Being Hated Tops Wall Street’s Love in This Race: John Dorfman

Once again, the unthinkable has happened. In 2010, the stocks that carried the worst ratings from Wall Street analysts when the year began outperformed the stocks that enjoyed the highest ratings.

It wasn’t even close: The despised stocks rose 30 percent while the adored stocks rose only 7 percent.

For comparison, the Standard & Poor’s 500 Stock Index gained 15 percent. All figures are total returns including dividends.

The stock with the lowest analyst rating, Motors Liquidation Co., which was charged with selling off certain assets of bankrupt General Motors Corp., did badly, just as analysts expected. It was down 81 percent.

However, two other scorned stocks, Post Properties Inc. and Gabriel Resources Ltd., returned 91 percent and 82 percent respectively. The former is a real estate investment trust in Atlanta, the latter a mining company based in Toronto.

Eastman Kodak Co. of Rochester, New York, the photography company that was rated a “sell” by four of six analysts, advanced 27 percent.

Meanwhile, three of the four most-favored stocks rose, but none by more than 24 percent. And Fuel Systems Solutions Inc. pulled down the adored stocks’ average with a 29 percent loss. The New York-based company designs systems to help internal combustion engines run on fuels such as propane or natural gas.

Strange Anomaly

The seemingly anomalous result, which casts doubt on how helpful analysts’ expertise is in stock picking, isn’t an isolated finding. I have made a similar comparison annually since 1998 (with the exception of 2008, when I was temporarily retired as a columnist).

In the 12 years for which I have data, the most-hated stocks have beaten their more-popular brethren six times. The most-loved stocks have outperformed the most-hated issues five times. One year, 1998, was a tie.

What’s more, the average gain for the four most-despised stocks was almost 8 percent, while the average gain for the most-loved stocks was less than 1 percent.

The field of stocks eligible for inclusion in the study included all stocks covered by four or more analysts, except in 2007 when I restricted it to stocks in the Dow Jones Industrial Average.

Anyone who has spent much time talking with analysts knows that they are smart, well-educated, hardworking people. They can discourse knowledgeably on companies’ managements, strategies, cash flows, profit margins and earnings.

Little Avail

Yet all this knowledge is to little avail when it comes to picking winners in the stock market, my study suggests.

Perhaps this is because the stock market is analogous to a horse race in which the faster horses must wear the heaviest saddles. The stock-market equivalent of a heavy saddle is a high price-earnings ratio -- that is, a stock price that is high relative to the company’s per-share earnings. Struggling companies sell for low P/Es, giving them more chance to rise.

In addition, there is the strange but true consideration that foretelling the future is impossible, even for genuine experts. The world is too complicated and unpredictable.

Try, Try Again

Of course, analysts get to try again every day. As 2011 began, there were three stocks that enjoyed unanimous buy recommendations from 10 analysts, with no dissenting votes. In order of market value, they were Affiliated Managers Group Inc., Ancestry.com Inc., and LogMeIn Inc.

Affiliated Managers, based in Prides Crossing, Massachusetts, takes ownership stakes in money-management firms and helps them achieve efficiencies in areas such as trading, compliance and risk controls. As a money manager myself, I have heard some good things about the company. The stock doesn’t especially appeal to me, though. It sells for 22 times earnings, not cheap in my estimation. And debt is greater than equity.

Ancestry.com is an online genealogy and history site, with headquarters in Provo, Utah. I think it’s a useful service, but the stock seems overvalued to me at five times revenue and 65 times earnings.

LogMeIn of Woburn, Massachusetts, makes software that lets people control their personal computers from a remote location. I love the product, and use it almost every day. But with a P/E ratio of 84, I wouldn’t touch the stock.

In fourth place among analysts’ darlings was Orbital Sciences Corp., which enjoyed the unanimous approbation of nine analysts. The company, based in Dulles, Virginia, does private satellite launches and delivers cargo to the International Space Station for NASA.

Most Despised

As for the most-despised stocks, they began with Alon USA Energy Inc. of Dallas, a refiner and pipeline operator that also runs convenience stores. Six analysts unanimously scorned it. It has posted six quarterly losses in a row and has debt exceeding equity.

Five analysts covered Pzena Investment Management Inc., a New York-based money manager. Three rated it a “sell” and two a “hold.” No one called it a buy.

Barnes & Noble Inc., the bookstore chain based in New York, was the next-most-despised, with no “buys,” four “holds,” and three “sells.” Yet it may be a takeover candidate. Borders Group Inc., a smaller chain, wants to take it over and might be able to get financing to do so.

And then there was Sears Holdings Corp., with “sell” ratings from four of the eight analysts who followed it and “buy” recommendations from none, and recommended by none. The Hoffman Estates, Illinois-based retailer sells for less than book value (assets minus liabilities per share).

Disclosure note: I have no long or short positions in any of the stocks discussed in this week’s column.

John Dorfman, chairman of Thunderstorm Capital in Boston, is a columnist for Bloomberg News. The opinions expressed are his own. His firm or clients may own or trade securities discussed in this column.)

To contact the writer of this column: John Dorfman at jdorfman@thunderstormcapital.com.

To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net

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