CONTRARIAN INVESTING

Contrarian investing pays if you are a patient investor. We have numerous examples of how stocks which are out of favour with investors, but are fundamentally sound, have given handsome returns once the reasons behind their underperformance ease off.

Consider capital goods stocks in 2003. Stocks like BEML, BHEL, L&T and many others were available at a fraction of today’s prices. Investors’ who had the foresight and vision to invest in such stocks at that point would be having 15, 20 or even 100 baggers on their hands. The logic behind investing in such companies would have been that they were high quality companies backed by good managements and having solid assets on their books. They had pedigree, market standing and years of experience. It was simply a case for investing and simply waiting for the investment cycle to turn around.

And what did investors do? I know people who got tired of holding on to such stocks and sold off only to see markets reviving and stocks reaching the stratosphere. My argument is that for earning the highest returns, an investor needs to identify stocks which have been hammered to their lows, analyzing whether such low valuations are justified given the history, management quality, nature of the business, quality of assets, size of the business and future prospects. Then if the investor is convinced that the business is not going to disappear any time soon and simply awaits a change in the business cycle to see better days, go ahead and invest in it. Market volatility may yet take the stock price lower, but one should have conviction that the buy is backed by solid reasoning and not panic. Rather the fall could be used to buy more.

All evidence points to the fact that the world’s best and richest investors like Warren Buffet, Charlie Munger, Mohnish Pabrai, Rakesh Jhunjhunwala etc. have this philosophy at the core of their investment strategy. Each may his own variations on stock selection and valuation matrices, but the core strategy remains buy low and sell high. Contrarian investing is the only way you can follow this strategy. This strategy need not be applied only to a particular industry or stock, but to asset classes or markets as a whole. As described in a previous post, right now income and Gilt funds seem to be logical examples of contra investment as applied to debt investments.