The Hindu Business Line : Contrarian investing

If there is a rebel in you, you just might make a good contrarian investor. Contrarians go against the market crowd in their investment decisions. They buy stocks or sectors that have been neglected or have lost favour with the markets and sell those that are highly fancied. If they are proved right and the market, which represents the thinking of the majority, is proved wrong, the returns can be multi-fold.

Conventional market theories suggest that the market is largely right in assimilating information. Momentum investing means staying on the right side of the market — you ride the wave so long as everyone is buying and jump off when things start souring. This herd mentality is what typically drives the market. But short-termism and sentiment often create exaggerated reactions in the market. There might be too much pessimism about a stock’s prospects or too much optimism surrounding a sector’s outlook.

Contrarians view these swings in asset values as aberrations or as a temporary mis-pricing. They buy or sell depending upon their alternate view on the stock and wait for the rest of the market to catch on.

For instance, following Tata Steel’s announcement of a highly leveraged acquisition of the UK-based Corus last October, the stock languished, falling 20 per cent from its October 2006 peak to Rs 400 levels in March 2007. A contrarian investor would have viewed that low as a good entry point believing that the downside from that level was limited. He would have been right. The stock has doubled since then. Concerns were seen as overdone and with steel prices looking up, the market leader could not be left behind.

Similarly, cement stocks took a beating earlier this year, on the back of Government’s efforts to rein in prices so as to contain inflation. However, contrary to the belief at the time, the ruling did not significantly affect performance of cement companies. It would have taken a good contrarian investor to zoom in on cement stocks during that time.

What would be a contrarian view now? Maybe buying IT stocks on the belief that the rupee concerns have been overdone or buying auto stocks on the expectation that an interest rate cut by the RBI would stimulate demand once again, with low valuations providing a good cushion to downside.

Being Contrarian

But being contrarian is not easy. A contrarian investor’s research, understanding of the industry or company and information would have to be superior to what is normally required for investing in the stock market. You can rarely rely on good, old-fashioned luck. Secondly, you need to be patient with your investment, as it might take a while for your stock or sector to come back in market’s favour.

Timing your investments in these contrarian picks can be a huge challenge. Getting into a sector or stock much before the turnaround might involve significant opportunity costs. You need to pick up such stocks at a time when they are still out of favour but the trigger for a revival in investor interest is near. At the same time, you need to see the trigger much before everybody else does. The window of opportunity to latch on to these picks, therefore, is small.

If you decide to adopt a contrarian approach to investing, rest assured, it won’t be easy. You need to have a lot of conviction in your ideas if you wish to go against the tide. After all, if you were wrong, the whole market would say, “I told you so”. The market is not right all the time, but it is often right. In knowing when it is wrong, lies the challenge.

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