"Why do you like tobacco stocks so much?" my colleague asked our boss, David Dreman (Trades, Portfolio), about two decades ago.
"Because," answered Dreman, "I've never seen a group so hated."
That is contrarianism, the belief that the best way to make money in the stock market is to go against the crowd. Dreman's was a studied contrarianism, but even a naïve, simplistic contrarian approach will succeed under some market conditions.
Beginning in 1999, I've compiled each year a "Robot Portfolio," which is based on a naïve contrarian model.
Start with all U.S. stocks with a market value of $500 million or more, eliminate those with debt greater than equity and those with losses in the past four quarters, then simply select the 10 with the lowest prices relative to per-share earnings.
Triumph and tragedy
The triumph of the Robot Portfolio over the past 22 years have been a total cumulative return of 1,027%%, dwarfing the 449%% figure for the Standard & Poor's 500 Index.
The compound annual return has been 11.2% for the Robot, 7.1% for the index.
Bear in mind that my column recommendations are hypothetical: They don't reflect actual trades, trading costs or taxes. These results shouldn't be confused with the performance of portfolios I manage for clients. Also, past performance doesn't predict future results.
The tragedy of the Robot Portfolio has been that the paradigm has worked poorly over the past 10 years, beating the index only twice during that time and posting losses in four of the 10 years -- including the past three years in a row.
Last year, the Robot Portfolio, heavily laden with energy stocks, fell 9.4%, while the S&P 500 advanced 18.5%.
This reversal mirrors the big decline in the fortunes of value investing, which worked well most of the time from 1930 to 2007, not so well from 2008 to 2017 and terribly in the past three years.
The cause of this sea change is mysterious, but one factor has been the rising popularity of index funds, which has created a lot of demand for the stocks weighted heavily in the S&P 500, such as Microsoft (MSFT), Apple (AAPL) and Amazon (AMZN).
Robot's new picks
I still believe there is merit in contrarian investing and its close relative, value investing. Companies that are down may hire new leaders, develop new products or get acquired (boosting the stock price).
Here are the cheapest stocks in the market now, under the qualification system described above.
Cannae Holdings Inc (CNNE, Financial) is the cheapest cheapie, selling for less than three times earnings. Based in Las Vegas, it holds a majority stake in The 99 and O'Charley's restaurants and minority stakes in Dun & Bradstreet and Ceridian. It's a possible play on the revival of restaurants post-vaccine.
American Equity Investment Life Holding Co. (AEL, Financial), from West Des Moines, Iowa, is primarily a seller of annuities. Its stock goes for just under three times earnings.
Ingles Markets Inc. (IMKTA, Financial), weighing in at less than a five multiple, operates supermarkets in the Southeast. It has been consistently profitable and profits have improved lately, probably because of the pandemic.
Future Fuel Corp. (FF, Financial), selling for just under five times earnings, makes biodiesel fuel and agricultural chemicals. The company has barely a speck of debt.
Unum Group (UNM, Financial), also at just below five times earnings, is one of the largest disability insurance companies in the U.S. Recessions are tricky for disability insurers since claims tend to go up in hard times.
Selling for five times earnings is Renewable Energy Group Inc. (REGI, Financial), which hails from Ames, Iowa. Like Future Fuel but to an even greater extent, it focuses on biofuels.
Also at a price-earnings ratio of five is Worthington Industries Inc. (WOR, Financial) of Columbus, Ohio, which makes steel and metal products such as gas storage cylinders.
Bio-Rad Laboratories Inc. (BIO, Financial) makes medical diagnostic and test equipment and laboratory instruments. After years of so-so profits, it's been highly profitable in the past two years. The price-earnings ratio is five.
Piedmont Office Realty Trust Inc. (PDM, Financial), based in Atlanta, is a real estate investment trust that owns office buildings in most of the largest U.S. cities. As a REIT, it must pay out at least 90% of profits in dividends. Unfortunately, the dividend hasn't grown since 2011. The price-earnings ratio is less than six.
Huntsman Corp. (HUN, Financial) is a chemical company that has shown negative sales growth over the past 10 years. That's why the stock sells for under six times earnings.
Disclosure: I don't own any of the 10 stocks discussed today, for clients or personally.
John Dorfman is chairman of Dorfman Value Investments LLC in Newton Upper Falls, Massachusetts, and a syndicated columnist. His firm or clients may own or trade securities discussed in this column. He can be reached at [email protected].
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