Morningstar's new Contrarian portfolio.
It's only 10 stocks equally-weighed. All of them have a 5-star rating. According to the article below, last year's model portfolio returned over 47%. If returns are half as good this year, I'll be happy.
Micrel - MCRL
Fed. Investors - FII
Lear - LEA
Group 1 Auto. - GPI
Millennium Phar. - MLNM
Intersil - ISIL
DeVry - DV
Allied Waste - AW
eSpeed - ESPD
Fifth Third Bank - FITB
Stock Strategist
Morningstar's Contrarian Portfolio--10 Stocks to Buy
by Dreyfus Neenan | 02-18-05 | 08:30 AM
Contrarian investment strategies are popular among value-oriented investors, and in our opinion, rightly so. Stocks that are widely ignored or despised are more likely to sell at an attractive discount to fair value than stocks with heavy analyst coverage or a household name.
At Morningstar, we do a lot of behind-the-scenes research looking to uncover attractive investment returns, and contrarian strategies are a natural fit with our preference for uncovering stocks that are selling with an attractive margin of safety. Over the past couple of years we've been researching our Web site traffic, comparing the returns from popular stocks with the returns from unpopular stocks, and the results surprised us. Investing in the stocks that are most popular with Morningstar's audience offers good odds of achieving market-beating returns, but higher returns seem much more likely in less-popular, or "contrarian," stocks. We're not surprised that many stocks don't attract much attention. We follow about 1,500 stocks, a good portion of which are from overseas markets or obscure industries, and frequently add new coverage. It's probably impossible to keep up with such a lengthy list--but therein lies an advantage. We think that learning more about lesser-known stocks, especially those that have a Morningstar Rating of 4 or 5 stars, can really pay off. To help you get started, we've decided to publicize a portfolio of our 10 best "contrarian" 5-star stock ideas for 2005.
Before we cut the ribbon, we'd like to walk through our research and explain how we selected our "Contrarian 10"--and why our research concluded that this strategy has merit. At Morningstar, we can directly measure a stock's popularity--or lack thereof--with our subscribers. Using our Web site data, we count unique page views for each stock we cover, and then create a page rank that measures that stock's popularity with our clients. We define a page view as one client clicking on the Analyst Report for a stock once. This yields a direct, and unique, measure of "popularity." For example, in 2003, Pfizer PFE was our most-viewed Analyst Report (with a page rank of 1), while Footstar FTSTQ (page rank 6,495) was least popular. By creating an ordinal ranking of the stocks we cover using our page ranks, we can easily identify the most "contrarian" stocks we cover.
Let us be the first to note that this methodology isn't perfect. Our 5-star stocks are the most popular, so they generate more page views and thus higher page rankings, and well-known stocks tend to get more page views regardless of value or market activity. And a stock that has a strong run through part of the year will get a popularity boost, even if it tanks later on. Our page-rank data is also a partial measure of our subscribers' interests, which tend to lean heavily toward undervalued stocks in general. Finally, we can't prove that Morningstar's subscribers are a representative sample of the financial markets. However, we think the data are reliable enough to prove useful, and any strategy that helps investors uncover good businesses they can buy with an attractive margin of safety has merit. What's more, we also think that awareness of the most-popular stocks among Morningstar subscribers has its own usefulness.
To get started, let's review the 10 most popular stocks among Morningstar subscribers in 2003 and 2004:
2003's 10 Most Popular Stocks
Name Rank 2003 Return 2004 Return
Pfizer PFE 1 17.76% -22.31%
Wal-Mart Stores WMT 2 5.73% 0.51%
Microsoft MSFT 3 6.81% 8.95%
General Electric GE 4 30.75% 20.68%
Home Depot HD 5 49.42% 21.47%
Altria Group MO 6 42.74% 18.38%
Johnson & Johnson JNJ 7 -2.11% 25.17%
Cisco Systems CSCO 8 84.96% -20.26%
General Dynamics GD 9 15.97% 17.40%
First Data FDC 10 16.28% 3.72%
Average Return (equally weighted) 6 26.83% 7.37%
S&P 500 -- 28.69% 10.88%
Outperformance -- 1.86% -3.51%
2004's 10 Most Popular Stocks
Name Rank 2004 Return
Pfizer PFE 1 -22.31%
Microsoft MSFT 2 8.95%
Wal-Mart Stores WMT 3 0.51%
General Electric GE 4 20.68%
Merck MRK 5 -27.76%
Coca-Cola KO 6 -16.12%
Johnson & Johnson JNJ 7 25.17%
Anheuser-Busch Companies BUD 8 -1.95%
Home Depot HD 9 21.47%
Berkshire Hathaway B BRK.B 10 4.30%
Average Return (equally weighted) 6 1.29%
S&P 500 - 10.88%
Outperformance - -9.59%
While most of these stocks are unsurprisingly popular, the returns aren't consistently attractive. The 2003 stocks delivered positive returns in both years, but lagged the returns an investor in the S&P 500 would have accrued. The 2004 stocks barely broke even, and both Pfizer and Merck MRK declined by more than 20%. These returns certainly aren't horrible, but we'd be inclined to try a little harder.
So let's review the returns of Morningstar's 10 least popular stocks for 2003 and 2004. If our "contrarian" theory has merit, these should be higher:
2003's 10 Least Popular Stocks
Name Rank 2003 Return 2004 Return
Neiman Marcus NMG.A 1,907 76.60% 34.57%
Gabelli Asset Man. GBL 1,645 32.56% 26.50%
Knight Ridder KRI 1,467 24.48% -11.83%
Navistar Intl. NAV 1,403 97.00% -8.17%
Citizens Comm. CZN 1,288 17.73% 34.09%
Getty Images GYI 1,265 64.09% 37.34%
Sealed Air SEE 1,251 45.15% -1.61%
VISX EYE 1,210 141.65% 11.75%
Barra* 1,201 * *
Bausch & Lomb BOL 1,199 46.11% 25.30%
Average Return
(equally weighted) 1,384 54.54% 14.79%
S&P 500 -- 28.69% 10.88%
Outperformance
* Was acquired,
data unavailable
-- 25.85% 3.91%
2004's 10 Least Popular Stocks
Name Rank 2004 Return
Equity Lifestyle Properties ELS 6,393 20.88%
Pemstar PMTRE 6,377 -44.99%
WebMethods WEBME 6,324 -20.77%
TIM Hellas Telecom. SA ADR TIMHY 6,278 45.09%
Distribution y Servicio D&S ADR DYS 5,816 -11.12%
Molex MOLXE 5,732 -13.66%
Marsh Supermarkets A MARSA 5,667 8.57
Kindred Healthcare KND 5,630 15.24%
United National Group A UNGL 5,494 5.38%
Com. Brasileira de Distribuicao CBD 5,445 2.76%
Average Return (equally weighted) 5,916 0.74%
S&P 500 - 10.88%
Outperformance - -10.14%
And generally speaking, they are. The returns on our least popular 2003 stocks were more than double the returns of the most popular, and they outperformed the S&P 500 in 2003 and 2004 by a healthy margin. That's more like it. However, the 2004 returns lagged both the S&P and the most popular stocks, although not by much, so we have more research to do. One aside is important at this point--note the average page rank of these stocks. For the 2003 stocks it was 1,384, and for the 2004 stocks 5,916. In other words, on average during 2004 there were more than 5,900 stocks that were more popular among Morningstar's subscribers, so we're definitely in contrarian territory. (Morningstar only covers about 1,500 stocks, so the other rankings reflect page views for stocks we don't cover). Now we need a further reality check--in the form of the returns of the 10 best-performing stocks we covered during 2003 and 2004. For our contrarian theory to hold up, the average page rank of these stocks ought to be low:
2003's 10 Best Performers
Name Rank 2003 Return
Capital One Financial COF 63 106.74
Netflix NFLX 206 396.73%
DR Horton DHI 207 152.07%
Guidant GDT 244 96.11%
Countrywide Financial CFC 252 97.41%
Millennium Pharmaceuticals MLNM 295 133.42%
Centex CTX 298 117.54%
Jack Henry JKHY 331 72.51%
National Semiconductor NSM 624 162.56%
Ann Taylor Stores ANN 1,076 90.99%
Average Return (equally weighted) 360 142.61%
S&P 500 - 28.69%
Outperformance - 113.92%
2004's 10 Best Performers
Name Rank 2004 Return
Cheniere Energy LNG 1,473 444.44%
Elan ADR ELN 186 295.50%
Chicago Mercantile E CME 52 218.54%
Autodesk ADSK 328 209.62%
Apple Computer AAPL 65 201.36%
American Eagle Outfitters AEOS 478 188.04%
Metris Companies MXT 1,814 187.16
AK Steel Holding AKS 943 183.73
TXU TXU 332 177.67
BanColombia SA ADR CIB 4,426 176.40%
Average Return (equally weighted) 1,010 228.25%
S&P 500 - 10.88%
Outperformance - 217.37%
And sure enough, in both cases our best-performing stocks boasted an average page rank in the bottom third of our research universe. (Morningstar covered 500 stocks in 2003, 1,500 during 2004, and even more today). Even Chicago Mercantile Exchange CME, the most popular of these stocks, was only the 52nd most-popular stock among our subscribers during 2004. So it seems safe to conclude that our contrarian strategy has merit. To put our research into action, early last year Morningstar formed a 10-stock contrarian portfolio. In January 2004, we chose 10 stocks with a 5-star rating, subject to the constraint that the average page rank of the portfolio had to be in the bottom third of our research universe. The results confirmed our previous research:
2004 Morningstar Contrarian Portfolio
Name Rank 2004 Return
CarMax KMX 163 0.39%
Chicago Mercantile Exchange CME 175 218.54%
Accenture ACN 215 2.58%
AutoZone AZO 226 7.16%
Biogen IDEC BIIB 247 81.50%
Expeditors Intl of WA EXPD 334 49.04%
Washington Post WPO 385 25.21%
Triad Guaranty TGIC 513 20.12%
TransCanada TRP 515 20.44%
CH Robinson Worldwide CHRW 979 48.14%
Average Return (equally weighted) 375 47.31%
S&P 500 - 10.88%
Outperformance - 36.43%
Our "Contrarian 10" delivered a much-healthier return than the 10 most popular stocks we highlighted earlier, and trounced the S&P 500. These are definitely the kind of returns that catch our eye. And true to contrarian form, the average page rank of these 10 was 375--easily placing them amongst the least popular of 2003.
Introducing Morningstar's 2005 Contrarian Portfolio
We think that the promise of our Contrarian strategy warrants releasing it for investors to consider. To that end, we'll evaluate our 2004 and 2005 contrarian portfolios over time, and if the concept continues to generate attractive returns we may publish these annually. While we won't release page rank data, we will provide an occasional update on our contrarian portfolios. Here are our 10 contrarian stock ideas for 2005, along with their page ranks and 2004 returns:
2005 Morningstar Contrarian Portfolio
Name Star Rating Rank 2004 Return
Micrel MCRL 2,865 -29.18%
Fed. Investors FII 151 5.00%
Lear LEA 477 0.85%
Group 1 Auto. GPI 893 -12.96%
Millennium Phar. MLNM 600 -34.91%
Intersil ISIL 474 -32.28%
DeVry DV 420 -30.92%
Allied Waste AW 293 -33.14%
eSpeed ESPD 271 -47.322
Fifth Third Bank FITB 162 -17.89
Average Return
(equally weighted) -- 661 -23.28%
S&P 500 -- -- 10.88%
Outperformance -- -- -34.16%
The higher average page rank of this year's contrarian portfolio reflects a relative lack of 5-star stocks--itself a comment on the market's valuation. And all of these stocks performed poorly during 2004, helping them trade at the margin of safety required to earn our 5-star rating. Based on our research, we think our contrarian portfolio has a better-than-average chance of earning attractive returns. It's also a good way to focus your research on some undervalued names you may be less familiar with.
But the real proof is in the investment returns. We'll check back in with these portfolios for 2004 and 2005 later in the year. |
