Contrarians Gain from Unfavorable Names

 | Nov 21, 2011 | 3:00 PM EST
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Investors who try and outsmart the market by being a contrarian for no other reason than being different will lose enough to offset any winners. On the other hand, investors who can identify an excellent business that is currently under severe distress have an advantage. The problem is, it's not often that such a price-to-value anomaly exists.

Today, Bank of America (BAC) is at $5.70, and is a fat pitch. If the bank is too big to fail, then it merely needs to split itself up, in which case, the sum of its parts is worth substantially more than the whole. Core operations are earning more than $10 billion under the current stress-tested environment. Splitting off the profit-gushing, global banking and investment management divisions would likely result in a business worth $65 billion to $90 billion against a combined market cap today of $58 billion.

But, BofA doesn't need to split up, it needs time to undo the excesses of the past, and CEO Moynihan is doing just that. It won't be a quick fix, but it will happen. Of course, investors looking through a six-to-12-month prism will be hard-pressed to like BofA. Everyone hates it now; the next time BofA has an "outperform" rating, the stock will be trading north of $12, 120% above today's levels.

Another great opportunity today exists with Hewlett-Packard (HPQ). Dissatisfaction with past decisions sent investors on a mass exodus. No one really knows yet what to expect from the new CEO Meg Whitman, but if her legacy as CEO of eBay (EBAY) is any guide, HP investors are likely not going to be disappointed. During her nine-year stint at eBay from 1998 to 2007, eBay shares surged more than 500%. HP will release its quarterly results after the market closes today. I wouldn't read too much into reduced expectations; Whitman may likely reduce expectations today only to exceed them later in future.

During the past several months, some serious smart money has been piling into BP (BP), and it's easy to see why. The share price more than compensates for any future oil spill liabilities. The fact that the company's 4% dividend yield is still going to equity holders is just one clue that the company is in better shape than the stock price currently reflects. While BP shares trade at 6x forward earnings, Exxon Mobil (XOM) trades at a 50% multiple premium. At current oil prices, BP's operations generate more than $50 million in free cash flow per day -- an annual run rate that will help the company handle whatever liabilities comes its way.

Investing is simple but not easy since not many investors wants to buy troubled businesses at moments of maximum pessimism. But, if you are an investor who would buy a house in today's market and will get up at 3:00 a.m. on Black Friday to take advantage of sales, remember that Mr. Market is flashing a big sale sign today for these excellent names.

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