6 Contrarian Stock Picks With Tons of Upside
These companies are out of favor for one reason or another, but they could pay off for patient investors.
When the stock market is hitting new highs and even the laggards are rising, what’s a contrarian investor to do?
Contrarian investing centers on buying segments of the market that are currently out of favor, and since late 2020, the investments that had been unloved – value-priced stocks, shares in small and midsize companies, and even foreign firms – have soared in price.
“It’s tough to be a contrarian” these days, says Janet Johnston, chief investment officer at TrimTabs Asset Management, “because everything is working.”
So today’s contrarians must be selective. A good choice might be a company trying to emerge from a scandal or crisis, or a firm in the middle of a change in strategy – or maybe a business that’s dealing with a temporary setback, such as a failed acquisition, says Thyra Zerhusen, chief executive and chief investment officer of Fairpointe Capital.
Successful contrarian investors don’t abandon the basic tenets that guide good stock picking. They stick with high-quality companies – firms with strong balance sheets, solid business strategies and niches in their respective industries, and talented executives at the helm. Look for a catalyst for change, such as a new chief executive, a bold restructuring program or a new product about to launch. Avoid firms in declining industries, such as broadcast television, print media and coal, which face long-term, uphill challenges.
And prepare to be patient. Many contrarian investment theories take time to play out.
“We consider ourselves patient investors, but it’s easy to get stuck in value traps,” warns James England, manager of Meridian Contrarian fund. (Value trap is a term that describes a stock stuck in perpetual decline.) “Our best way to avoid that is to focus on earnings growth. We don’t invest unless we strongly believe that earnings can turn positive in the next year or two.”
We’ve found six contrarian stock picks for consideration. Check them out!
Returns and data are as of Jan. 8.
The past year has been awful for stocks in real estate investment trusts. But shares of Colony Capital (CLNY, $5), a midsize REIT, have held up better than peers. The shares have nearly recovered from their 72% price drop during the 2020 bear market. That may not seem like the makings of a contrarian stock. But Colony has its share of problems.
The REIT has been struggling since 2017, posting steadily declining revenues and earnings as it tries to shift its focus from industrial, health care and hotel properties to digital infrastructure (think cell towers, data centers, fiber networks and small cells, or short-range radio access nodes that facilitate wireless communication). When COVID hit, the REIT’s hotel properties proved to be a drag; Colony suspended dividends in March to build up cash.
But the firm has been unloading its non-tech properties, raising nearly $700 million in 2020. It will redeploy that cash into digitally focused properties, which stand to benefit from a world that is shifting increasingly online. Last July, new chief executive Marc Ganzi started; he was hired in part to accelerate Colony’s shift. At the end of September, Colony had $46.8 billion of assets under management, and about half of those assets are now digital real estate and infrastructure.
Extra patience may be required. Colony won’t be a purely digital REIT until 2022 or 2023. And funds from operations, the traditional yardstick used to measure REIT profits, will be nonexistent or in negative territory until then. Still, says England, who recently bought shares, “we like the new managers and the collection of assets they want to focus on.”
Stock in DXC Technology (DXC, $30) should be riding high. The company offers information technology services and consulting on matters such as cloud computing, network security and analytics to other companies around the world. Clients include Campbell Soup (CPB), Swiss bank Cantonal Bank of Berne and Australian medical device firm Device Technologies.
But the stock has been in a steady decline since 2018; it’s down almost 70% in price from its high of $91 a share that year. Increased competition within its industry – which is dominated by giants including Accenture and Amazon Web Services – has hurt company results, and DXC has been losing customers. The firm cut costs, but too deeply, says value investor Vitaliy Katsenelson, chief executive of Investment Management Associates, a Colorado investment firm. “Customers and employees started to leave,” he says. DXC carries a heavy long-term debt load that recently stood at $8 billion, or roughly 40% of annual revenue.
Change is on the horizon. Accenture veteran Mike Salvino took over as chief executive in September 2019, and he’s streamlining the firm’s focus on cyberbusiness, cloud computing and big data, a fast-growing sector. Analysts see $2.09 in earnings per share for the fiscal year ending in March 2021. That’s below the $5.58 that DXC earned in the previous fiscal year, but analysts project a nearly 70% earnings jump, to $3.54 a share, in fiscal 2022.
Elanco Animal Health
Elanco Animal Health (ELAN, $31) is suffering from “under-execution,” says T. Rowe Price Value fund manager Mark Finn. Over the past few years, revenues and earnings growth at the health care company, which focuses on the fast-growing subindustry of livestock and domestic pets, have fallen below the industry average. And integration of Bayer’s animal health division, which Elanco acquired last August, may hamper growth even more.
Like a run-down house on a good block, Elanco is “the fixer-upper in a high-quality industry,” says Finn.
But Elanco has a promising future. More than 25 new treatments will launch through the end of 2024, including eight by the end of this year. All in, the new products could boost annual sales by a cumulative $600 million by 2025, say Credit Suisse analysts. (The firm is expected to report revenues of $3.1 billion in 2020.)
In October, a New York-based activist investment firm bought a 9.1% stake in Elanco in order to push for changes. And three new board members, appointed in December, “should ensure greater shareholder accountability from management,” says William Blair analyst John Kreger.
Over the past year, the stock has climbed 9.9% – far less than the 26.7% gain lodged by Zoetis (ZTS), Elanco’s biggest competitor. Shares trade at what may seem a lofty 35 times expected earnings for 2021, but that’s an 11% discount to the year-ahead price-earnings multiple for Zoetis shares.
Southwest Airlines (LUV, $47) is a play on a post-pandemic return to normalcy. After more Americans receive the COVID-19 vaccine, pent-up travel lust is bound to fuel a rebound in flights, says TrimTabs’ Johnston.
At $47 a share, Southwest stock trades at a 20% discount to its 52-week high. COVID gutted the airline’s business. Southwest is expected to report a loss of $6.50 a share in 2020, after a profit of $4.27 in 2019. Earnings will move into positive territory in 2021, albeit just 19 cents a share, according to estimates.
Analysts believe a rebound in travel may take some time. But Southwest “is the best-positioned airline,” says Johnston. “It has the best balance sheet and strongest management team.”
Things should be peachy for a private-label packaged food and beverage company – think pasta, single-serve coffee, maple syrup and frozen waffles – that counts Walmart (WMT) the country’s largest grocery store chain, as its biggest customer.
But TreeHouse Foods (THS, $40), a midsize firm with a $2.3 billion market value, has logged average annual earnings declines of 6% over the past five years, thanks in part to a lumpy acquisition-and-integration strategy.
A new CEO in 2018 and a restructuring plan that started in early 2020 may turn things around. Meridian’s England says he thinks earnings have at long last bottomed. On average, analysts project profits of $3.01 a share in 2021, a 10% climb from what the company is expected to report for 2020.
The stock has bounced off of its March 2020 low. But it still trades at 13 times analysts’ earnings expectations for 2021, a 32% discount to the typical price-earnings multiple of other food companies. “Earnings have turned, but the stock’s price doesn’t reflect that,” says England. Boding well for the stock is solid growth in the packaged food industry overall.
Wells Fargo & Co.
Wells Fargo (WFC, $33) is the fourth largest bank in the country and once had a pristine reputation as a conservative institution. But it is still reeling from a fraudulent-account scandal that surfaced four years ago – and that’s partly what makes it a good contrarian choice. Another reason: Growth is coming.
Since 2018, the bank has been hindered by a Federal Reserve–enforced asset cap initiated after the scandal; the cap prevents Wells Fargo from increasing assets at levels similar to peers. But Wells is making strides toward getting the cap lifted as soon as the middle of 2021, says Matt Egenes, a client portfolio manager at asset management firm Barrow, Hanley, Mewhinney & Strauss. To get the cap removed, the bank must further improve its governance and operational risk management.
A fresh start will come not a moment too soon. Growth in revenues and earnings has been underwhelming of late. And shares have fallen far more than the shares of most of its peers. Of course, that means Wells Fargo stock is cheap. It currently trades at a price-to-book-value ratio (price relative to assets minus liabilities), a traditional measure for bank stocks, of less than 1. The typical major bank, by contrast, trades at 1.5 times book value, according to Zacks Investment Research.