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Stocks Analysts Hated Beat the Ones They Loved: John Dorfman

As 2010 gets under way, the stock that Wall Street’s security analysts love most is CMS Energy Corp. It garners 14 “buy” recommendations, with no dissenting votes. One might think that this stock can’t miss.

History suggests otherwise.

Accenture Plc, which recently saw its Tiger Woods-centered advertising campaign turn to dust overnight, was analysts’ favorite stock in 2002. Sixteen analysts urged investors to buy the stock; not one said to hold or sell. How did Accenture do? Shares fell 33 percent that year.

That result was not a fluke. For 11 of the past 12 years, I have studied the performance of analysts’ four favorite stocks, and the fate of the four they most scorned. My analysis covers 1998 through 2009, except for 2008, when I was temporarily retired as a columnist.

Their favorites, on average, were flat during those years while the four stocks they hated most gained about 6 percent annually. The Standard & Poor’s 500 Index had an average gain of about 9 percent.

Last year was particularly good for the despised stocks. Led by Sears Holdings Corp., they rose 47 percent compared with 23 percent for the analysts’ favorites.

Pariahs Triumph

How could the Wall Street experts have known that the raging recession and bear market, still in full force in January 2009, would give way to a stock-market recovery, and then an economic recovery? They couldn’t.

And that is just the point. Analysts are not all-knowing. For the most part, they are intelligent, well informed and highly paid. But like most human beings, they extrapolate the recent past as a guide to what comes next.

Of course, the stocks with the highest number of “sell” ratings don’t always beat the ones with the most “buy” ratings. In fact, they managed to do that only half the time in the 11 years, with one year (1998) a tie.

All figures in my study are total returns including dividends. Most years the study included any stock covered by four analysts or more. In 2007 it was restricted to stocks in the Dow Jones Industrial Average.

Let’s see which stocks currently have the highest -- and lowest -- ratings. CMS Energy, the analysts’ top favorite, is an electric and gas utility with headquarters in Jackson, Michigan. At 13 times earnings, it is fairly priced, in my opinion. The dividend yield, at 3.2 percent, is skimpy for a utility.

In Favor

5N Plus Inc., which has the unanimous approval of a dozen analysts, is based in Saint-Laurent, Canada. The company sells extremely pure metals and alloys to the electronics industry. It earned a healthy return on stockholders’ equity of 21 percent in fiscal 2009, and sells for 14 times earnings. I like 5N, but I’m slightly puzzled by analysts’ extreme enthusiasm, since they predict that fiscal 2010 earnings will be down about 22 percent.

Reinsurance Group of America Inc., whose headquarters are in Chesterfield, Missouri, is rated “buy” by 10 brokerage-house experts, again with no dissent. The stock appears cheap at nine times earnings. However, profitability in 2008 was skimpy, with a 6 percent return on equity.

Fuel Systems Solutions Inc., based in Santa Ana, California, also has 10 “buys.” It designs systems to help internal combustion engines run on clean fuels such as natural gas or propane. Shares are zig-zagging around $50, up from about $10 at the end of 2002. Perhaps it will prove a durable growth stock, but at 27 times earnings it is too expensive for a value investor like me.

The Despised

This year, I don’t much like the despised stocks either. General Motors, alias Motors Liquidation Co., which was second on the most-hated list last year, heads the list this year. All four experts covering the stock say “sell.” Although GM last week boldly predicted a profit for 2010, I doubt the stock will do much this year. Its book value (corporate net worth per share) is negative $149 a share.

Gabriel Resources Ltd. is a mining company based in Toronto that wants to mine gold in Romania. It has had no revenue in recent years. Four analysts say “sell,” one says “hold.”

Rochester, New York-based Eastman Kodak Co. has been trying to reinvent itself as a digital photography company. Things are not going well: Revenue fell to $9.4 billion in 2008 from more than $19 billion in 1991. Four analysts say “sell,” two say “hold.”

I have higher hopes for Post Properties Inc. of Atlanta, which develops upscale apartment communities in the Southeast and Southwest. I think Post may show some pep this year. Yet 11 of the 14 experts covering the stock say “sell” while three say “hold.” They estimate that it lost money in 2009, and expect it to post another loss in 2010.

Disclosure note: I have no long or short positions in the stocks discussed in this week’s column, personally or for clients.

(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.)

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