Contrarian strategy: Investing the Calvin and Hobbes way
Contrarian investors look for fundamentally strong companies that have been under performing
by Teena Jain/FE Investor
In the popular comic strip Calvin and Hobbes by Bill Watterson, Calvin looks at Hobbes as someone who is alive and all other characters look at the tiger as a stuffed doll. Bill Watterson once clarified that Hobbes is more about the subjective nature of reality than dolls coming to life.
In a similar way, contrarian investment is about the subjective analysis of investors who have a different opinion of reality.
Today, when the Sensex is hovering around 10K the risk level of the market is higher than a year back and one could no longer move ahead with herd mentality. It is the right time to look for good and fundamentally strong companies that have been under performing for quite sometime. This is what contrarian looks for and sometimes hit the gold mine doing this.
Human minds are not perfectly rational. Investors move in a herd and tend to buy at tops and sell at bottoms. Bucking this trend, contrarians invest in fundamentally strong companies that have not performed as they have been missed by the herd due to variety of reasons.
The reason could be a shadowy outlook for the sector, less-than-optimistic earnings and temporary loss in market share or fall in earnings.
Contrarian investing is a variation of value investing. "Contrarian and value investing are two different but overlapping terms. All contra stocks do not fall under value investing and all value investing stocks do not fall under contra circle," said Tridib Pathak, chief investment officer, Chola Mutual Fund.
Contra investing involves buying out-of-favour stocks of good companies that are undervalued by market. Currently there are three contra funds - SBI, Tata, Kotak - in the market while two are open for subscription.
Does contrarian strategy pay?
It is often said that contrarian strategy works in the bear market, however the fact is that there are always few stocks in the market that are under performed.
The only need is to pick up the right stocks. "Contra fund is ideal for diversification of investor portfolios which are focused predominantly on conventional value and growth stocks.
They could be a hedging opportunity as movement of contra stocks is often not correlated with that of others," says an analyst from Tata Mutual Fund.
Even in high P/E stocks there can be short-term contra opportunities when some situations are blown out of proportion and the price outlook gets depressed for purely non-fundamental reasons. It could be earnings disappointment in one quarter like in Infosys or family dispute in a large business conglomerate like Reliance.
Chances are high for contrarians when short-term negatives become too much highlighted to overshadow long-term fundamentals.
For example, Ranbaxy stock saw a major fall ahead of the Q2FY06 results announcement after the UK High Court dismissed its legal challenge against the protection of Pfizer's patent of Lipitor. From Rs 489.15 on October 11, 2005, the stock plunged 17.7% in just 6 trading sessions to Rs 402.10 on October 20, 2005.
As a matter of fact, a huge portion of the world's economy is run by irrational behaviour. This mentality often puts them at an extreme position where stocks trade at a much higher value or at a much lower value than their intrinsic value. It is the latter pattern which contrarians eye on.
One such example was of Indian Hotels, whose stock rolled down after 9/11 tragedy because there was a change in pattern by the investors towards tourism industry. Nothing was wrong with the fundamentals of the company, only the pattern made by the investor went for a toss.
Investment strategy
In the broad market, mid-cap stocks sharply outperformed large-caps between April 2003 and October 2004 and that was a contrarian opportunity to invest in large-caps.
With large-caps running ahead of mid-caps in the recent past, there can soon be a contrarian opportunity to invest in mid-caps. During last calendar year, out of BSE 200 scrips 122 were under performed and around 40 gave negative returns.
While looking for opportunities among sectors, performance of health care and metal sector was not on par with the Sensex with returns of only 2% during calendar year 2005. Within the steel sector, share prices of most steel companies have been a cause for concern.
In the last calendar year the Sensex moved up by almost 40% whereas the BSE Metal index has gone up merely by 2.3%. The share price of Tata Steel and Sail had given negative returns of 1.2% and 13.3% in last calendar year.
Considering the slump in international demand and build-up of inventory, for the quarter ended December 2005, sales turnover profits of Tata Steel and Sail fell down drastically. Tata Steel posted a net profit of Rs 753.74 crore for Q3 December 2005, a fall of 15.3% whereas Sail's net profit came down by almost 54.78% at Rs 684.59 crore.
With infrastructure and consumerism taking top spots and domestic growth being the major parameter for growth, for many analysts, software has taken a backseat. Yet the third quarter results for the top and the middle level companies in this industry show that there is room for growth especially for companies that are operating in the banking financial services and insurance (BFSI) domain.
For the quarter ended December 31, 2005, the consolidated revenues and profits for Mphasis BFL moved up by 26% and 52% to touch Rs 242 crore and Rs 40.84 crore.
During the last calendar year PSU sector gave the return of 21.67%. There are 240 PSUs out of which only eight falls under the navratna category, eighty-eight are in red and the rest are making profits. The government has identified profit-making non-navratna companies for divesting its minority stakes.
On the back of rising crude price and mounting subsidy losses, the oil marketing companies (OMC) HPCL and BPCL, posted loss of 556% and 800%, respectively, during the third quarter. HPCL and BPCL, during the last calendar year, gave negative returns of 18% and 6%, respectively. The improvement in operating profits of the company is anticipated only with the change in retail prices. Some of the PSUs that are under performed against the Sensex but have sound fundamentals are Shipping Corporation of India, LIC Housing Finance, Andhra Bank, Dena Bank, Bank of Baroda, IDBI and MTNL.
Contra investing appeals to investors who are wary of the rapid rise of equity market in recent times. Contrarian stocks are available at relatively moderate valuations even when the index touches new peaks; hence the downside risk is relatively controlled. The one important aspect of contra investing is to consider the time factor. Investors should be aware why the profit margins of the company are under pressure and what could really trigger off the company profits.
A similar contrarian is available with PNB Gilts. Check out my post on the same -
http://small2big.blogspot.com/2006/02/pnb-gilts.html
I had one more question - how do you manage to get the #1 ranking in the google search for value investing india. Pl share the secret. Mine is not visible anywhere. :-)
Warm regards,
Shankar
small2big.blogspot.com
Posted by
Shankar Nath |
6:31 PM
Hi
is it no. 1 in google search?? I frankly dont know how did that happen. any more queries plz email me at toughiee@gmail.com
Posted by
toughiee |
7:16 PM