2007 Contrarian Portfolio: Performance Update

If you don't have anything nice to say, don't say anything at all. Wise advice in general--but if we took that to heart regarding our 2007 contrarian portfolio, our update would end right here.

The danger of providing quarterly updates on a long-term, contrarian-based portfolio is that the short-term results have a good chance of looking quite ugly. This continued to be the case during the past three months as we most certainly have not been in a contrarian market.

Of the 10 stocks in our contrarian portfolio, only one has outperformed the S&P 500 Index since the portfolio's February 2007 inception. And even that firm,  Radware (RDWR), still had a negative return. The table below summarizes the portfolio's six-month performance.

Contrarian Portfolio Performance Update
Company	Morningstar Rating*	Six-Month Total Return*
Jabil Circuit (JBL)		-13.24%
Angiotech		-12.22%
Advance Auto Parts (AAP)		-18.30%
Radware (RDWR)		-1.73%
GMH Communities		-21.95%
Celestica (CLS)		-15.11%
Finish Line		-54.78%
MarineMax (HZO)		-18.36%
Carter's (CRI)		-8.74%
Vimicro International		-28.84
Average		-19.33%
S&P 500		-2.56%
Performance		-16.77%
*As of 08-15-2007.

While the market as a whole has struggled during the past six months, our 10 picks have underperformed the S&P 500 by nearly 17% during the period. We're sticking to our guns, however, and all 10 names are currently rated 5 stars by our analysts. Let's look under this portfolio's hood to figure out not only what went wrong, but also why we still like these stocks.

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
We'll divide our performance review into three sections: the good, the bad, and the ugly. First, let's start with the good.

Now that we've finished reviewing the good, let's move onto the bad. Four of our stocks were down between 1% and 15% during the period; given the rough market conditions, this is disappointing, but not terribly so. Radware has been our best performer so far, and although we expect the firm to remain unprofitable through mid-2008, we still like its chances as a turnaround play in the small-cap technology sector.  Carter's (CRI), a children's clothing manufacturer, continues to struggle integrating its purchase of the OshKosh brand; however, in our opinion, the firm's long-term story remains intact. Our analysts are also standing by their fair value estimates for  Angiotech Pharmaceuticals  and  Jabil Circuit (JBL).

On to the ugly. We are skeptical of  Celestica's (CLS) business model, and the electronics manufacturing firm's share price continues to fall, but on a discounted cash-flow basis it still looks cheap to us.  Vimicro  is another technology manufacturing firm whose share price is tumbling, but we think its turnaround story still holds true.  Advanced Auto Parts (AAP) turned in a very disappointing second quarter, but we're buying into the firm's plan to increase its productivity and returns on invested capital. We also still really like the cash-generating nature of the auto parts business. Not surprisingly, the boating downturn continues to weigh on  MarineMax's (HZO) results. Nevertheless, our long-term thesis of the firm gaining market share from much weaker competitors remains intact. Last but not least,  GMH Communities Trust , a student housing REIT, has met our expectations for 2007 thus far but has been caught up in the industrywide sell-off. We think affordable and high occupancy student housing may be one of the better real estate plays out there.

Finally, in a category of its own well beyond ugly, is the shoe retailer  Finish Line  . Its stock has lost a whopping 55% of its value since the inception of our 2007 contrarian portfolio, primarily driven by what looks to be a poorly conceived acquisition of competitor  Genesco (GCO). In our opinion, Finish Line has agreed to pay a hefty premium for Genesco to prevent Foot Locker from buying the business and becoming an even more powerful rival. This value-destroying deal has led us to lower our fair value estimate by $7. With the stock falling to less than $6, however, we still have a 5-star rating for the firm. It may not rebound to the level of our original expectations, but given how far it has fallen, we still think there is a substantial upside.

Tomorrow Is Another Day
If we were short-term investors, we'd throw in the towel right now. With our long-term perspective, we're more than willing to wait out these tough times, however, and we fully expect our performance to turn around over the next two to three years. We'll continue to provide quarterly updates, but we recommend patience and a strong stomach when viewing the portfolio's results.