by SANDEEP TALWAR
Director, Banyan Tree Advisors
December 20, 2011
It takes a contrarian to go against the tide of popular market sentiment and not be influenced by the mob mentality.
Let me let you in on an investing secret: “Buy low, Sell high.”
Now, before you click your way out of here, assuming that I’m just being infuriatingly droll, hold your horses! The truth is that most investors find it extremely difficult to abide by this simple maxim. And I’m not talking here of just the small investor. Even sophisticated, intelligent investors don’t always follow this most elementary bit of investing wisdom.
The reason is that in a market which abounds with different theories about the behaviour of stock prices, investors are seldom sure of what’s high and what’s low. However, there is one strategy that has proven itself to be both rewarding and safe over a long period. This is the maxim of contrarianism.
And what is the nature of this beast? Simply put, it means taking a stance that is diametrically opposed to the prevailing popular belief.
Recently, when a friend was leaving my house in Bandra to catch a late-night train to Vashi, I asked him why he insisted on commuting at such an ungodly hour. “The trains will be empty now,” he said. Now, that’s a good example of contrarian
behaviour. So, if the prospect of travelling alone in a late-night train doesn’t quite give you the heebie-jeebies, read on: you just might discover a contrarian streak in you.
Go against the grain. Contrarianism allows a savvy investor to buy a good stock at throwaway prices because the rest of the market, for reasons best known to it, believes that the stock is not worth the paper it is printed on. (Oops! Isn’t that an
anachronistic usage in today’s dematerialised world?). However, it’s not so easy to follow the contrarian strategy. That’s because the stock pages of the pinkies are chock-a-block with scrips that are hitting new lows everyday. Would buying a
basket of all these stocks be considered intelligent contrarian behaviour? Not quite.
While the ‘new lows’ list is a good starting point for a contrarian who is looking to buy low-priced stocks, it would definitely be unrewarding to buy the entire lot — because many of the stocks are hitting new lows for very good reasons.
For a start, you’ll need to research your contrarian picks thoroughly. There is usually a lot of bad stuff floating around, which, in the perception of the market, stinks. However, somewhere in all this stench lurks the perfect pick for the
contrarian. For, as we all know, the market tends to swing between extremes (remember Mr Market?) — and throws the baby out with the bathwater — when it turns bearish.
Let me illustrate this point with an example. MTNL was, until recently, the monopoly provider of telecom services in Mumbai and Delhi. Now, the popular view is that MTNL, as an inefficient government-run erstwhile monopoly, will find the going extremely tough in the face of competition from private operators. The argument goes that private operators are sure to ring MTNL’s death knell by skimming off the cream of MTNL’s profitable clientele. This view was strengthened during the IPO of Hughes Tele.com. Among the more market-savvy investors, the widely held belief is that PSUs are a four-letter word and should not be touched — not even with a 10-foot barge pole.
I don’t wish to enter into an argument about whether MTNL is a good long term investment, but suffice it to say that MTNL has one big asset: the last-mile access to about 3.5 million customers in Mumbai and Delhi. That is not just big, it is huge in the new convergence economy: ask any analyst who covers New Economy stocks. Add to that new services such as the Internet and cellular telephony and then consider that it is available at a juicy price — in the Rs 120-130 range — and you have a brilliant concoction for a contrarian pick.
Another potential contrarian pick is Telco, an old-economy company that dominates the commercial vehicle market. It supplies products to the transport sector, which drives industry. No one doubts that Telco’s commercial vehicle business is a great business to own. In a good economic environment, it should be easy for this business to report profits of Rs 500-750 crore (the company’s net profits for 1995-96 and 1996-97). The trouble is with the car division, which has
haunted this stock for some time now.
However, at Rs 72 per share, the market capitalisation of the company is merely Rs 1,800 crore. Add to that the outstanding debt of Rs 3,000 crore and Telco is cheap when you consider that the company spent about Rs 2,000 crore to set up the car project and that in a good year, the commercial vehicle divison can earn as much as Rs 750 crore (as it did in 1996-97). It could even be a potential takeover target, given the Tatas’ relatively low stake in the company. (Whether a hostile takeover bid against the Tatas can succeed is, of course, debatable.) The prospect might force the management to hive off the car subsidiary to a joint venture with a car major in order to keep its existing shareholders happy. If the stock falls any further, one would expect an accumulation by the promoters themselves or by value-hunters and potential raiders.
Show me the money! However, spotting a contrarian pick is not enough in itself. A profitable contrarian strategy requires that you have the courage of your convictions and that you put your money where your faith is. Bad news will probably continue to flow in. And those traders who are used to looking at prices on a daily basis and marking their stocks to market on that basis — at least mentally if not with pen and paper (there goes another anachronism!) — will perhaps find their confidence shaken quite a bit. You need oodles of patience to ride the contrarian pick. And lots of conviction to ride out the bad news. If your contrarian pick is as solid as your research says it is, you could be sitting on potential 2-3 baggers. And those are not returns to scoff at.
I think it’s time investors stopped reminiscing and going all mushy about the glorious year that was (that is, 1999) because for the next couple of years it seems like it’ll be extremely difficult to get even 50 per cent annual returns. If you have an investment strategy that systematically yields better returns than that, mail me: I’ll give you some of my money to invest.
Sometimes, when you’re making contrarian picks, you need an inside understanding of a company, its management and its prospects — maybe as an ex-employee or as a customer of the company. And it ‘s best to tread only in areas that are within your circle of competence, so that you are aware of the potential pitfalls in the selection of such a stock. Also, make a list of all the things that could go wrong with the company and the probability of these downsides coming true. Only if the odds are in your favour should you make the purchase.
The contrarian theory works as much for selling as for buying. The legendary investor Warren Buffett asks all investors to be “greedy when others are fearful and fearful when others are greedy”. There is no superior advice for a contrarian.
When your stock flares up to unheard-of valuations (as Wipro did in February 2000, when it rose to Rs 9,600) for reasons that are somewhat wishy-washy (such as “The company is going for an ADR!”), you must take your exit cue.
I read somewhere that in financial markets, where there’s a crowd, you can be sure that there is risk lurking around. So, get far away from the madding crowd. Being a Lone Ranger can be an extremely lucrative proposition, particularly if you’re sure of your footing. It could sometimes even be the safest option. All you need is patience. Because to be a successful investor, you need not only good stock-picking skills, but also great strength of character!