.6% |
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| Petco | 532 | 32.1% |
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| BankAtlantic Bancorp A | 413 | -0.3% |
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| Deutsche Telekom ADR | 636 | 15.0% |
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| International Speedway | 1,315 | 6.7% |
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| Avg. (equally weighted) | 10.2% | |
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| S&P 500 | 15.8% | |
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| Outperformance | -5.6% | |
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Given our long-term view, we are not totally disheartened by our 2005 and 2006 results. A longer-term view seems particularly relevant for a contrarian investor, as momentum traders often continue to trade down a stock price much longer than one might expect. To this end, we are encouraged that our 2005 portfolio actually outperformed the S&P in its second year. Regarding our 2006 portfolio, absent Educate's struggles, the average return would have been almost exactly the same as the S&P 500's performance. Furthermore, we were able to pick several big winners, including BT Group , Alleghany , and Petco (which was bought out during the year).
All that said, we believe there is room for improvement in our methodology. Specifically, we are going to broaden our definition of contrarian to also include stocks that investors have beaten down over the past year. Therefore, we determined our 2007 contrarian in three steps. First, we identified all of our stocks with 5-star ratings--there were 78 in total. Second, we reduced this list to only those that had total returns at least 25% lower than the S&P 500 (translating to a -9% or worse total return) during the previous 12-month period, thus narrowing our list to 42 names. Lastly, we chose the 10 "least popular" stocks from this group. Without further ado, here is our 2007 contrarian portfolio:
| The 2007 Contrarian Portfolio | |||
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| Stock | Morningstar Rating* | Page View Rank | 12-Month Return* |
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| Jabil Circuit (JBL) |  | 328 | -31.2% |
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| Angiotech Pharma. | | 338 | -57.1% |
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| Advance Auto Parts (AAP) | | 358 | -11.2% |
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| Radware (RDWR) | | 364 | -22.9 |
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| GMH Comm. Trust | | 412 | -34.0% |
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| Celestica (CLS) | | 468 | -38.6% |
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| Finish Line | | 512 | -28.6% |
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| MarineMax (HZO) | | 635 | -24.9% |
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| Carter's (CRI) | | 1,297 | -35.7% |
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| Vimicro Intl | | 1,854 | -40.9% |
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| Average | 657 | -32.5% | |
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| S&P 500 | 16.0 | ||
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| Outperformance | -48.5 | ||
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| *As of 02-15-07 |
As one would expect, Morningstar tries to get the word out on its 5-star opportunities, so the average page view ranking is well above the midpoint of our 1,900-plus stock coverage list. However, several of these companies are relatively small-cap firms, meaning that they might represent new investment ideas to a large percentage of our subscribers. In any case, we think we have identified some intriguing investments here that are certainly worth looking into. Here are a few of our thoughts on these firms and why they might be good contrarian plays.
Jabil Circuit (JBL): Investors have punished Jabil for its stock option backdating investigation as well as a number of operational hiccups. Nevertheless, organic growth remains strong, and restructuring improvements in 2007 should improve margins.
Angiotech Pharmaceuticals : Efforts to diversify away from its reliance on its Taxus stents should pay off for Angiotech down the road.
Advance Auto Parts (AAP): Advance Auto Parts' operating margin slipped in 2006, but the firm's long-term cash generating potential is still quite sizable.
Radware (RDWR): This switching company is still in the early stages of a turnaround process that might take a while, but we believe Radware represents one of the best small-cap technology turnaround opportunities currently available.
GMH Communities Trust : GMH is a REIT focused on providing college student and military housing. Rental revenue growth has slowed while operating expenses climbed faster than expected, but its problems are fixable and its rental properties should remain in high demand over the long term.
Celestica (CLS): Although we believe the near-term outlook is bleak at this electronics manufacturing services provider, our conservative operating margin forecast of 2% still brings us to a fair value estimate that is much higher than Celestica's current share price.
Finish Line : The apparel and footwear industries have always been cyclical businesses, and Finish Line's 2006 offerings tended to be a bit out of step with the current fashion trends. Nevertheless, we believe that the firm has carved out a nice little niche for itself, and its efforts to cater to women should pay off in the future.
MarineMax (HZO): MarineMax is currently dealing with a weak marine environment, and recent investments to shore up the business have dramatically reduced near-term operating profits. Nevertheless, in the long run MarineMax remains poised to continue gaining market share through the ups and downs of the cycle. We think that investor sentiment has likely turned overly negative during this cycle, and we consider this to be a great long-term buying opportunity.
Carter's (CRI): Management has forecast flat same-store sales growth in 2007, a clear sell signal to many investors. We believe the company's solid stable of kid's clothing brands and multiple distribution channels provide it with an advantage in a competitive industry.
Vimicro International ADR : Vimicro has quickly ascended to become one of China's premier semiconductor companies, but seasonality and the delay of Microsoft Vista's launch have cut into its near-term profitability. We think the firm's long-term growth prospects remain intact, however, and it should be able to take advantage of favorable trends in the Chinese semiconductor industry.
There you have it--the 10 firms that make up our 2007 contrarian portfolio. We think that these stocks are trading at attractive valuations, and we continue to believe in the contrarian philosophy, but the proof of our methodology is obviously in the results. We'll be checking in on a quarterly basis to update you on our performance.
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