Morningstar's 2006 Contrarian Portfolio 10 stocks for investors who aren't afraid to go against the crowd. by Justin Fuller | 02-27-06 | 06:00 AM | E-mail Article | Print Article | Permissions/Reprints Contrarian investment strategies posit that attractive returns are earned by investing in stocks that are out of favor with most investors. A few years ago, we decided to test this theory, and started analyzing Morningstar's Web site traffic to compare the returns from stocks that are popular with our subscribers with those that are unpopular. Although we believe that investing in the stocks that are most popular with Morningstar's audience offers a good shot of achieving returns that outperform the market, our research indicates that even higher returns seem more likely in less-popular, or "contrarian," stocks. At Morningstar, we can directly measure a stock's popularity--or lack thereof--with our subscribers. Using our Web site data, we can count unique page views for each stock we cover, and then create a page rank that measures the 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 2005, Microsoft MSFT was our most-viewed Analyst Report (with a page rank of 1), while Monolithic Power Systems MPWRE (page rank 8,006) 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.We continue to acknowledge that our methodology isn't perfect. Our 5-star stocks are the most popular, so they generate more page views, and thus higher page rankings. What's more, well-known stocks tend to get more page views regardless of value or market activity. 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 that they can buy with an attractive margin of safety has merit.To get started, let's review the 10 most popular stocks among Morningstar subscribers in 2003, 2004, and 2005: 2003's Most Popular Stocks Rank 2003 Return( % ) 2004 Return( % ) 2005 Return( % ) Pfizer PFE 1 17.76 -22.31 -10.45 Wal-Mart Stores WMT 2 5.73 0.51 -10.26 Microsoft MSFT 3 6.81 8.95 -0.94 General Electric GE 4 30.75 20.68 -1.48 Home Depot HD 5 49.42 21.47 -4.35 Altria Group MO 6 42.74 18.38 27.30 Johnson & Johnson JNJ 7 -2.11 25.17 -3.22 Cisco Systems CSCO 8 84.96 -20.26 -11.39 General Dynamics GD 9 15.97 17.40 10.53 First Data FDC 10 16.28 3.72 1.72 Avg (equally weighted) 6 26.83 7.37 -0.25 S&P 500 28.69 10.88 4.83 Outperformance -1.86 -3.51 -5.08 2004's Most Popular Stocks Rank 2004 Return( % ) 2005 Return( % ) Pfizer PFE 1 -22.31 -10.45 Microsoft MSFT 2 8.95 -0.94 Wal-Mart Stores WMT 3 0.51 -10.26 General Electric GE 4 20.68 -1.48 Merck MRK 5 -27.76 3.70 Coca-Cola KO 6 -16.12 -0.50 Johnson & Johnson JNJ 7 25.17 -3.22 Anheuser-Busch BUD 8 -1.95 -13.29 Home Depot HD 9 21.47 -4.35 Berkshire Hathaway B BRK.B 10 4.30 -0.02 Avg (equally weighted) 6 1.29 -4.08 S&P 500 10.88 4.83 Outperformance -9.59 -8.91 2005's Most Popular Stocks Rank 2005 Return( % ) Microsoft MSFT 1 -0.94 Pfizer PFE 2 -10.45 Wal-Mart Stores WMT 3 -10.26 Berkshire Hathaway B BRK.B 4 -0.02 Coca-Cola KO 5 -0.50 Johnson & Johnson JNJ 6 -3.22 Anheuser-Busch BUD 7 -13.29 General Electric GE 8 -1.48 ExxonMobil XOM 9 11.80 Dell DELL 10 -28.93 Avg (equally weighted) 6 -5.73 S&P 500 4.83 Outperformance -10.56 While most of these stocks are certainly popular, their returns aren't consistently attractive. The 2003 stocks delivered positive returns in 2003 and 2004, but they have lagged the returns of the S&P 500 in each of the last three years. The 2004 stocks underperformed the S&P 500 by about 9 percentage points over the last two years. And 2005's most popular stocks were even worse, lagging the S&P 500 by more than 10 percentage points, with only ExxonMobil XOM generating a positive return.Let's review the returns of Morningstar's 10 least popular stocks for each of the last three years. If our "contrarian" theory has merit, these should be higher. 2003's Least Popular Stocks Rank 2003 Return( % ) 2004 Return( % ) 2005 Return( % ) Neiman Marcus 1,907 76.60 34.57 ** Gabelli Asset Manage GBL 1,645 32.56 26.50 -8.86 Knight Ridder KRI 1,467 24.48 -11.83 -3.30 Navistar NAV 1,403 97.00 -8.17 -34.92 Citizens Comm CZN 1,288 17.73 34.09 -4.06 Getty Images GYI 1,265 64.09 37.34 29.66 Sealed Air SEE 1,251 45.15 -1.61 5.44 VISX EYE 1,210 141.65 11.75 1.60 Barra 1,201 ** ** ** Bausch & Lomb BOL 1,199 46.11 25.30 6.14 Avg (equally weighted) 1,384 54.54 14.79 -0.83 S&P 500 28.69 10.88 4.83 Outperformance 25.85 3.91 -5.66 ** Was acquired, data unavailable 2004's Least Popular Stocks Rank 2004 Return( % ) 2005 Return( % ) Equity Lifestyle Prop ELS 6,393 20.88 24.76 Pemstar PMTR 6,377 -44.99 -18.23 WebMethods WEBM 6,324 -20.77 6.93 Tim Hella ADR** 6,278 45.09 ** Distribucion y Serv ADR DYS 5,816 -11.12 7.75 Molex MOLX 5,732 -13.66 -12.91 Marsh A MARSA 5,667 8.57 -17.88 Kindred Healthcare KND 5,630 15.24 -13.99 United National Group A INDM 5,494 5.38 -1.40 Com. Brasileira de Dist. CBD 5,445 2.76 29.80 Avg (equally weighted) 5,916 0.74 0.48 S&P 500 10.88 4.83 Outperformance -10.14 -4.35 ** Was acquired, data unavailable 2005's Least Popular Stocks Rank 2005 Return( % ) Monolithic Power MPWRE 8,006 61.18 Calpine CPNLQ 7,437 -94.67 Charles Schwab SCHW 7,373 22.57 Tasty Baking TSTY 6,830 -4.82 MSC.Software MNSC 6,807 62.37 Cadence Design Systems CDNS 6,631 22.52 Stewart Enterprises STEIE 6,577 -21.53 National Interstate NATL 6,574 23.15 Petroleum Geo-Serv ADR PGS 6,125 49.78 Gramercy Capital GKK 5,765 17.84 Avg (equally weighted) 6,813 13.84 S&P 500 4.83 Outperformance 9.01 And for the most part, they are. The returns on our least popular 2003 stocks more than doubled the returns of the most popular stocks in 2003 and 2004, and were in line with the returns of the most popular stocks in 2005. The returns from 2004's least popular stocks lagged the S&P 500, but handsomely beat the return of the most popular stocks last year. And for 2005, the returns on the least popular stocks bested the returns of the most popular stocks by almost 20 percentage points. One aside is important at this point--note the average page rank of these stocks. For the 2003 stocks it was 1,384; for the 2004 stocks, 5,916; and for the 2005 stocks it was 6,813. In other words, on average during 2005, there were more than 6,800 stocks that were more popular among Morningstar's subscribers, so we're definitely in contrarian territory. (Morningstar covers only about 1,900 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, 2004, and 2005. For our contrarian theory to hold up, the average page rank of these stocks ought to be low: 2003's 10 Best Performers Rank 2003 Return( % ) Netflix NFLX 206 396.73 National Semiconductor NSM 624 162.56 DR Horton DHI 207 152.07 Millennium Pharmaceuticals MLNM 295 133.42 Centex CTX 298 117.54 Capital One Financial COF 63 106.74 Countrywide Financial CFC 252 97.41 Guidant GDT 244 96.11 Ann Taylor Stores ANN 1,076 90.99 Jack Henry JKHY 331 72.51 Avg (equally weighted) 360 142.61 S&P 500 28.69 Outperformance 113.92 2004's 10 Best Performers Rank 2004 Return( % ) Cheniere Energy LNG 1,473 444.44 Elan ADR ELN 186 295.50 Chicago Mercantile Exchange 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 ADR CIB 4,426 176.40 Avg (equally weighted) 1,010 228.25 S&P 500 10.88 Outperformance 217.37 2005's 10 Best Performers Rank 2005 Return( % ) Myogen MYOG 1,423 272.99 New River Pharmaceuticals NRPH 1,361 246.79 Great A&P Tea GAP 828 210.05 aQuantive AQNT 796 185.68 Frontier Oil FTO 576 184.16 Southwestern Energy SWN 328 183.66 Netlogic Microsystems NETL 1,040 172.40 Vertex Pharmaceuticals VRTX 1,022 161.78 SanDisk SNDK 208 151.58 Celgene CELG 452 144.34 Avg (equally weighted) 803 191.34 S&P 500 4.83 Outperformance 186.51 And sure enough, in 2003, 2004, 2005, the best-performing stocks boasted an average page rank near the bottom half of our research universe. (Morningstar covered 500 stocks in 2003, 1,500 during 2004, and 1,800 during 2005). So it seems safe to conclude that our contrarian strategy has merit. To put our research into action, a few years ago, we formed our inaugural 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 Contrarian Portfolio Rank 2004 Return( % ) 2005 Return( % ) CarMax KMX 163 0.39 -10.85 Chicago Mercantile Exchange CME 175 218.54 61.49 Accenture ACN 215 2.58 8.04 AutoZone AZO 226 7.16 0.48 Biogen Idec BIIB 247 81.50 -32.02 Expeditors Intl of WA EXPD 334 49.04 21.35 Washington Post WPO 385 25.21 -21.43 Triad Guaranty TGIC 513 20.12 -27.27 TransCanada TRP 515 20.44 31.23 CH Robinson Worldwide CHRW 979 48.14 36.19 Avg (equally weighted) 375 47.31 6.72 S&P 500 10.88 4.83 Outperformance 36.43 1.89 Our inaugural "Contrarian 10" delivered a much-healthier return than the 10 most popular stocks we highlighted earlier, and beat the S&P 500 in both 2004 and 2005. 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 among the least popular of 2003. In early 2005, we published our second annual "Contrarian 10," but due to a dearth of 5-star stocks--itself a comment on the market’s valuation--we had to boost our selection criteria to the bottom half of our coverage universe from the bottom third. 2005 Contrarian Portfolio Rank 2004 Return( % ) 2005 Return( % ) Micrel MCRL 2,865 -29.18 5.17 Federated Investors FII 151 5.00 23.73 Lear LEA 477 0.85 -51.71 Group 1 Automotive GPI 893 -12.96 -0.22 Millennium Pharmaceuticals MLNM 600 -34.91 -20.10 Intersil ISIL 474 -32.28 49.91 DeVry DV 420 -30.92 15.21 Allied Waste AW 293 -33.14 -5.82 eSpeed ESPD 271 -47.32 -37.67 Fifth Third Bancorp FITB 162 -17.89 -17.17 Avg (equally weighted) 661 -23.28 -3.87 S&P 500 10.88 4.83 Outperformance -34.16 -8.70 The returns from 2005's "Contrarian 10" were not as encouraging as 2004's, but we note that most of the poor performance stemmed from only two stocks, Lear LEA and eSpeed ESPD, that dragged the portfolio's returns down by over 10%. If we omit these two stocks, the remainder of the portfolio outperformed the S&P 500 by about 2 percentage points. Even though we can't escape last year's weak results, we don't think that two exceedingly poor performing stocks invalidate our overall approach, and we're encouraged by the good performance of our other 2005 selections.The 2006 "Contrarian 10"In keeping with tradition, we've selected 10 contrarian stock ideas for 2006, and published their page ranks and 2005 returns: 2006 Contrarian Portfolio Rank Morningstar Rating 2005 Return( % ) Valeant Pharmaceuticals VRX 321 -30.20 Educate EEEE 385 -11.54 White Mountains Insurance WTM 387 -12.30 BT Group ADR BT 448 1.94 Hewitt Associates HEW 474 -11.87 Alleghany Y 477 1.55 Petco Animal Supplies PETC 532 -44.40 BankAtlantic Bancorp A BBX 696 -28.88 Deutsche Telekom ADR DT 762 -23.17 International Speedway ISCA 1,077 -9.17 Avg (equally weighted) 556 -16.80 S&P 500 4.83 Outperformance -21.63 Morningstar Rating as of 02-23-06 We note that this year, as in last, the ratio of 5-star stocks to our overall coverage universe was low, which again forced us to choose stocks with a relatively high average page rank. That said, all of these stocks performed somewhat poorly in 2005, helping them trade at the margin of safety required to earn our 5-star rating. While we can't guarantee our investment performance, we do think our research indicates that our contrarian portfolio has a better-than-average chance of producing attractive returns.But the real proof is in the results, so we'll periodically check back in with these portfolios later in the year, and provide an update on our performance.
