Despised Stocks

Wall Street Analysts Stumble on 2006 Stock Tips: John Dorfman

By John Dorfman

Jan. 9 (Bloomberg) -- The four stocks that Wall Street analysts most despised at the beginning of 2006 posted an average 21 percent return for the year.

The four stocks they most loved returned only 2.4 percent, which was far worse than the return of almost 16 percent on the Standard & Poor's 500 Index.

In short, the despised stocks walloped the favored ones. Is that a freak result?

No, it is not.

For nine years, I have been studying the annual performance of the four stocks that analysts most unanimously recommend, and the performance of four stocks on which they issue an unusually large number of ``sell'' recommendations.

The analysts' darlings lost 3.7 percent a year, on average. The stocks they hated declined 0.2 percent.

Both groups of stocks did worse than the S&P 500, which returned 7.4 percent a year, on average, during the period of the study: 1998 through 2006.

Analysts are tastemakers in the investment world. They set the frame of investors' expectations, provide much of the information on which the public invests, and move stocks with their ``buy'' and ``sell'' recommendations.

Yet as my little study shows, they are far from infallible.

I don't begrudge Wall Street analysts their successes when they have them. I simply say that you should make an independent decision when you invest. Analysts generally can't foretell the future any more than you can.

Underdogs Win

When 2006 began, five analysts had published opinions on the stock of Martha Stewart Living Omnimedia Inc., and four of those opinions were ``sell'' recommendations.

Based in New York, the company publishes magazines, licenses merchandise, and produces television shows, all promoting a stylish, elegant lifestyle.

It was easy to see why the analysts were negative at the start of last year. Founder Martha Stewart had just served five months in prison for obstruction of justice, and was barred from running the company in the future. It had posted losses in eight of the past 10 quarters.

So what did Martha Stewart stock do? It rose 29 percent in 2006, even though red ink continued to flow. Investors liked the rising revenue of the company, which they expect will turn profitable in 2007.

An even bigger gain that analysts didn't foresee was that of CBOT Holdings Inc., parent company to the Chicago Board of Trade. It was up 62 percent last year, even though five analysts out of seven slapped a ``sell'' rating on it.

CBOT Is Overvalued

Truth to tell, I would have agreed with those analysts. I think CBOT stock was overvalued then, and is even more so now at 56 times earnings, 12 times book value (assets minus liabilities per share) and 14 times revenue.

The analysts were right about Sycamore Networks Inc., which fell 13 percent. The other stock they hated a year ago was Washington Federal Inc., which turned out to be a modest gainer in 2006, up 6 percent.

And what about the stocks they loved a year ago?

SI International Inc., which was unanimously recommended by 11 analysts, rose 6.1 percent but didn't do as well as the S&P 500. The Reston, Virginia-based company provides information technology to the federal government.

Petrohawk Energy Corp., beloved by eight out of eight analysts, dropped 13 percent. The Houston-based company explores for and produces oil and gas.

Another loser was Sunterra Corp., a timeshare-vacation company with headquarters in Las Vegas. It declined 15 percent even though all seven analysts who followed it recommended it.

Best Performer

TAL International Group Inc. was the best performer among the adored stocks. The Purchase, New York-based company leases large freight containers that can be moved by ship, rail or truck. Last year, it jumped 29 percent in price, and returned 32 percent including dividends.

For the past nine years, I have gotten key data for this study from Zacks Investment Research Inc. in Chicago. This year, I was unable to find the information on its Web site, so I am taking a new tack.

Using Bloomberg data, I looked at analysts' recommendations on the 30 stocks that make up the Dow Jones Industrial Average. Bloomberg publishes average ratings for each stock, on a scale where five equals a ``strong buy,'' three is a ``hold,'' and one is a ``sell.''

Altria Group Inc., a New York-based company that owns Kraft Foods and is the largest U.S. cigarette producer, is analysts' favorite stock among the 30. Its average rating is 4.64.

Altria, AIG

There are many things to like about Altria, among them a dividend yield of almost 4 percent, and a return on equity last year of more than 31 percent. However, the stock has quadrupled since the end of 1999, and I think it is now fairly valued.

American International Group Inc., United Technologies Corp., General Electric Co. and Honeywell International Inc. also get high analyst ratings, ranging from 4.30 to 4.62. Of these, I prefer AIG, which sells for only 15 times earnings.

Analysts don't like General Motors Corp. (2.22), yet I wouldn't be surprised to see it do well in the year ahead. Merck & Co. and Intel Corp. get lukewarm grades (3.57 and 3.58). I like them but don't love them after recent run-ups.

Disclosure note: I own shares of Merck personally, and Intel for one or two clients.

(John Dorfman, president of Thunderstorm Capital in Boston, is a Bloomberg News columnist. The opinions expressed are his own. His firm or its clients may own or trade investments discussed in this column.)