Contrarian Investing Is For All Seasons!
The market is finally showing signs of weakness after a one-way movement from the time it hit the lows in March 2020. This correction in stock prices will create opportunities for investors. However, the question is about which strategy will work best in the current market situation. Will contrarian investing approach suit in the current market conditions? Yogesh Supekar explains why contrarian investing approach is for all seasons and how it works
The benchmark index Sensex has fallen by about 8 per cent from its all-time high levels. This fall has been across merely 27 trading sessions. Thus, a sudden change in trend has taken several bulls by surprise even though, to be fair, a correction was expected by market participants. It is the depth of the correction and the speed that has surprised a few. What is interesting to note is the performance of the private banks. BSE Private Banks index is now the worst performing sectoral index and is down by more than 13 per cent in the past one month. Banks have indeed underperformed the markets even though PSU Banks has shown relative strength when compared to private peers.
In the recent fall we have seen that metal stocks too have tumbled along with those of private banks. The BSE Metal index is down by more than 10 per cent in the past one month. Interestingly, even real estate and energy stocks have been a part of this correction. If we look at the performance on YTD basis it is the metal stocks, power-sector related stocks and real estate stocks that have outperformed the markets handsomely. The broader markets have been able to give confidence to investors as the BSE Small-Cap index has fallen by less than 2 per cent while BSE Sensex is down by about 7 per cent in the past one month. The broader market outperformance is remarkable in the current fall.
"The trend is your friend, at least until the bend in the end." -Anonymous
The change in market trend is always a testing time for longterm investors. The extent of market correction is not easily estimated and more often than not investors have no clue as to how long any such correction may last. The price and time correction can frustrate even the best of investors. In such difficult times when market volatility is unnerving and valuations are stretched, what investing strategy can work best?
"Follow the course opposite to custom and you will almost always be right." -Marc Faber
What if we apply the principles of contrarian investing in the current times when the valuations are stretched and market participation is at a record pace?
Contrarian Investing In simple terms, contrarian investing is doing the opposite of what the majority of investors are doing. In a contrarian bet you are going against the market and hence the strategy of contrarian investing is not an easy strategy to adopt and execute. It is the opposite of the trend following strategy or momentum investing. In momentum investing strategy one just buys stocks that are gaining momentum and on most occasions the valuations are ignored. Comments Mandar Mulay, an equity investor who believes in long term investing: “I have made money in the market consistently by following market trends. I do not think I need to change my investment style as I am getting good returns on my risk capital. However, when the market valuations are stretched, and the market trend changes suddenly I tend to get lost a little bit.”
"Embracing risk and losses in good times is the way to prosper in a crisis." - Mark Spitznagel, Fund Manager
What is Contrarian Investing?
Contrarian investing in simple terms means going against the trend. It means that if everyone is following the herd mentality by buying stocks because of the bullish trend in the market, a contrarian investor will short sell his investments and vice versa. The belief behind this strategy is that this type of investor has a strong conviction that the markets are overvaluing certain stocks and undervaluing those which have real growth potential in the future and that herding is causing exponential valuations of the stocks and the market in general.
“A close friend mentioned that he has been following the contrarian style of investing for several years and it has helped him beat market returns. I have not practiced contrarian investing because I am not aware of the detailed process that one needs to adopt while practicing contrarian investing. I do think, however, that a different approach to investing will come in handy especially now that the market trend is a little uncertain and volatility is on the rise. I am actively considering adopting a contrarian style of investing. I sincerely believe that searching in unpopular areas of the market certainly doesn’t guarantee success but it can be a good way to explore opportunities,” he adds. There are some basic rules to follow while investing the contrarian way:
1) It is observed that when a stock begins to hit the headlines, the positives are already factored in and there is very little room left in the stock to outperform. In the case of many stocks that create a buzz, by the time investors make up their mind to invest in them the stock starts underperforming as it is over-owned. For example, the shares of Praj Industries climbed from Rs 87 per share in November 2020 to Rs 398 per share in June 2021, thus generating 326 per cent returns in quick time. The stock started attracting investors’ attention and was in the news almost on a daily basis. However, after being highlighted by the media and analysts, it began to the number of 52-week high stocks to estimate when the market is near its top heavily underperform the market. It is down by about 20 per cent since June 2021. Here, a contrarian investor will avoid stocks that are popular or in favour by investors.
2) Buy when everyone wants to sell and sell when everyone wants to buy. When adopting a contrarian style, it is important to have an independent view which is opposite to what the majority of investors think. When the market is at an all-time high and trending, it is common to see investors actively participating since most are trend followers. The uptrend and price momentum ensures that more and more investors get on board on the long side and that is where the contrarian investor must take a view that goes against the market view. Contrarian investors can use advance decline indicators and track the number of 52-week high stocks to estimate when the market is near its top.
Technical analysis also helps to estimate if the market is in an overbought situation. In a bull run the market tends to be in an overbought situation for months; hence, a lot of patience if required to taste success while adopting contrarian investing. The same can be said when the markets are down and in a corrective phase. A contrarian investor must show courage extraordinaire to buy when a majority of investors are selling. It takes a lot of practice to do so and the skill-set to think and act contrarian comes with experience. As if often said, most people fall prey to the herd mentality and would rather take the path of least resistance. A contrarian investor does the exact opposite and chooses to tread the unknown path.
3) Don’t take tips or advice and don’t believe in external research. As it takes loads of conviction to take a view and position against the market view, a typical contrarian works alone without tips or recommendations from any brokerage houses. The decisions should not be made based on the research reports published by brokerage houses or any advisory services. At the heart of contrarian investing is independent or original thinking that contradicts the market opinion and view. If one works with tips and acts according to the research reports one may align his or her views as per the market trend.
Warren Buffet and Contrarian Investing
Warren Buffet is often considered one of the best exponents of contrarian investing. Apart from being super-smart and guided by an overarching investment philosophy, he is always considered unemotional and mentally flexible. These are the very qualities that make Buffet a top-notch contrarian investor. He is indeed an iconoclast and true contrarian if one studies his investment decisions. When you observe the investments done by Warren Buffet, it is not difficult to recognize that he is countercyclical. It is emotionally easy to invest when the economy is improving, however, Warren Buffet has repeatedly demonstrated his ability and preference to invest at the bottom of the cycle. His big-ticket investments during the global financial crisis are legendary and most of his big contrarian bets have been made when optimism was in short supply. Another easy to recognize investment behaviour of Warren Buffet is that he has long-term focus almost in all his decisions and that he is unconcerned about the market volatility. Warren Buffet is considered a perfect exponent of his contrarian investment style as he has shown a tendency to be fearless about his big bets and best ideas. His willingness to remain inactive and high on conviction in his ideas makes him successful in exploring contrarian investing. Any investor willing to exploit a contrarian approach can benefit by observing Warren Buffet’s investing pattern and behaviour.
Roop Bhootra, CEO - Investment Services, Anand Rathi Shares and Stockbrokers
What is contrarian investing according to you and does it work in a bullish market environment like the current one? Contrarian investing is a style of investing in stocks, sectors or themes that are currently out of flavour in the market. This investing style works well even in bull markets, but it totally depends on the stock-picking ability of the investor. Yes, contrarian stock selection works in any kind of market scenario, including the current one. The key trigger points can be the turn of an economic cycle or a company’s business cycle
What contrarian bets would you suggest in the current market condition? PSU banks, other PSUs, real estate and capital goods were out of favour for many years now and can be interesting contrarian bets with a timeframe of 2-3 years. So far, in the last 3-5 years we have seen a strong performance in the consumption theme but now may be the time to look at the investment theme. But focus more on stock selection and bet on those companies where there is strong visibility of earnings with good corporate governance.
What are the most important things to keep in mind while taking a contrarian bet? Contrarian investing requires deep understanding of the business cycles, future moats for business and management quality and a track record of who is at the helm of the business. In a way contrarian bets are also known as turnaround stories. The contrarian bets in your portfolio may underperform the market in the short term but over a long term can be a big positive surprise on the upside. One should do a review of contrarian bets at least on a quarterly basis.
Contrarian Investing and High Dividend Yield Stocks Value investing and contra investing is often used interchangeably. Value investing is often considered as contra investing because value investor usually purchases those stocks that are out of fashion. Margin of safety should be high for a value investor to buy a stock. High dividend Yielding stocks usually offer value and somewhat fit into the contrarian style of investing. High dividend yielding stocks however are low growth stocks and do not promise extraordinary price gains, in short term at least. One need to be patient while investing in high dividend yielding stocks.
Santosh Meena, Head of Research, Swastika Investmart Ltd.
Do high dividend-yielding stocks outperform? It is utterly unclear to say that high dividend-yielding stocks tend to outperform. They are generally considered low-risk, low-return stocks. High dividend-yielding stocks are conventionally a good investment idea as they provide a regular source of income. In India, dividend yields above 5-6 per cent are considered to be high dividend-yielding stocks. Typically, the dividend story is not exactly a favourite among institutional and small investors because dividend yield stocks are lowgrowth stocks.
Also, the market is always willing to give a higher PE ratio for growth stocks than regular income stocks. Therefore, dividend yield stocks rarely see a re-rating of the PE ratio. A high dividend yield stock is seen as a company that has limited investment opportunities in the business and therefore market remains conservative while giving valuations to these companies. Globally and in India, high dividend-yield stocks tend to be in sectors like utilities and commodities which are not exactly high-growth stories.
How can one pick high dividend-yielding stocks?
Investors should look for dividend yield instead of dividend amount while choosing any stock for the high dividend. The dividend yield is a ratio that helps investors understand how much dividend a company pays out each year relative to its stock price. The formula for the dividend yield is annual dividend ×100 per share price. This ratio is an excellent way to compare the dividend-paying capability of different companies. The primary thing that investors must keep in mind is that they should not focus only on the dividend yield to make investment decisions.
Since the yield is a ratio of dividends to stock price, if the market price of the share falls, the dividend yield can be high. Investing in such stocks without analysing the reason behind the drop in the stock price can be risky. Some of the important parameters that should be considered while choosing stocks for dividend income are a history of paying dividends consistently, consistent increase in the dividend yield and payout ratio.
Which are your top picks from high dividend-yielding stocks?
ITC, Bajaj Auto, Britannia, VEDL and HCL Tech are our top picks from the private sector while Powergrid, REC Ltd. and BEL are preferred bets in the PSU basket.
True Blue Contrarians
John Neff : He ran the Vanguard Windsor fund for 31 years and averaged 13.7 per cent growth per year, beating the S and P 500 by an average of 3 per cent. Jesse Livermore: He took huge huge short positions before the 1906 San Francisco earthquake and the Wall Street Crash of 1929. Many of his bold moves are considered legendary today — in a time when analysis was a largely new concept and breaking away from market sentiment and public opinion was far less common and far more risky. Ray Dalio: Famously quoted for saying, “You can’t make money agree with the consensus view,” he is a powerhouse investor running the largest hedge fund in the world. His contrarian style of investing has allowed him to predict and act defensively regarding several market drops, including the housing crisis of 2008. Marc Faber: He rallied against popular opinion to forecast Black Monday in 1987, the Japanese bubble in 1990, the gaming stock crash of 1993 as well as the Asia Pacific crisis of 1997.
Conclusion
It goes without saying that the market trend has reversed. The ‘sell on rally’ kind of market mood was visible for more than 2-3 weeks now and a broad-based correction was expected in the markets. Now that at the key benchmark index level we are down by almost 8 per cent, the question remains whether it is a good time to buy and whether a contrarian investing style can be adopted in the current market situation. Contrarian investing, like any other strategy, succeeds depending on the way it is executed. Looking at the current market situation there are plenty of opportunities that may fit the description of contrarian investing style, as for example, in sectors such as pharmaceuticals, automotive and FMCG. Before finding a contrarian bet it is important that we understand the ‘trigger’ that may lead to a rise in the stock price.
Whether it is an earning upgrade, selling of non-core assets, change in government regulation, opening up of a sector for private investments, etc., there are multiple factors that can drive stock prices higher. However, there could also be just one single factor that could be leading to the re-rating of the stock prices, as for example, in the case of Zen Technology the trigger was the government allowing drones for private commercial purposes. This announcement re-rated the stock and its price climbed by more than 100 per cent in no time. Till that time it had been ignored by investors. Contrarian investing as a strategy has no flaws but investors may make an execution error that could lead to losses. Wrong selection of stocks and timing can lead to losses and heavy underperformance.