What is Contrarian Investing?
In the first place, let’s try to understand the meaning of Contrarian investing.
Is it Investing against the trend of the market or a stock?
Is it investing when the cycle is at the bottom for a particular industry/stock?
Or is it investing against the herd when there is a sudden collapse in stock price based on an event or a piece of news?
If so, how do you identify the same and take advantage of such opportunities?
In my experience, it can be either or a combination of these. As easy as it looks to hear, contrarian investing in ‘Indian markets’ is the toughest to do.
Not alone are you betting on a sector which is fundamentally weak with ‘consistent’ negative news flow on Industry structure, negative credit rating reports along with both global and local headwinds but the expectation of a turnaround can take months and in many cases years as well.
Hence the opportunity cost in terms of other winning bets along with FOMO in the market can make your investment decision and thought process swing to momentum.
Contrarian Investing can be done for about 20-25% of your portfolio weightage as these are the opportunities that might take a long time or might not work due to the changing circumstances.
This should be done only if the conviction on a stock or an industry is high. Fundamental news like quarterly earnings, macro trends for the industry, promoter buying at lower levels, revoke of pledge needs to be tracked closely.
It is important that management walks the talk rather than it just becoming a hope story.
Infact, Howard Marks famously said:
“We have to practice defensive investing, since many of the outcomes are likely to go against us. It’s more important to ensure survival under negative outcomes than it is to guarantee maximum returns under favorable ones.”-Howard Marks
Contrarian Investing Examples
Let me explain with few examples on all 3 scenarios in 3 different time frames:
First, is as recent during Covid period was Indigo, India’s largest passenger airlines with a market share of 55%.
A debt-free company as the model it works is the sale and leaseback and hence it has limited borrowings. It is a cash-rich company and only profitable airline company in India with 1500 daily flights to 70+ locations.
As Covid hit, the stock collapsed from 1600 to 800 in no time as fear hit a peak that people would not opt for travel for a year or two.
Negative news kept hitting the stock where DGCA had also ordered IndiGo to replace all Pratt & Whitney (P&W) engines for its twin-engine Airbus A320neo with new P&W power units and industry was downgraded as well when Warren Buffett sold his entire stake worth $4 bn in US Airline Industry.
This is exactly a contra opportunity when it was available at sub-30k Cr with an FY20 revenue of 35k Cr.
The question then arises what if the price would have gone to hit sub 500 as was predicted by many analyst reports.
This is where conviction and past experience of such contra bets come into play along with a margin of safety as that would determine the risk-reward scenario.
Potentially in such cases the Risk-Reward should be 1:3.
The stock is now back to 52-week high and is inching towards life highs.
Secondly, I would like to emphasize on how much time contra bets can take time to the turnaround.
I had bet on Tata Motors around Oct 2018 at an average price of Rs 200 (when it came down during a bad cycle from Rs 350 in a matter of months).
My bet was that JLR pain won’t last long, there will be a pick-up in automobile sales – both in India, China, and the UK on the back of ample liquidity with interest rates coming down as well as Management would start serious action on debt reduction.
Even though the margin of safety was quite visible when I had purchased, the market kept on punishing the stock and during the Covid period the stock went on to hit Rs 65 in March.!
At this point, the stock was available at 20,000 CRS Mcap (Consol EV of under 1 lac crore) which was extremely cheap for a brand like Tata motors doing a revenue of 3 lac crore annually.
Now for anyone to imagine, the stock would bounce back quickly given the circumstances with the fact that you start getting self-doubts about the thesis is something Contrarian investing will teach you to face.
The stock since then has went up from Rs. 65 to Rs. 200 per share.
Thirdly, I would like to emphasize on a failed bet where opportunity became a hope story.
It was Suzlon.
When I took this bet in 2011 with expectations of the future being wind energy with a strong order book, my concerns on company paying 400-450 crs a quarter of interest were mitigated by pick up in orders for the US & Europe.
Also during that period, we had a 10-year tax holiday period along with accelerated depreciation for wind power projects.
The production capacity of 2500-3000 MW a year was an ambitious target set by the company.
But things continued to slop down for them as relentless production and overcapacity by China, withdrawal of tax holiday period, and confusion on Generation based incentive (GBI) along with an increase in debt kept the business on the hook.
Subsequent defaults on FCCB loan sealed its fate.!
Another important aspect one has to remember is that, even if you get the timing right, unforeseen events can deter turnaround as all 3 factors have to play right – “economy related news”, “market events” and “stock driven business news”.
Some call it patterns. Some as cycles.
Howard marks in his book – Mastering the Market cycle has explained beautifully the cycles on Credit, distressed debt, real estate, cycle in profits, cycle positioning, market cycle etc.
We have the likes of Shyam Sekhar and Jatin Parmar who have been early betters on Industry-specific cycles.
Watch: Good Investing is Inherently Contrarian by Howard Marks
To conclude, the following aspects can help you assess the Investment bet you wish to make –
- Whether past patterns are repeating in the industry/stock
- Is it a news-driven event or a structural change? If news-driven, does the stock provide enough margin of safety? If it’s a regulatory driven event, does it impact the growth of the company?
- Does the behavior from analysts, news channels, investors suggest there is extreme fear?
- Is there a fundamental change to the business.? If yes, Is the company the market leader? If yes, will the company be able to find new avenues for growth – both vertically and horizontally.?
- Avoid on to bets where there are corporate governance issues repeatedly.
After all Contrarian investing is all about investor psychology.
As Howard Marks said:
In business, financial and market cycles, most excesses on the upside and the inevitable reactions to the downside, which also tend to overshoot are the results of exaggerated swings of the pendulum of psychology.
Thus understanding and being alert to excessive swings is an entry-level requirement for avoiding harm from cyclical extremes, and hopefully for profiting from them.
Cover Image: ET