Contrarian Investing

Contrarian investing means that you buy a share when nothing seems to be going right and everyone else is selling and hammering the price down. It defies most common investment reasoning - who wants to hold on to a share that not many are willing to buy? Why should I buy shares of a company that is doing badly? This is a short term perspective - a large majority of those who try the stock markets are traders, and invest for the short term. Most others are medium term investors, whose plans are for a great rise over three to six months. The contrarian strategy has worked for me once, and I'm trying it again:

1. Reliance:
This will probably go down in history as one of the biggest opportunities of them all, which a lot of people missed. The market was moving upwards, with Reliance, one of the heavyweights, being battered down after rumours of the split. The media war lasted well over six months, and in that time, while the market neared 7000, Reliance tanked down to a lowly 480-530 range. In fact, with the rest of the market doing so well, had Reliance kept pace, the market would have been at 9000 then – Reliance’s recovery to the 850+ levels has pushed the market up beyond 9000. Everyone was following the news about the split, and the share price was extremely volatile, but still within a Rs.30 range on a day-to-day basis.

I took the risk of purchasing the stock just before the market factored in the news of a board meeting called by Mukesh Ambani to consider a share buyback in early December. Businesswise, to me, Reliance seemed fairly safe – they have always been in the business of making money, and the share was still operating on a low PE (Share Price/Earnings per share) of around 11, as opposed to a market PE of around 18. It could only rise from there, and there were no management problems- only the question of uncertainty of leadership. In any case, if one looked at it from a three year perspective, things could only improve. So, I bought at Rs. 480, and a year on, at this very minute, it is at Rs. 857 – that’s an increase of 78.54% but I’m not selling. More on selling later in this post.

2. Ranbaxy
has been battered down by terrible news of losing two patent cases in the recent past. Everyone (I’ve read a few reports) is advocating a sell, and the share price has been battered down from around Rs.650 to Rs.360 – a fall of around 45%, 32% since October. This is primarily because earnings estimates, which had been factored into the price earlier, have now been lowered. The estimated PE for 2005 is as high as 54, which is crazy, but this has been a bad year. Given Ranbaxy’s management, and the impact of possible successes in patent cases, expected PE’s will lower over the next few years. Ranbaxy has 43 drugs pending approval in the US, and expects to file 15-17 ANDAs next year. It’s a major risk, perhaps a bigger one than Reliance was, but if you don’t dare big, you won’t win big. Day trading is much riskier, and requires a lot more work. At 360, Ranbaxy has a PE of 54. If the PE goes down to 25, that'll mean an improvement by around 55%- a similar increase in Ranbaxy’s price will see it at Rs.550. It’s risky, however, to predict a bottom for this stock – I’ll be picking up stocks as it moves downwards.

Hit and trial method of buying IPO’s
My dad did this fifteen years ago, when he started investing – he would put in 3-4k into some select IPO’s and just forget about those shares. For all the companies that went bust, a few survived and did extremely well, and have more than paid off for all those that failed. I’m not sure if this is advisable now, though – IPO’s are aggressively priced in bull markets. If Maruti were to launch an IPO today, they would probably price it at Rs. 430- Rs. 440, instead of the measly Rs.120 when the market was at around 3500 levels. And again, you'll have to wait for a long time for such returns.

On selling shares
The New Buffetology by Mary Buffett states an interesting analogy – if you buy a drugstore and it makes good money – would you sell it when things improve by, say 20% or 30%? It’s the same with shares – you’re buying part ownership into the company, and if it the business grows and earnings improve, even if it doesn’t give a dividend, why not just stay invested? In fact, if it doesn’t give a dividend and earnings are retained for investment – that makes it even better since your earnings are being compounded. Short term is more risky and takes a lot of work to keep tabs on consistently. We made the mistake of selling stake in a company that my dad bought into 12 years ago. We sold it a couple of years ago, albeit at around 175 times the cost.

It has more than doubled since, and we feel that we should have stayed invested. If a company is good, there is no sense in selling your stake, unless you need the money. Nestle, for example, was around Rs. 300 four years ago. It’s now at around Rs.930. Markets are quick to factor in news, and slow to factor in the valuation; not many people make a call based on cash flow predictions. However, markets do factor in business growth into the share price, even if the company doesn't give a dividend - Microsoft and have never given a dividend.

A caveat applies to all that I’ve said – investing in stocks markets is fraught with risk and you should make your own decisions based on your understanding, and perhaps your brokers advice. I’m not responsible if you take the risks that I am, based on what I’ve stated here. Oh, and I’ve no degrees in finance, so just about everything I've said is a laypersons opinion…
Blogger Sfx said...

Interesting qns first up in that post ...there's this terrific series of books on trading in markets by Jack Schwagger ...

"The call of the countertrend"

There's a constellation of cognitive and emotional factors that make people automatically countertrend in their approach. People want to buy cheap and sell dear; this by itself makes them countertrend. But the notion of cheapness and dearness must be anchored to something. People tend to view the prices they're used to as normal and prices removed from these levels as aberrant. This perspective leads people to trade counter to an emerging trend on the assumption that prices will eventually return to "normal". Therein lies the path to disaster.
- From the William Eckhardt interview in the New Market Wizards

December 20, 2005 10:13 AM  
Blogger Nikhil Pahwa said...

Thanks for the Jack Schwagger reference - will look that up.

As bad news (in the Reliance case - not related to the operations of the company) beats the share price down, without really affecting the performance of the company, it uncovers value. As such, it isn't anchored on previous prices, rather - on projected earnings and the value resulting out of an attractive price.

News has a shorter lifespan than value. :-)

December 20, 2005 10:36 AM  
Blogger Sfx said...

I'm in the business of trading - but currency and not equities .. and altho admittedly they are somewhat different in their character - am strongly of the view, that the only news that affects prices (from the point of view of investors and not traders) is genuine , hardcore and nitty gritty fundamentals of the company and not the weekly / quarterly news releases, gossip, etc... Its something that no one probably understands better than Warren Buffet. That said, he's an equity guru and these past couple of years has tried his hand at currency markets with a view on the US economy - with very little luck and decently significant losses... Its alarmed the trading community a little but its too early to judge - because nobody knows his time frame....


December 20, 2005 10:46 AM  
Blogger Nikhil Pahwa said...

Well, the Indian equity market is an unpredictable beast. I wanted some info on steel co's today, with a three year period in mind, and my broker couldn't advise. It's trading at a surprisingly low PE of 3 to 5, but that is on last years earnings. So obviously, something has hit steel hard this year. My broker, though, said "I can only advise you on trading, not investing."

The equity markets here move largely on news and rumours, though only in the short term. Day traders, in particular, take great risks blindly. One analyst voices a viewpoint on TV, and the stock starts moving. A majority of the mutual funds look to create and ride waves, and movements are based on how foreign markets are doing and news, while retail investors are usually left scratching their heads.

Both the cases that I have mentioned, particularly that of Reliance, are news based. Even in case of Ranbaxy, Deutsche Bank has downgraded it and lowered PE forecasts, but have stated that they would rerate if Ranbaxy's wins any patent battles. I'm taking a risk, knowing that if Ranbaxy wins even one case, it'll result in a revaluation of the stock.

I've no clue about currency markets, or even derivatives. Didn't know that Warren Buffett was playing the currency game. Should be interesting - will look it up.

December 20, 2005 11:49 AM  
Blogger Sfx said...

Good luck with trying to find out about the Sage - you'll find most of it in the accounts and just for his curency bets, they're worth a look-see.
As of the end of last year , he had a US $ 21.4 bln bet AGAINST the US Dollar - basically on concerns about the economy etc. Most of them being the USD agst the Euro, Yen , Sterling , Swiss, Canadian and the Aussie. A total of 12 currencies tho.
Booked a profit of USD 1.63 bln on them as of last year but has spent the three quarters so far this year getting hammered with losses ranging from USD 300 to 700 mio each quarter. The year end bit shud see more losses just given the way the currencies have behaved over the last quarter or so - however, the goss is that he's trimmed down his bets to a large extent.

December 21, 2005 8:12 AM  

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