Contrarian thinking helps while investing in Stocks

Contrarian investing is a proven way of finding multi-baggers and generating great wealth in the long run. Simply put, a contrarian investment strategy involves buying stocks which have fallen out of favour with the market for some reason or the other. It could be that the market is taking an exaggerated view of the ills plaguing a stock or even the industry it belongs to, or that the markets are focussing on the short-term negatives while ignoring the longer term fundamentals.

The essence of this style of investing is to buy good quality shares at bargain prices, the prerequisite being, the stocks under consideration must be sound and stable large-cap companies backed by solid fundamentals and having a good past history of adding shareholder value.

Consider capital goods stocks in 2003. Stocks such as 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 10, 15 or 20 baggers on their hands. It’s not as if these companies were available at depressed valuations for a small period of time. In fact, they quoted at bargain prices for quite a length of time and presented ample opportunities for investors to enter these stocks. 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 decades of experience. It was simply a case for investing and patiently waiting for the investment cycle to turn around.

Many investors not only missed the bus, but also sold off some of the shares held in their portfolios for long periods of time.

My argument is that for earning the highest returns, an investor needs to identify stocks which have been hammered to their lows, and analyse whether such low valuations are justified given the history, management quality, nature of business, quality of assets, size of business and future prospects, etc. 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, he needs to 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 fundamentals. Panic should not creep in at this point; rather, the fall should be used to buy more of the stock.

Generally speaking, the same analogy could be applied to the entire stock market or any other asset class. For instance, an investor could have taken a contrarian call on the Indian markets in 2002 and bought stocks, seen them go down further until 2003 and then increase by more than 500% in subsequent years. The gains made would have more than compensated for the initial notional decrease in values.

The writer is proprietor of Capital Management Services. He blogs at www.investologic.blogspot.com and can be reached at mknaik99@rediffmail.com.