Contrarian Investing

Contrarian Investing… Be Brave. Be A Contrarian With These 2 Stocks
by Louis Basenese, Advisory Panelist, Investment U
Wednesday, November 7, 2007: Issue # 728

Editor’s Note: Last week, Oxford Club Associate Investment Director Louis Basenese showed you three ways to log big returns… the same way hedge fund managers do. Today he picks up where he left off, with the fourth - and perhaps most reliable - way to profit. (If you missed the other three, see the recap below.)

One thing hedge fund managers tend to be is contrarian. They look for opportunities to invest in unloved or unwanted assets… and don’t mind waiting to be vindicated.

Nothing prohibits us from doing the same. Timing is the only critical issue. But if we stay on the lookout for subtle changes in fundamentals and/or investor sentiment, we can time contrarian investing opportunities right.

I know, sounds ambiguous. So let me use two recommendations to illustrate this strategy.

Contrarian Investing Opportunity #1

1. Motorola (NYSE: MOT): Time to Ring Up A Troubled Company

At the beginning of the year, investors and the board of directors started growing impatient with the much-hyped CEO Ed Zander. That’s because the company kept losing market share to Nokia and Samsung. And margins and sales were slipping. Then the unthinkable hit - Motorola reported two consecutive quarterly losses.

Bottom line, distaste for the stock kept mounting and share prices cratered. The credit crunch helped exacerbate the final leg down. Nonetheless, along the way, something subtle, but important happened…

In the midst of the worst news, Carl Icahn started adding to his stake. And shortly after, Ed Lampert (ESL Investments) followed suit.

You see, despite all the troubles, Motorola was sitting on a $15.6 billion mountain of cash. And each quarter, it kept adding to the pile by millions, thanks to solid free cash-flow generation. Even still, shares hovered at a 70% discount to the industry average price-to-sales ratio.

In sum, shares represented a screaming bargain. A turnaround was imminent as the company was cutting costs, shaking up the executive ranks and still held a dominant market share position. Experienced contrarians Icahn and Lampert knew this all too well.

Sure enough, the first signs of a turnaround just appeared on October 25. Motorola reported a $60 million quarterly profit, beating expectations.

If you were tracking the subtle changes along the way, the mid-August low would have been the ideal entry point. And on October 25, you could have cashed out a quick 24% profit in just 69 days.

But all is not lost. Vindication for Ichan, Lampert and any other Motorola contrarians hasn’t completely materialized. But it’s coming.

Expect each quarterly report to show additional signs of a turnaround. And in turn, expect shares to keep edging higher. For those reasons, I’m convinced Motorola’s still worth your consideration.

Now, here’s an earlier-stage contrarian play…

Contrarian Investing Opportunity #2

2. Sotheby’s (NYSE: BID): Bid This One Down

I recommend taking a short position in the Sotheby’s. Here’s why…

In recent years, excessive Wall Street bonuses (for hedge fund managers, private equity principals and investment bankers) propelled art prices to record levels. After all, they needed an outlet for their newfound wealth. In turn, Sotheby’s enjoyed substantial profitability.

But conditions are changing…

Many hedge funds are going the way of the dodo bird, thanks to poor investments in subprime assets, emerging-markets debt and financial stocks. Private equity deals are in a Georgia-like drought. And investment bankers are being “reassigned” by the thousands. Just last month, Bank of America announced plans to cut 3,000 investment-banking jobs.

All told, the fat bonus checks required to maintain the fine art speculation are quickly dwindling.

Granted, Sotheby’s recent regulatory filing suggests a busy fall auction season, with outstanding auction guarantees jumping 52.4% to $378 million. But this does not automatically translate into earnings…

Auction guarantees only promise the seller a minimum price. If the item sells for less, guess what? Sotheby’s is on the hook for the difference.

Here’s the thing. The October auction during the Frieze Art Fair in London suggests Sotheby’s will find itself in this uncomfortable “low bid” position more frequently than management anticipates.

For the first time in months, many pieces did not sell at the high end or above the expected prices. Instead, many fetched minimum bids, or less. As one insider noted, “There’s not the same irrational exuberance that we once saw.”

Here’s another contrarian indicator - “flippers” are multiplying. Just like we witnessed during the real estate boom, the same properties keep reappearing on the art scene. At higher prices. In some cases, more than triple the price fetched a few years ago.

As Mary Hoeveler, the managing director of Citigroup’s art-advisory service, indicates, “The auction houses are flooding the market with this material.”

Cleary the sentiment is changing, although you’d never know it if you looked at share prices. They hit a new high three times last month and are up 68% year-to-date. But that’s what makes this such a compelling contrarian play.

Expect a weak dollar to prop up international buying in the short-term. But it won’t be enough to offset the exodus of U.S. buyers.

And if you position your portfolio now, it shouldn’t be long before Sotheby’s profits start going down, and your profits start going up.

Good investing,

Louis Basenese

Today’s Investment U Crib Sheet -
4 Ways to Trade (And Profit) Like A Hedge Fund - A Recap

1. Go both long and short in the same account.
2. Monitor 13-D and 13-G filings for compelling buys.
3. Buy individual companies operating like hedge funds.
4. Be a contrarian.

No matter which strategy you choose, they all offer notable advantages over actual hedge funds.

One, you automatically qualify. No investment minimums or hard-to-come-by invitations are required.

Two, you drastically reduce expenses. Instead of paying ridiculous 2% to 4% management fees and 20% to 40% profit sharing fees, you pay the minimal transaction costs associated with an everyday discount brokerage account.

Lastly, and most importantly, you maintain control over your assets.

Unlike most hedge funds that carry lock-up periods prohibiting you from withdrawing any funds for up to five years, you can take profits or redistribute your capital whenever and however you see fit.

Find out where to get 13-D and 13-G filings here, in last week’s issue.