Vikas Singhania
If you are willing to stand up against the crowd and face constant criticism and ridicule, you are probably tuned in to be a contrarian investor. Contrarian trading is generally compared to standing in front of a running train. However, some of the most successful investor’s have just done that and lived to tell the tale. Among the various style of investing, contrarian is perhaps that one that requires a cool head and a strong conviction. Because when the world is going in one direction the investor is probably the only one walking the other way.
This style of investing goes against the prevailing market as it entails investing in companies that are beaten down and only bad news is all one can hear. Similarly contrarian investing requires selling a stock when there is only a stream of good news appearing in the market and everyone is rushing to buy the stock.
A contrarian investor searches through the list of stocks looks for companies that have not participated in the rally. They look for companies which are beaten down, but have enough inherent strength to rise back strongly when tides change.
Let’s take the case of oil in the month of February 2016. Oil prices were slipping uncontrollably, with analysts lower their guidance at a faster pace than the actual fall. Analysts were reported in January 2016 as saying that oil prices would go below the $20 mark. News report pointed out the complete chaos low prices was creating in oil producing countries, especially the ones in middle-east. Striking workers, abandoned houses, workers being sent to their home countries were flashed across all television channels.
This was the time when smart investors bought oil. The reasoning was simple, oil production, especially in the USA was not feasible below the $40 mark. Since oil in the US is produced by private companies unlike governments who have control on oil assets in the middle-east, it was not possible for US companies to pile on losses for a long time. They would have to shut down production unless supply demand matches. And that is exactly what happened when oil prices rebounded with a vengeance catching most short sellers on the wrong foot. All it needed was a cool head to think through the dynamics of oil market to take the contrarian trade when even the most reputed and high paid analysts were crying from the roof tops that oil market all but dead.
There are several similar examples in the Indian context too. Take the case of public sector banks. There is no dearth of bad news for the sector. Banks’ loan books are full of borrowers who are no longer in a position to repay their loans. News reports frequently flashed headlines that banks are likely to be crushed under their own weight. Yet the contrarian investor saw through the whole news as banks with very high intrinsic value were available at mouth-watering valuations. Public sector banks are backed by government guarantee. Under no circumstance will the government allow these banks to go under. Public sector banks have given a decent return over the last one year and are still in the lower range of their valuation band.
Another example is of the sugar sector. India is one of the largest producer and consumer of sugar in the world. Many sugar mills in India were making losses. There were hardly any analysts who were covering any stocks. Yet in less than a year most sugar companies rose by an average of 10 times in value. Sugar is a political soft spot in the country. Many politicians destiny is linked to sugar prices. There was no way government was going to allow sugar companies to go under, nor was it going to let sugar prices rise in the market. A contrarian would have seen through the importance of sugar in the Indian political and day-to-day life of its population. A series of government action and poor rains helped the sector post a record rally in the market.
Contrarian investing per se is easy. But the hard part is the noise around you. Also, it would take some time for a contrarian investor’s bet to work out. A contrarian investor is best tested during the bull phase of the market. Bull markets reach their peak when valuations are the last thing that investors look at. Since the time market history has been recorded euphoria has seen valuation reach absurd level. During the Tulip mania, price of a Tulip bulb was more than that of a house. During the 2000 internet bubble, companies without any revenue were trading at much higher valuations than those with a solid business model. In 2007 analysts were using 10 year forward numbers to justify valuations of power companies. All a contrarian does is uses his clear head to see through the noise and exits his position only to re-enter when prices will be depressed.
Contrarian investing has a lot to do with behavioural finance than with investing. Humans for thousands of years have made decisions on a collective basis. Hunting for animals was a collective affair for thousands of years. Standing against the crowd when a lion is approaching was the shortest way to death. It was always better to run with the herd rather than stand apart from the crowd and be an easy meal for the wild cat. Same tendency has continued to this day.
Contrarian investors faces the fact of being called a loner or an anti-social, but at the end of the day in the game of investing all that matters is who walks home with the money. Contrarian approach is hard for both individual and professional investors, which is why the rewards are high. As legendary investor and perhaps the best example of contrarian investing Warren Buffett said be fearful when others are greedy and greedy when others are fearful. The fact that there are few rich investors who follow the adage exemplifies how difficult controlling the mind is, even if it is an intelligent one.
The writer is Executive Director of Trade Smart Online.
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