Schaeffer's Top Two Contrarian Stock Picks for 2021
NO ONE WANTS TO BE "a face in the crowd," especially when it comes to investing. The central principle of contrarian investing is very basic and difficult to dispute – when "everyone" is bullish, buying power has been exhausted and a top is at hand and the next major move is down. And when "everyone" is bearish, selling pressure has been exhausted and a bottom is at hand and the next major move is up. This idea of going against the sentiment of the crowd has become well-established. Options analysts have generally been on the leading edge of sentiment-based analysis, as they regularly encounter crowd behavior by those who use options as a leveraged tool for expressing their bullish or bearish views. They've also noted how often "real world" results are quite the opposite of those crowd expectations. While every day examples of heavy accumulation of call options preceding a shocking price reversal in a popular stock can be heady stuff for contrarians, we ultimately learn that the goal of developing that "perfect" sentiment indicator is an elusive one. But is, nevertheless, a very worthwhile pursuit. As early as the 1950s, Humphrey Neill – author of the classic work on sentiment analysis called The Art of Contrary Thinking– said the following: "No problem connected with The Theory of Contrary Opinion is more difficult to solve than (a) how to know what prevailing general opinions are; and (b) how to measure their prevalence and intensity". In other words: "Who is this crowd that we want to fade, and how do we measure its activity?" I've been a proponent for many years of using options-based sentiment indicators as contrarian tools. The activity of options speculators, many of whom are poorly capitalized, emotion driven, and inadequately informed, can be an excellent measure of the extremes in crowd sentiment that can provide strong contrarian trading signals. The challenge over the years has been to separate the activity of those speculators with strong directional views who buy options as leveraged trading vehicles from the activities, from those who sell options as part of what they see, as a conservative trading strategy for generating income. In other words, the activities of those who sell option premium – through strategies like covered call writing and the sale of spreads, condors and butterflies – are generally irrelevant to contrarians who are seeking to fade the strong directional opinions of that elusive "crowd." *Originally featured as a guest column Barron's The Striking Price by Bernie Schaeffer*
“As contrarians, the only thing to fear is the lack of fear itself” -Bernie Schaeffer
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Fulgent Genetics (NASDAQ: FLGT)
California-based medical device maker Fulgent Genetics (FLGT) specializes in clinical diagnostic genetic sequencing, and was at the forefront of the coronavirus pandemic thanks to its RT-PCR COVID-19 test. While hopefully the pandemic is firmly put in the rearview mirror for 2021, FLGT should still be on your radar as your prep your investing strategy for the next year and beyond. After spending the last four months in a consolidating pattern, Fulgent Genetics stock looks ready to break out from an ascending triangle to fresh all-time highs. FLGT's recent pullbacks were contained by its 40-day moving average, while breathers back to the 20-week moving average also presented numerous buying opportunities throughout 2020. Yes, the equity ended the year up a sizable 301%, but the company's conservative balance sheet still makes it undervalued compared to its peers in the medical device industry.
Tailwinds on the charts could come from an exodus of short-sellers. Short interest is down 12.3% in the most recent reporting period, rolling over from all-time high levels. However, a healthy 23.1% of FLGT's total available float is still sold short, an ample amount of buying power that could hit the market and fuel an unwind. There's a lot more to unpack regarding FLGT and COVID-19 testing. Many analysts regard Fulgent's kits as temporary with multiple vaccines on the way. Yet even amid an efficient vaccine rollout – and we're a ways from that – COVID-19 testing will likely remain a key component of healthcare for the next few years. It might be sobering to come, but pandemics are rarely neatly eradicated within a year. Fulgent is well-equipped to handle the volume though. It's expected to outpace rival Co-Diagnostics (CODX) by up to 30% in total revenues in 2020, and was able to scale its test and up the headcount growth, while still inching margins up by 8%. These are encouraging numbers that could directly impact FLGT’s trajectory on the charts. Beyond COVID-19, genetic testing is here to stay. Fulgent's core genetics testing division grew by 52%, far exceeding sector peers InVitae (NVTA), Illumina (ILMN), and Natera (NTRA). This means that even if the coronavirus pandemic becomes quickly under control, FLGT can still hang its hat on core genetic testing. Fulgent offers 18,000 genetic tests – thousands more than the competition -- and considering medical panels collectively screen for around 5,700 genetic conditions; it's not unreasonable to suggest FLGT stock could benefit if the company continues to cement its position at the forefront of genetics testing.
Datadog (NASDAQ:DDOG)
Software stock Datadog (DDOG) recently broke out of a weekly flag pattern after quickly dipping below –and then regaining -- its 20-week moving average. This trendline was strong support during the broad-market selloff in September and could prove to be a springboard once again in 2021. With year-over-year revenue growth at roughly 62.5% and the company free cash flow positive already, there is reason to believe Datadog stock has room to run. Digging deeper into a 2021 outlook for Datadog, the company’s management team raised guidance by 5% during its third-quarter earnings report, ahead of the release of Wall Street's expectations, which we can likely see as a theme in 2021. The lowered 2021 growth outlook is largely from expectations that budgets will be conservative for customers' IT spend. Still, as we move out of pandemic mode, we can expect budgets to open up, allowing DDOG to beat earnings expectations and raise guidance consistently.
A short squeeze could keep the wind at DDOG's back. The stock continued to rise in the face of short interest increasing toward all-time high levels. A healthy 7.8% of DDOG's total available float is sold short, and at the stock's average pace of trading, it would take more than three days for shorts to buy back their bearish bets. A shift in analyst sentiment is overdue as well. Of the 18 brokerages covering DDOG, 11 maintain a tepid "hold" stance. Meanwhile, DDOG premium is affordably priced, which could draw more buyers to the table. This is according to the security's SVI of 52%, which sits in the lowest annual percentile, which means options traders are pricing in relatively low volatility expectations at the moment. Plus, the equity's Schaeffer's Volatility Scorecard (SVS) sits at 84 (out of 100), meaning the stock has greatly exceeded option traders' volatility expectations during the past year.
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