Stock picks for 2014: Will these 50 stocks outperform?

WHAT STOCKS to invest in in 2014?

A series of our articles in 2013 highlighted stock picks at the start of each of the four quarters of the year.

Amazingly, in aggregate, the stocks gained 51% in 2013. See: Wow! NextInsight Readers' Picks Gained 51% In 2013!

Now we present a list of 50 stocks -- but these were chosen using strictly different criteria from before.

The criteria were low PE, low price/book and dividend-paying. We used Bloomberg to coldly sort these stocks and we made no judgement on whether any of the stocks should be booted out for whatever reason.

The list is presented in a table below.

Why the 3 criteria? To begin with, each of these is sound and well-accepted criterion for stock hunting.  

The strategy was championed by David Dreman in his best-selling book, Contrarian Investment Strategies, published in 1980.

"I buy stocks when they are battered. I am strict with my discipline. I always buy stocks with low price-earnings ratios, low price-to-book value ratios and higher-than-average yield. Academic studies have shown that a strategy of buying out-of-favor stocks with low PE, price-to-book and price-to-cash flow ratios outperforms the market pretty consistently over long periods of time." – David Dreman

The strategy happens also to be the stock-picking approach of some fund managers including start-up Aggregate Asset Management in Singapore.

Since inception, the NAV of the Aggregate Value Fund has steadily appreciated by 12.6% over the past year (14 Dec 2012 to 30 Nov 2013), outperforming the MSCI AC Asia Ex Japan and the STI.

Why Investors Like Dividends

Investors like dividends for regular income and love dividend paying stocks even more if they also have the potential for share price appreciation.

When investing in small- to mid-cap stocks, regular dividends are also a signal from companies that their operational profits are real.

Dividends give some assurance that investors are not misled by reports of strong historical or projected earnings growth because of aggressive accounting practices rather than good business outlook.

Large cap companies, on the other hand, are more likely to pay dividends as these are mature companies with stable cash flow from operations.

When the company or industry is at a mature stage of its life cycle, reinvesting profits to expand the business is unlikely to result in significant earnings growth.

This means there is limited upside to the share price and shareholders are better off if the profits are distributed as dividends.

(However, mature companies in highly capital intensive sectors, such as property developers, usually do not pay dividends as they need the cash for working capital.)

Out-of-Favor Stocks

There are stocks with good growth potential and strong business fundamentals but have low PE because of some perception stigma, such as uncertainty in earnings visibility, or high risk (S-chip discount).

Market developments can correct the factors contributing to the market perception stigma.

What the contrarian investor needs to do is to decide for himself the likelihood that a stock can rid itself of this stigma and wait for the market correction on its stock price.

Using Bloomberg data, we short-listed 50 dividend paying stocks with the lowest PE trading on SGX.  We have also eliminated stocks trading above book value.

Over the next 4 quarters, we will be presenting updates on how this list of 50 performs.