Making Money Contrarian Way!
The moment we say, ‘contrarian investing’ the first thing that comes to investors’ mind is going ‘against the herd mentality’ and ‘good amount of market outperformance’. Most people easily connect with the perception of ‘going against the herd mentality’ when it comes to contrarian investing. However, unfortunately, they might miss generating excess market returns by adopting such a proven strategy. One of the most common reasons why investors are not able to execute the contrarian investing strategy is the lack of patience (not willing to wait for the long term) and the lack of clarity on the strategy itself. Indeed, it is a rare quality to make good decisions and be correctly contrarian in adversity. Many a investors fall in trap of being a contrarian for the sake of being a contrarian, without analysing the consequences of going wrong on the bet.
Guide to contrarian investing
Going against the crowd is exactly what a contrarian does with an objective to earn extra returns. In order to earn excess returns, following things can be done by investors within the framework of contrarian investing strategy: -
1) Turnaround companies : - As a long-term investor, one can find contrarian bets by identifying companies that are in a turnaround phase. The company may have been making losses or there is a sudden drop in profits for the company. However, due to stock-specific or industry-specific factors, the company is expected to revive its fortunes and is expected to be back on track when it generates revenues that brings it back into profitability.
Every company goes through different business cycles and we believe in joining the ride when we are at the trough (lower point of business cycle). Every industry has its own dynamics and, generally speaking, a business cycle spans 7-8 years
Turnaround example 1 : Tata Steel:After touching the peak of around Rs.535 in July 2014, the stock of Tata Steel started its southward journey, and during the second-half of 2015, the stock hit rock bottom of around Rs.200 as the domestic players were reeling under pressure due to cheap imports, especially from China. Also, the subdued global and domestic demand added pain to the metal industry. However, the cycle later reverted as the government introduced minimum import duty on the steel and the Chinese government clamped down on steel plants to curb pollution, which revived the demand and improved the prospects of steel players. From the low of Rs.200 in 2015 to the start of 2018, the stock touched the mark of Rs.700 and at present it is trading around Rs.550.
Turnaround example 2: EIH Ltd :- The hotel industry in India started its downtrend from around 2007-08, and since then, the industry has not achieved the occupancy level seen in 2005-06. During this time frame, the gap between demand and supply widened, and this gap led to deterioration in the performance of the hotel industry. Lately, the hotel industry started to witness an upcycle due to various reasons, such as improving economic activities, increasing domestic and foreign tourist spends, etc. Consequently, the demand started to pick up amid lower room additions, which is likely to lead to healthy average room rates and robust occupancy levels
DSIJ Contrarian Bets Of 2019 |
Companies In Turnaround Phase: Sun Pharma, Aditya Birla Fashion and Retail, United Spirits
Companies trading below fundamental value: Yes Bank, Balkrishna Industries, Escorts, VIP Industries, Tata Steel, JSW Steel, Hindalco, Vedanta
De-rated growth companies: ZEEL, Maruti, Motherson Sumi, Tata Motors, Nilkamal, Indian Metals & Ferro Alloys Ltd, ICICI Bank
2) Value buying: - This is one of the most common practice famously professed by none other than Warren Buffet. In this contrarian strategy, one has to simply identify those companies that are trading below their fundamental value. This is easier said than done, because a large percentage of investors find it difficult to calculate the intrinsic value of the underlying stocks correctly. Even fewer understand the concept of relative valuation. A seasoned investor, however, can use this strategy profitably. During the financial crisis of 2008, Warren Buffet invested a huge amount in Goldman Sachs, thus going against the prevailing market trend. Few years down the line, Warren Buffet was able to easily beat the markets as Goldman Sachs started delivering phenomenal growth after the recovery from the financial crisis. It was as example of value buying which helped Warren Buffet beat the market returns.
3) De-rated companies: - De-rated companies are those companies which, due to their deteriorating fundamentals, the market is not willing to pay the same P/E multiple as it used to. For example, let us say a company ‘XYZ’ was trading at a P/E multiple of 40 in FY18. However, owing to certain changes in the fundamentals, the company is now trading at a P/E multiple of 20. Such de-rating causes the prices to drop sharply. Contrarian investors can always hunt for such opportunities in the market and identify stocks that are de-rated by the markets.
Contrarian investing can involve buying low P/E stocks:-
Yes, contrarian investing is about going against the herd, but it is also about identifying companies that are trading below their fundamental values. Low P/E ratio is often interpreted as value buying opportunity. In a bullish environment, growth stocks tend to outperform, while the value stocks outperform during the bearish environment. However, it is the value stocks that outperform in the longer run.
Contrarian investor should ideally hunt for value stocks which currently the market has not priced in fully. In other words, a strategy of identifying low P/E stocks with higher ROEs and acceptable growth rate in earnings can prove to be extremely profitable.
"It is a rare quality to make good decisions and be correctly contrarian in adversity. Being a contrarian for the sake of being a contrarian is a bad idea."
Contrarian investing strategies also include :-
1. Buying a loser with the hope that the stock will revert to the mean or normal levels.
2. Identifying collaterally damaged stocks where the market or a sector has turned negative, thus dragging the fundamentally sound stocks along with it.
3. Betting on a stock after analysing the reasons for a drastic fall in the price of the stock and taking a call on its outlook after concluding that the reasons for fall in the stock price are temporary and fixable in nature.
Portfolio construction using contrarian investing strategy
Let us assume that an investor has constructed an equal weighted portfolio with investments in technology, energy, banks, cement, real estate and precious metals. Let us suppose, in one year, the market moves up, with the Sensex gaining 10 per cent and the portfolio of stocks delivering following returns :-
The technology stocks go up by 25 per cent, energy stocks go up by 10 per cent, real estate stocks go down by 20 per cent, banking socks inch up by 40 per cent, cement stocks go down by 12 per cent and precious metal stocks slid by 5 per cent.
After one year what the investor finds is that due to euphoria in the banking stocks, the stocks have run ahead of their fundamentals along with the technology stocks. These two sectors look overvalued and are no longer trading at lower or attractive PE value. On the other hand, the cement stocks have been pushed to attractive valuations as the government put curb on prices, thus not allowing the cement companies to encash the rise in demand for cement due to infra projects. Cement stocks have suddenly started looking attractive due to lower valuations even as the growth remains intact for cement producers due to infra projects in the country. However, pessimism persists in prices of cement stocks and most cement producers are trading close to their 52-week lows, while banking stocks are trading at their peak 52-week highs, thus reflecting optimism in the banking sector.
The Best Contrarian Investors of Our Time >>>
Marc Faber
"Follow the course opposite to custom and you will almost always be right."
John Templeton
"The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell"
Sam Zell
"If everyone is going left, look right"
David Dreman
"The success of contrarian strategies requires you at times to go against gut reactions, the prevailing beliefs in the marketplace, and the experts you respect. It’s very hard to go against the crowd. Even if you’ve done it most of your life, it still jolts you. Favoured stocks underperform the market, while out-of-favour companies outperform the market, but the reappraisal often happens slowly, even glacially."
John Neff
"It’s not always easy to do what’s not popular", but that’s where you make your money. Buy stocks that look bad to less careful investors and hang on until their real value is recognised. I’ve never bought a stock unless, in my view, it was on sale. Buy on the cannons and sell on the trumpets!
Benjamin Graham
"An intelligent investor gets satisfaction from the thought that his operations are exactly opposite to those of the crowd. Buy when most people, including experts, are pessimistic, and sell when they are actively optimistic. The best values today are often found in the stocks that were once hot and have since gone cold."
Philip fisher
"Be extra careful when buying into companies and industries that are the current darlings of the financial community."
John Templeton
"Bull markets are born in pessimism, grow on scepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell."
As a contrarian investor the right portfolio strategy to adopt is to reallocate the capital from banking sector to cement sector. By doing so, the contrarian investor is betting against the market sentiment and collective wisdom of the market.
The most important aspect in this process is identifying the overvalued sector stocks and the undervalued stocks in the portfolio. The portfolio rebalancing will take place under such process only after identifying overvalued stocks and undervalued stocks and the capital will flow from overvalued stocks to undervalued stocks.
In a bullish environment, normally portfolio managers and growth investors usually chase performance and that will lead to underperforming sector to severely underperform and the outperforming sector to outperform excessively as more capital chases few outperformers. As a contrarian investor, you just have to find the excesses on both the sides and sit tight on the value buying you have done. It is a difficult process to follow for common investors, but a rewarding one.
Performance of MFs adopting Contra Investing Strategy
Contrarian funds have historically managed to outperform the Sensex over a long period of time. Invesco India Contra Fund (G) has managed to outperform the benchmark over long periods. The fund delivered returns of 19.19 per cent in a 5-year period as against 10.96 per cent for the Sensex. Over a 10-year period, Invesco managed to clock returns of 19.25 per cent as against 12.61 per cent for the Sensex. Kotak India EQ Contra Fund (G) also managed to outperform the Sensex delivering returns of 14.44 per cent and 15.81 per cent over a 5 and 10-year period. SBI Contra Fund Reg- (G) delivered returns of 12.29 per cent and 12.55 per cent over a 5 and 10-year period.
Ritesh Ashar
CSO, KIFS trade Capital PVT LTD
In the current market scenario, if one observes the metal index, we can witness that there is some selling pressure seen on the metal index where CNX Metal has given a negative rally from the level of 3177 towards the level of 2985 and still the weakness can be clearly observed in the index. Currently, if someone wants to contra invest in some stocks or sector, then the metal stocks and metal sector are the perfect bet for that.
The global metal prices are on the rise and, as a result, the metal stocks and the metal sector have taken a hit. On the other hand, the domestic as well as the global market demand are not supporting. The fall which is observed can be capitalised as a buying opportunity and also 'buy on dips' strategy can be applied and such metal stocks like Hindalco, JSW Steel and Tata Steel can be accumulated by long term investors as contra bets.
Metal stocks like Hindalco, JSW Steel and Tata Steel seem to be good buying bets at the current levels as the fundamentals of these stocks are quite strong and accumulation of these stocks would fetch the investors a great return over the long term horizon as these stocks are available at cheaper rates after their fall to the current levels.
Conclusion
To be a contrarian means that when most people are euphoric about a stock, you become cautious for rational and mathematical reasons. Also, when majority investors are afraid due to the downtrend in the market, you as a contrarian investor get optimistic as you see how undervalued the businesses are. Contrarian investing strategy is a particularly useful investing strategy during periods of bubbles and busts due to extreme market over-reaction. Contrarian investing is for those investors who are self-confident as this investment strategy involves taking bets against the market momentum and going against the herd mentality. It is that much more difficult to invest in those companies when everyone else is selling. Another important quality that is required for being a successful contrarian investor is - patience. There is a good chance that the contrarian bet that you make may face increased short term volatility and one must be ready to face failures in the short run. The ability to stomach short term volatility is a must. Being a smart contrarian also requires investor to gradually move money from overvalued sectors to undervalued sectors.
Just as Sachin Tendulkar made straight drives look more graceful and productive by his execution style, it is the manner in which an investor executes the contrarian investment strategy that will impact the end result and how productive the strategy is. There will always be multiple opportunities in any market condition for a contrarian investor. One must simply hone the contrarian investing skills and ensure the investment process is made more robust. Always remember, contrarian strategy may sound simple, but it is not easy!