Unloved Stocks: Trash or Treasure?
11/08/2016 8:00 am EST
In a popular episode of Seinfeld, George Costanza, the stingy and opportunistic friend of Jerry Seinfeld, gets caught eating an éclair he had fished out of a trash can, jests Richard Moroney, editor of Dow Theory Forecasts.
“It wasn’t down in, it was on top,” says George. “Above the rim.” Jerry doesn’t buy the argument, concluding, “Adjacent to refuse is refuse.”
Contrarian investors must be willing to suffer some ridicule when they buy a stock discarded by analysts or other investors. Contrarian investing is not for the impatient or insecure.
But if you consider the strategy from the perspective of supply and demand, unloved stocks have a bigger crowd of potential buyers sitting on the sidelines to eventually drive up their prices when the stocks gain popularity.
Consider that the stocks most owned by mutual fund managers are on pace to underperform the least-popular stocks for the third straight year, according to The Wall Street Journal. This trend may be partly explained by the forced selling at mutual funds as more investors embrace passively managed funds.
Among the tools we use to measure sentiment for particular stocks are average analyst ratings and short interest. Most stocks receive favorable ratings (the typical S&P 500 stock averages an analyst rating of 2.3), in part because analysts tend not to cover stocks they don’t like. Think of it as rejection by omission.
Short selling occurs when an investor sells shares borrowed from a broker in the hope of buying the shares back at a later time at a lower price. The number of trading days needed to cover outstanding short positions is called the short interest ratio.
A high ratio indicates the likelihood for a short squeeze, which happens when shorted stocks begin to rally, forcing short sellers to scramble and buy to cover their positions, pushing the stock even higher.
You may need to hold your nose, but consider buying the stocks in the list below, especially the ones in bold.
Unloved by analysts
Unloved by short sellers
Unloved by analysts, short sellers, and investors
By Richard Moroney, Editor of Dow Theory Forecasts