For the most part the market is efficient, and prevailing opinion is often based on very sound reasoning. That being said, the market is not perfectly efficient and never will be. Which is awesome. If the market were perfectly efficient then investing would be boring. Optimistic opinions and pessimistic ones, no matter how justifiable, will carry certain stocks too far in one direction or another. Identifying those instances, and capitalizing on them, is what investing is all about.
Contrarianism takes courage, but the classic Buffett phrase does not go “be greedy when others are greedy and fearful when others are fearful.” That’s a surefire formula for terrible investing. Sometimes you have to be willing to take the plunge when everyone else is standing on the sidelines.
I have found three companies that the market isn’t too fond of right now. In my humble (and by no means always correct) opinion, each one is a case where justifiable pessimism ended up pushing a stock down too far–to the point that those with the courage to be contrarians could stand to reap massive rewards.
The most shorted stock on the Dow
Alcoa Inc (NYSE:AA) is the most hated stock in the Dow Jones Industrial Average. Of course there are perfectly sound reasons for this being the case. Margins are headed in the wrong direction, mainly due to the fact that the price of aluminum is falling down, recently hovering around $1,830 per pound. Why has it been falling? Basic economics–when supply outpaces demand a surplus is created and prices suffer. Our planet has been producing more aluminum than we can sell in recent years, leading to a huge surplus.
Margins of Alcoa Inc (NYSE:AA) have been decimated, and its TTM net profit margin is 1%. But considering how tough times have been for the industry, that in and of itself is an achievement.
The largest four aluminum companies in the world are Russian giant Rusal, the aluminum arm of Rio Tinto, Rio Tinto Alcan, Chinese Chalco, and Alcoa Inc (NYSE:AA). For the full year 2012 Rusal posted a loss of over $300 million, Chalco losses totaled more than $1.3 billion. Rio Tinto Alcan had margins of less than 1/1000th of one percent.
Compared with that carnage, Alcoa Inc (NYSE:AA)’s net profit margin of 1% doesn’t look so bad. The world isn’t abandoning aluminum anytime soon, and Alcoa Inc (NYSE:AA) appears to be best of breed in an industry that has fallen on hard times.
A Spanish telecom giant
What spooks investors about Telefonica S.A. (ADR) (NYSE:TEF) is its massive debt load. How bad of a problem are we looking at? Telefonica S.A. (ADR) (NYSE:TEF)‘s total debt to equity ratio is an unnerving 3.01. America’s top two telcos, Verizon Communications Inc. (NYSE:VZ) and AT&T Inc. (NYSE:T) have ratios of 1.59 and 0.84, respectively.
How well has Telefonica S.A. (ADR) (NYSE:TEF) been handling its massive debt problems? In this author’s opinion, pretty well. It’s been selling off subsidiaries and, to the chagrin of many shareholders, TEF cut its dividend last year. Personally, this Telefonica S.A. (ADR) (NYSE:TEF) shareholder applauds the willingness by management to undertake actions that, while disappointing to shareholders, are in the best long term interest of the company.
Plus Telefonica S.A. (ADR) (NYSE:TEF) announced in April that it would be paying a dividend this year, with the first payment to be made in November. If Telefonica is true to their word, it will deliver a dividend this year to shareholders of 97.5 cents. That’s equal to a 7.5% yield based on the stock’s current price, higher than the dividends of both AT & T and Verizon.
