2007 Contrarian Portfolio: Performance Update
We still predict strong returns for this set of beleaguered stocks.
Stock Strategist
With its massive size and displacement, an aircraft carrier takes a long time to turn around. Likewise, with a wave of bad news and negative investor sentiment, sometimes it can take a quite a while for the fortunes of struggling stocks to change. With that in mind, it's not too surprising that our 2007 contrarian portfolio got off to a rough start.
During the three months since we introduced our portfolio, it produced a total return of negative 4.41%. This stands in stark contrast to the positive 3.49% that the S&P 500 returned during the same period. Obviously, no investor would be thrilled with an almost 8% underperformance. Attempting to sugarcoat these returns would be pointless. Quite simply, they stunk.
Three months is a very short timeframe to judge a contrarian portfolio, however. The premise underlying the selection of these 10 stocks was that the market was overly focused on past mistakes and did not fully appreciate their long-term earnings potential. To expect the market to suddenly do so in such a short timeframe is a bit unrealistic, and we think the success of the portfolio will be better judged over a much longer time horizon. In the meantime, it is important to provide quarterly updates on the performance of individual stocks in the portfolio, and to highlight significant reiterations or changes to Morningstar's thinking.
| Contrarian Portfolio Performance Update | ||
 | | |
| Company | Morningstar Rating* | Three-Month Total Return* |
| ||
| Jabil Circuit (JBL) |  | -14.80% |
| ||
| Angiotech | | -2.98% |
| ||
| Advance Auto Parts (AAP) |  | 4.59% |
| ||
| Radware (RDWR) | | -9.08% |
| ||
| GMH Communities | | 2.17% |
| ||
| Celestica (CLS) | | 3.74% |
| ||
| Finish Line | | 0.35% |
| ||
| MarineMax (HZO) | | -10.17% |
| ||
| Carter's (CRI) | | 12.89% |
| ||
| Vimicro International | | -30.13 |
 | ||
| Average | -4.41% | |
| ||
| S&P 500 | 3.49% | |
| ||
| Outperformance | -7.90% | |
| ||
| *As of 05-15-2007 |
Portfolio Philosophy
As a recap to our readers, the 2007 Contrarian Portfolio used three criteria to determine which stocks to include. First, we limited the stock universe to stocks with 5-star Morningstar ratings. Next, we reduced this list to only firms that underperformed the S&P 500 by 25% or more during the previous year. The last step was to use Morningstar's proprietary subscriber information to narrow this list down to the 10 least-viewed stocks.
This methodology allowed us to select 10 stocks that other investors hate or just plain don't know about, but that our analysts found reason to love. Contrarian investing is certainly not an investing philosophy for the impatient investor, but with our long-term investment horizon we think that many of these recent dogs may just turn out to be long-term stars.
Drivers of Performance
With an overall return of negative 4.4%, it's difficult to find a lot of bright spots in our portfolio's three-month performance. The biggest gainer of the group was Carter's (CRI), which posted a 12.89% gain during the period. The clothing manufacturer posted solid first-quarter sales results, and we think margins will improve as the year progresses. Advance Auto Parts (AAP) also was one of the stronger performers. We continue to believe in the long-term story of the automotive parts retailer and look for same-store sales to pick up.
The portfolio had three firms down more than 10% during the three months, once of which, Vimicro International ADR , declined more than 30%. Our analyst for this firm, Andy Ng, sees a limited downside with the Chinese semiconductor firm due to its large cash position and strong fundamentals, and he views Vimicro as even more of a bargain now than it was before. A switch in auditors and the delayed launch of Microsoft Vista did not do Vimicro any favors, but we think this is another case of good fundamentals being overwhelmed by short-term bad news.
Jabil Circuit (JBL) and MarineMax (HZO) also struggled during the period. In Jabil's case, near-term profitability took a hit from restructuring and a new manufacturing model, and we lowered our fair value estimate slightly after the firm's first-quarter earnings release. Strong revenue growth and confidence in Jabil's ability to capture additional market share provide us with reason for optimism, however. In the case of MarineMax, poor industry conditions have hit premium boat sellers hard and continued to do so during its first quarter. We think that MarineMax will eventually be able to turn this lemon into lemonade, though, and will come out of the slump in a better competitive position than when it entered.
All in all, as can be seen from our star ratings, Morningstar is sticking by these beleaguered stocks. Looking past near-term noise to really understand the long-term business dynamics is something that we pride ourselves on here at Morningstar, and these 10 picks reflect that thinking. As usual, we will be sure to update our fair value estimates if our thinking on any of these firms (or any of our 1,900-plus companies we cover) changes, but as of now, we still believe that the 2007 Contrarian Portfolio has good returns ahead of it.