You may be right. I may be crazy.
-- Billy Joel
I've long been skeptical of the opinions of sell-side analysts. During the dot-com boom, I just didn't get the new paradigm shift or the utility of metrics such as "eyeballs," or so I was often told. At Avalon Research, we specifically went against the sell-side consensus, and that led to my current role writing a contrarian-focused column for
In my process for coming up with stock ideas to write about, I always check the consensus. Lots of times a stock will look good on the surface; I'll start investigating why the analysts have it wrong, only to realize that they don't. Even I have to acknowledge the sell side sometimes gets it right.
Here are two recent examples. The first I found from a search with the following parameters: stocks trading above their 50-day moving average, with return on equity higher than their five-year average and with low ratings by Wall Street analysts. Those metrics signal a strong stock with improving fundamentals that the Street has not yet recognized.
One name from the list that initially intrigued me was
, which currently has five hold ratings and four sells. Looking for signs of a turnaround, I saw that same-store sales are moving higher, net income jumped in the most recent quarter, and margin improved on a better sales mix, including better performance from private label. Cash flow is impressive as well. Not every number was stellar, but for a turnaround play you want to get in early before everyone notices that something positive is happening.
But a red flag popped up as I looked into management. Four members of the Dillard family are on the board of directors, and three of them are in upper-level management (and are paid quite well). The family owns the majority of the voting shares; that means that if you're a shareholder and don't like the way things are being run, there's not a whole lot you can do about it.
These types of publicly traded family-run businesses are almost always a bad idea in my book. It's one of the reasons I've been
and why I
wrote critically about American Pharmaceutical Partners, which has since changed its name to
. Shareholders were (and still are) at the mercy of majority shareholder CEO Patrick Soon-Shiong, who recently authorized the acquisition of a company that he owned for a questionably high valuation, diluting shareholders' equity and giving him an even higher percentage stake in the new company.
In the story on American Pharma, I quoted Todd Fernandez, senior research analyst with proxy adviser Glass Lewis, who stated: "Such actions prove why owning minority positions in majority-owned shares are not a good idea. Shareholders will have to take what's given to them."
The Dillard family has also come under fire. Although the company reported a solid quarter, "it is not clear whether the company has a sustainable strategy to continue its sales growth," Credit Suisse First Boston analyst Michael Exstein recently wrote.
Oppenheimer's Bernard Sosnick also expressed doubts as to whether Dillard's management is up to the job. "Dillard's will be at a competitive disadvantage in the department store sector that is vulnerable to market share erosion, and its ability to sustain sales growth during the fall and holiday seasons seems problematic to us," he wrote last week.
Both analysts rate the stock a sell. Neither own it, and their firms do not have an investment-banking relationship with Dillard's.
The Street clearly doesn't have faith that the Dillard family is the management team to pull the company out of its difficulties. Considering that shareholders can't do a darn thing about it if they feel the same way, I'm going to side with the analysts on this one, although I'm neutral on the stock rather than recommending an outright sale.
Another idea I had was to see if there was a down-and-out company that is unloved yet involved with ethanol. I figured that's the kind of stock that could catch fire as the fuel becomes more widely distributed and the analysts jump on board. I found one in
Sell-side analysts are not big fans of the stock. Only two rate it a buy, three have it at hold, and four recommend selling it. The company has a new CEO who is a supposed marketing genius. Revenue growth, while not stellar, was still positive. ConAgra has many household name brands and has big enterprise customers such as
. The balance sheet is being cleaned up, lower margin businesses and assets are being sold, and expenses are being cut. The stock pays a healthy 3.2% dividend.
JPMorgan analyst Pablo Zuanic fears that ConAgra "will need to reinvest a much larger share of its planned cost savings in
selling general and administrative expense, with little EPS growth in the next two years." (Zuanic has a sell rating and does not own the stock. JPMorgan has an investment-banking relationship with ConAgra.)
Another issue is that ConAgra said it would reduce its dividend starting in June. While I believe that and the sale of some businesses were necessary moves, a company that cuts its dividend and sells off assets is not one I want to invest in. It's a clear sign that things are just not going well.
own Jim Cramer has called ConAgra the
worst run food company in the world. At first glance, it seemed like the kind of story that could work from a contrarian perspective. But further research told me this is one where you're better off waiting for confirmation of a turnaround, rather than being too early.
I believe getting in front of the sell side in a turnaround play is a great way to make money in the market. Analyst upgrades can provide the necessary catalyst to get a stock moving. But the timing has to be correct. Rather than trying to jump the line in front of the analysts, I suspect they have the ConAgra story right.
In keeping with TSC's editorial policy, Lichtenfeld doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.
Marc Lichtenfeld was previously an analyst at Avalon Research Group and The Weiss Group and a trader at Carlin Equities. He holds NASD 86,87, 7 and 63 licenses. His prior journalism experience includes being a reporter/anchor for On24 in San Francisco and a managing editor of InvestorsObserver, a personal finance Web site. He is a graduate of the State University of New York at Albany. He appreciates your feedback;
to send him an email.