Analysts’ Reviled Stocks Often Outperform Those They Tout

John Dorfman

If you put faith in analysts’ stock picks, I might shake your faith a little.

For 18 years, I have tracked the total return on the four stocks analysts love the most at the beginning of the year, and the four they most disdain.

The analysts’ darlings have beaten their despised stocks nine times, and lost to them eight times. There was one tie. The average total returns (including dividends) are 9.2 percent for the analysts’ top choices versus 8.3 percent for the stocks they hate.

That’s a slim margin of victory. Neither group of stocks beats the S&P 500, which has averaged 11.2 percent. Only six out of 18 times have the analysts’ top picks beaten the index.

My analysis covers 1998 through 2016, with the exception of 2008, when I was temporarily retired.

Cliffs Triumph

Last year, the most-hated stocks won, thanks entirely to a 572 percent gain for Cliffs Natural Resources Inc. (CLF), an iron mining company that specializes in iron-ore pellets used by the steel industry.

Iron ore prices increased last year, and Cliffs stock benefitted from hope that a Trump administration will reduce imports of Chinese steel.

As a group, the despised stocks rose 96.5 percent from Jan. 13, 2016, through Jan. 6, 2017. The analysts’ four favorites gained 11.3. The S&P 500 Index returned 20.0 percent.

Among the analysts’ darlings, the best performer was Ally Financial Inc. (ALLY), up 23 percent. Sabre Corp. (SABR) did worst, with a 3 percent loss.

Current loves

As 2017 dawns, the top object of analysts’ love is Alphabet Inc. (GOOG), parent to Google. Thirty-eight analysts cover it, and all rate it a buy.

Alphabet shares carry considerable risk, selling for more than six times revenue, four times book value (corporate net worth) and 29 times recent earnings.

If interest rates continue to rise, stock-market valuations are likely to compress which could hurt higher-priced shares such as Alphabet. Any high-flying stock can be vulnerable to unpleasant surprises.

Second most popular, with 14 “buy” ratings and no “sell” or “hold” ratings, is Incyte Corp. (INCY). The Wilmington, Del., company is working on cancer drugs. Incyte’s valuations are over the moon. Its stock sells for 294 times recent earnings, 77 times estimated 2017 earnings, almost 20 times revenue and 68 times book value.

Third most loved, with 13 analysts unanimously recommending it, is Envision Healthcare Corp. (EVHC) of Nashville. It operates selected departments within hospitals and ambulatory surgical centers, such as general surgery, radiology, anesthesiology and ambulance service.

In the past five years, Envision has grown revenue and book value at an excellent clip, about 17 percent. But analysts aren’t paying enough attention to valuations. Envision sells for 100 times recent earnings.

For the second year in a row, LKQ Corp. (LKQ) landed on analysts’ adored list with 12 recommendations and no dissents. Based in Chicago, it distributes replacement auto parts and auto-repair equipment. It is not as expensive as the three stocks mentioned above, but it appears that its growth is slowing.

Newly Hated

Which stocks do analysts hate as 2017 begins? First on the blacklist is Credit Acceptance Corp. (CACC), rated a “sell” by eight analysts out of 12. It provides car loans through auto dealerships. The company’s debt has been rising, a possible danger sign. It specializes in loans to customers with poor credit ratings, meaning a bigger risk of defaults if the economy turns sour.

Owens & Minor Inc. (OMI) carries a sell rating from five analysts out of eight. The distributor of medical supplies has seen revenue growth slow and profit margins shrink.

Wesco Aircraft Holdings Inc. (WAIR) distributes bearings and other components to the aerospace industry. It suffers from slowing growth and shrinking margins. But the stock is pretty cheap at 1.0 times revenue and 12 times estimated 1027 earnings.

Heartland Express Inc. (HTLD), a trucking company, is branded a “sell” by six of 12 analysts. Its profits have headed down lately, but the company is debt-free.

Which will do better in 2017 — the analysts’ adored stocks, or the despised ones? My money is on the despised stocks. They sell for much lower valuations, and in some cases I think their problems are exaggerated.

Disclosure: One of my clients owns a Cliffs Natural Resources bond. Other than that, I have no positions in securities mentioned in this article.

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