Many investors look to winning areas of the market to find stocks. Top fund managers Billy Hwan, CFA, and Krishna Chintalapalli do just the opposite. They pick through the most hated and beaten-up sectors of the stock market, hunting for companies whose share prices have been unfairly dragged down. It takes conviction to buy what everyone else is shunning, but they believe if your time horizon is three to five years, investing in the right contrarian stocks is the smart way to prepare for the next economic expansion and bull market. Bottom Line Personal asked these contrarians how they find hidden gems now.
Also: For those who are more daring, Bruce Kaser takes a riskier but potentially more lucrative approach—betting on deeply troubled companies that are so cheap even just a little good news can push up their prices (see page two).
When the market gets clobbered, investors are quick to jettison stocks in the most damaged sectors. Perhaps a company’s potential is misunderstood…or its quarterly earnings fall short of expectations…or sales are suffering a cyclical downturn. In the near term, these companies don’t appear to be good investments. But certain criteria can indicate mid- to long-term potential, including…
High-quality business with a strong balance sheet and sustainable advantages over competitors.
Attractive valuations including low price-to-earnings ratios and price-to-book ratios relative to the company’s own history and those of its peers.
High ESG (environmental/social/governance) score. Many investors focus on the E and S but not enough on the G. Good corporate governance with strong compliance and ethical standards is essential for employee retention and avoiding lawsuits and reputational damage.
More than anything, being a contrarian requires patience. Even when a company meets all of our criteria, we often find that it can take months, even years, before our investment pays off.
Here are three areas of the market that have been devastated in the past year and the compelling stocks we have found in these sectors…
Technology: Tech, one of the S&P 500’s worst-performing sectors, fell 28% last year, hurt by supply-chain constraints and rising interest rates. The semiconductor market was especially hard hit. Once the demand for electronics and personal computers slowed, there was a glut in global chips and a cyclical decline in chip prices. Tech stocks we own now…
Micron Technology (MU), one of the largest manufacturers of memory chips essential for data storage. The stock plunged nearly 50% in 2022. Micron could see a few more quarters of declining revenue, and profits and earnings may not rebound until next year. Recent share price: $62.63.
What investors are missing: Micron’s technological superiority and financial stability should limit its downside until the chip markets recover. The 44-year-old company has rewarded investors who ride out its boom-and-bust cycles. With the help of Federal tax incentives and subsidies, Micron announced plans to build the largest semiconductor-fabrication facility in the US.
Oracle Corp. (ORCL) specializes in software that helps big companies in more than 175 countries store, customize and manage massive amounts of database information. The company, whose stock was down as much as 31% in 2022 before rebounding in recent months, had been regarded as an aging tech firm that generated anemic growth and couldn’t keep up with newer cloud-based competitors. Recent share price: $95.59.
What investors are missing: Oracle’s own cloud infrastructure business has taken off. The company recently scored a big win when it was named one of the selected vendors for a $9 billion contract from the US Department of Defense.
Banking: The KBW Nasdaq Bank Index sank 22% in 2022. Investors feared a recession would send loan defaults on mortgages and credit cards soaring. In early 2023, the index continued to drop due to the fallout from the Silicon Valley Bank collapse, even though major banks are better able to withstand shocks than they were in the 2007–2009 financial crisis. Bank stocks we own now…
Capital One Financial Corp. (COF), a regional bank, serves more than 100 million customers and specializes in credit card lending. As interest rates jumped last year, delinquencies and loan loss rates ticked higher, and outstanding credit card balances increased. The stock fell 36% over fears that a recession could lead to weaker consumers’ household balance sheets and much higher loan losses for the bank. Recent share price: $97.83.
What investors are missing: Despite all the broader macroeconomic fears and headwinds, Capital One still has produced solid financial results. The company also maintains a very strong capital position that it can lean on even if losses and defaults fare worse than expected.
Citigroup (C), the third-largest bank in the US, has about $2.4 trillion in assets under management. Its stock plunged 29% in 2022 over a litany of problems. The bank has lagged its peers in revenue growth since the Great Recession, and regulators slapped Citigroup with a $400 million civil fine in 2020 for longstanding issues related to its compliance, data and risk-management controls. Recent share price: $49.69.
What investors are missing: New CEO Jane Fraser was appointed in 2021 to turn around the struggling bank. She has worked to scale back Citicorp’s international operations and sell off less profitable parts of the business to improve profitability. Fraser also plans to double down in areas where Citigroup is strong, including investment banking and wealth management. While shareholders wait for these changes to take effect, the bank pays a solid dividend yield of 4.3%. Last year, Warren Buffett scooped up about $3 billion worth of Citicorp shares.
Homebuilders: In 2022, the Dow Jones US Select Home Construction Index dropped 26% as surging mortgage rates slowed the pandemic real estate boom. Investors were rattled by shrinking profits and reduced demand for new homes. One housing-related stock we own now…
D.R. Horton (DHI), the country’s largest homebuilder, operates in 33 states and specializes in affordable single-family detached homes. As year-over-year revenues shrank, the stock fell nearly 16% last year. Recent share price: $99.48.
What investors are missing: Long-term fundamentals look excellent for D.R. Horton, which carries minimal debt on its core home-building business and has more than $3 billion of cash on its balance sheet. Despite the cooldown in recent months, housing inventory levels remain near historic lows because there is a massive undersupply of homes nationwide. Once the Federal Reserve pivots to a more accommodative monetary policy, mortgage rates will come down and reinvigorate home sales.
