Contrarian Investing
Stockscores.com Perspectives for the week ending October 21, 2006
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In this week's issue:
A contrary investor is one that goes against the crowd, seeking to buy when the crowd is selling and sell when the crowd is buying. The idea behind this investment strategy is well worth considering since you can not expect to beat the market if you are part of the crowd. To beat the market, you have to lead the crowd and therefore have to, in some ways, go against what the crowd believes.
However, if you are to be a successful contrarian investor you must also buy stocks that the crowd will favor in the future. It is the financial power of the masses that makes stocks move and a strategy of differing from the crowd is only effective if the crowd comes to agree with you eventually.
The most well known contrarian investor strategy is to buy the so called "Dogs of the Dow". These are the highest yielding stocks out of the group of the largest companies in the world that make up the Dow Jones Industrial Average. Yield is the percentage return the investor receives from a stock that pays a dividend. Since yield goes up as price goes down, the Dogs of the Dow strategy seeks stocks that had seen a price fall while dividends have held up, giving a high yield.
At the beginning of 2006, the 10 highest yielding stocks from the Dow 30 average were the following:
General Motors (GM)
AT&T (T)
Verizon (VZ)
Merck (MRK)
Altria (MO)
Pfizer (PFE)
Citigroup (C)
DuPont (DD)
JP Morgan (JPM)
General Electric (GE)
Since the Dow 30 average is up quite a bit so far this year, it is not surprising that all of the stocks on this list have made gains. However, it is interesting to go through the following exercise.
You can plot a chart comparing any one stock with the Dow ETF by entering the stock symbol, a comma, and then DIA for the Dow ETF. So, to compare General Motors you would enter GM, DIA in the Get the Stockscores box. Once you do this, go in to the Chart settings and select the 9 month time frame to see how these stocks have performed since just after the start of the year.
For GM, you will find that it has gain better than 50%, although the Dow is up only about 12% over the same period. T is up better than 40%. VZ up about 22%. MRK up almost 40%. Only MO, PFE, C and GE have underperformed the Dow but as a group, these 10 stocks have beat the Dow handily. The best performers were the stocks at the top of the list that had the highest yield, indicating there is some credibility to the Dogs of the Dow strategy.
Does that mean we should go out and buy every beat up stock?
Keep in mind that the Dogs of the Dow strategy focuses on stocks that pay a yield and are therefore a different class of stocks than many of you may consider. Also keep in mind that the best stocks to buy are the ones that go up after you buy them. To make this happen, smart investors have to buy stocks that are about to see a change in the perception of fundamentals by the broader market. They need to buy stocks that the market does not like today but will like in the near future. How can we do this?
I think it is a good idea to look at stocks that have underperformed the market because the emotion that investors feel with these stocks may make them undervalued. However, rather than trying to catch a falling knife, it is better to look for signs that the stock is making a bounce and likely to reverse the trend.
One way to do this is to look for a break of the downward trend line. Look at a multiyear chart of the stock and draw a line across the falling tops on the chart. When that line is broken by a price gain, the stock is giving a good signal that is likely reversing it downward trend.
GM did that on Jan 24.
T did that on May 24
VZ did that on June 1
MRK did that on June 29
MO did that on June 28
Thus, a modified contrarian strategy is to look at well known companies that are in downward trends, those that are suffering, and just wait for them to break their downward trend lines.
So, what are the weak stocks today, the turnaround stories of tomorrow?
To answer that question, I utilized the Stockscores Sector Watch Tool. I went in to the US Indexes and sorted them by Sentiment Stockscore to find the industry groups with the lowest average Sentiment Stockscore. The big losers? Here they are:
Aluminum (.DJUSAL)
Precious Metals (.DJUSPM)
Oil Companies, Secondary (.DJUSOS)
Energy (.DJUSEN)
Coal (.DJUSCL)
Enter the symbols of these sector groups in to the Get the Stockscores box on Stockscores.com and see their charts.
What is really interesting is these worst performing sectors today were among the best performing sectors a year ago. See how it pays to be a contrarian?
Now, what do these sectors need to do to become tomorrow's winners? They need to break their downward trend lines. Print out the charts and draw a line across the tops of each. Do that and you will find that Coal recently broke its downward trend line, Energy is more or less in a sideways holding pattern and Aluminum and Precious Metals are still in the grip of the sellers but worth watching for a long term trend reversal.
Being a contrarian can mean always being wrong if you do not have patience to wait for a turn around in the weak. Watch the weak stocks for signs of life, when they show a pulse and look like they are starting down the road to recovery. When they break their long term downward trend line, consider buying them but always use a stop loss at the low of the down trend to protect your self from a big loss if you are wrong.Back To Top
I have found that stocks breaking their long term downward trends often do so with a day of abnormal price gains on abnormal trading volume. With that in mind, I did a Stockscores Market Scan filtering for Abnormal Price Up, Abnormal Volume and Number of Trades > 500. This found scan found 28 stocks and I found 2 that stand out as potentially making breaks of their long term downward trend lines. Consider the charts below which remain worth considering as long as they don't close below support and provided they don't gain so much as to take away the opportunity.Back To Top
1. GIVN
Suuport at $18.97.
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2. SYNA
Support at 22.29
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References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.
Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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