Not All Dogs Turn Good

 | Jan 07, 2013 | 4:30 PM EST
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Being an investment contrarian can have a huge payoff. Buying at the end of 2008 and 2009, investing in financials, and most recently betting on housing, have all been contrarian moves that have paid off well for patient investors. But like all things in investing, simply pursuing an investment angle because it sounds like a winning move is very foolish and often costly.

Each January, one of the most popular contrarian strategy kicks into gear and is known as the Dogs of the Dow trade. Basically the bet involves investing in the 10 worst performers of the Dow Jones Industrial Average (or S&P, or whatever index you choose) of the preceding year. Similar to a coin flip, over time the Dogs of the Dow theory has worked and, in some cases, worked very well. As a value investor, I can attest to the intrigue of investing in a business that has seen it share price drop by 50% or more in a year or less. In 2011, one of the Dow's worst dogs was Bank of America (BAC), which was down over 50% in 2011. BofA was top pick in 2012 as a result of the incredibly attractive stock price that was created by the 2011 decline. As it turned out, BofA took top honors in 2012, climbing 104%.

But some dogs have fleas that just won't seem to go away and instead of getting baited into the Dogs of the Dow hook, line, and sinker, I would examine the list very closely before salivating over the potential for big gains.

Looking at the S&P, the biggest dog is online education provider Apollo Group, down 62% in 2012. Trading at $22, Apollo shares are up nearly 10% already in 2012. With a P/E ratio of 6, it's tempting to think the company a huge bargain. In fact, with little effort Apollo shares could end the year at $30 more and turn out to be a big winner in 2013. Unfortunately, one of Apollo's and online education's biggest tailwind -- federal student loan funding -- has turned into a headwind with seemingly permanent repercussions. The net-net is greater competition from traditional universities and a slower rate of growth in online enrollment. So, from where I sit, Apollo may not yet be the contrarian opportunity it appears to be.

Best Buy (BBY), down 51% in 2012, also doesn't interest me for similar reasons affecting big box brick and mortar electronic retailers.

But other 2012 members appear quite intriguing. Hewlett-Packard (HPQ) declined 45% in 2012 but that didn't sway shareholders like Seth Klarman, who still owns a good chunk of the company's shares. Shares also pay a tidy yield of 3.5%. Previous comments from HPQ management indicate that 2013 won't be a spectacular year operationally as the company works to turn itself around. Nevertheless, with such a battered equity price, Mr. Market won't wait for tangible results, but will send shares higher in anticipation.

Two other 2012 dogs with intrigue are retailer J.C. Penney (JCP) and iron ore producer Clifffs Natural Resources (CLF). JCP's largest shareholder is Bill Ackman, who has installed former Apple (AAPL) retail guru Ron Johnson as CEO. Cliffs has been battered due to decline in steel demand. China, the largest consumer of steel on the planet looks set to establish its appetite again.

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