Trading Rule – “At times it pays to be a contrarian”…

What exactly do we mean by a contrarian? As the name suggests, it refers to an investor who has the gumption to go against the trend. It is hard to be a contrarian when you are a trader and trading with strict stop losses. However, for investors a contrarian approach to investing can really work if backed up with deep research. Buying infosys in 1995 or eicher motors in 2009 were highly contrarian calls. But they really paid off!

UNDERSTANDING WHAT THE CONTRARIAN APPROACH IS ALL ABOUT?

To be fair, a contrarian approach is somewhat dependent on the level of the market. When there is carnage in the market, all stocks irrespective of their pedigree correct. However, the beauty of a contrarian approach is that it can work even when the overall market is not in the midst of a bull market. Take the examples of how an Escorts or a TVS Motors performed between 2012 and 2017. The results have been absolutely stunning. While Escorts is up nearly 10 times, TVS Motors is up nearly 15 times during the same period. It would have been impossible to buy these stocks without a contrarian approach, as the tractor and two-wheelers sectors have hardly performed during these five years.

KEY STEPS IN A CONTRARIAN APPROACH?

Most investors today have grown up listening to stories on contrarian investing by Ben Graham and Warren Buffet. Let us be clear that contrarian investing is easier said than done. Firstly, contrarian investment calls for in-depth understanding of the sector, the theme and the stock in particular before taking a view. Secondly, it is very important to understand that for the good idea to translate into stock market returns there is the need for a trigger point. In case of Infosys, it was the Y2K problem while in case of Hero Honda it was the spurt in consumer demand for fuel efficient bikes. Thirdly, contrarian approach calls for self-belief and perseverance. A classic example is that of John Paulson who had started short-selling US sub-prime assets in 2005 but had to wait for over 26 months for his trade to fructify into the greatest trade ever. Any contrarian trade will really test your patience and above all your staying power.

“We simply attempt to be fearful when others are greedy and be greedy when others are fearful in the market” – Warren Buffett

6 SIGNALS TO IDENFITY A POSSIBLE CONTRARIAN BET IN THE MARKET…

  1. Is the company in question suddenly meeting a long-experienced need that has not been articulated? Hero Honda did that when it launched the fuel-efficient bikes in an Indian market that was limited by the cost of fuel. Infosys, Wipro and TCS managed to create an industry-level niche of outsourcing complex software tasks to India. More often than not, a contrarian stock is doing something that is way ahead of its time or the need for the product or service has not yet been articulated. These are the obvious signals of a contrarian stock.
  1. Very importantly, you must look at the management bandwidth. That is where it all begins. Companies like Hero Honda, Infosys, Bharti Airtel, Eicher Motors, TVS Motors all could become great contrarian multi-baggers over time as they had the management bandwidth to translate these opportunities into performance. While an Infosys and Patni Computers started out at the same time, it was Infosys that actually created scale in the IT industry and also became a super multi-bagger. In fact, not many investors gave that stock much of a chance in 1995, but by 1999 the tables were entirely turned. Similarly, Infosys and Satyam were at par for a long time but Satyam fell along the way as it failed to bring the corporate governance standards and the management excellence that Infosys could bring to the table.
  1. Is there are a profit plan in place? That is an important question to ask. Bharti became a multi-bagger between 2002 and 2007 because it could exponentially expand its market without compromising on its profits. In fact, profits went up sharply even as the company was up against tough competition and pricing pressures. The ability to sustain price advantage is the key to a contrarian target.
  1. Is the product proposition easy to replicate? An Infosys, TCS or Hero Honda or Eicher not only built a value proposition but also ensured that it was backed up by other advantages that made it hard to replicate. In case of Hero Honda, it was their unmatched dealer network that gave them all the advantage.
  1. Is the company sticking to its core competency? This is very important when the first four conditions are satisfied. In the last 30 years we have seen scores of companies that were erstwhile leaders in the market but ended up paying the price of too much diversification. For your contrarian idea to work, the company must be getting more focused not less focused on its core advantage.
  1. Finally, check what the institutions and the informed insiders are doing. Companies where institutions are exiting or where promoters are reducing their stake can never be good contrarian cases. With all the fundamentals in place, you want the existing promoter group to be focused on the company. That, by itself, adds a lot of long term value to any contrarian bet.

DEPLOYING A CONTRARIAN APPROACH TO INVESTING…

As mentioned earlier, contrarian approach is easier said than done. The 6 conditions / signals mentioned above are a good way to test if your contrarian bet can actually pay off in the long run. Remember, the key lies in patience. When you go contrarian, you actually bet that the eventual outperformance will be so great that all discussions of time value will become redundant. It is not just enough to buy a contrarian stock. Holding your nerve and keeping your patience intact are a lot more important!

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