Thursday April 26, 09:00 AM
Investing: A contrarian at work |
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By Equitymaster.com
It is widely believed that the high probability methods of beating the markets over the long-term is by knowing what the markets don't and by looking at where the markets are not looking currently. While the former method might require a lot of resources at one's disposal, the latter can be practiced successfully if one has patience and an adequate level of skill set. After all, investing is one of the few disciplines where a guy with an IQ of 100 can beat the guy with an IQ of 140, provided the former has patience and discipline by the truckloads.
Carrying the 'looking at where the markets are not looking currently' theme further, this method usually requires a contrarian approach to investing. In other words, it involvs buying stocks that the markets are shunning currently. However, we do not advocate being a contrarian for the sake of being a contrarian and believe that it has to be backed up with thorough research. The advantage that this method has is that it tries to take advantage of the psychological tendencies of majority of the investors of following the latest fad and not looking at beaten down stocks. Furthermore, while a most favoured stock might take a severe beating if expectations are not met, chances of similar decline with a beaten down stock is less as investors have already become negative with the company and hence, they will not react with as much recklessness as they would with a favoured stock.
Let us have a look at two places where one can come across such stocks:
52 week lows: While a lot of us take a look at stocks that have touched new highs everyday, seldom our attention is drawn towards stocks that have hit a 52 week low. Ironically, this is the place where if properly looked into, gains of much larger magnitude can be unearthed. Often, this list contains companies that have experienced some temporary problems, which once fixed can send the stock soaring again to new highs. If caught early, investor stands to gain not only from its journey back to its original price but if the company is fundamentally sound, then gains from growth in earnings is also in the offing. Thus, while downside can be limited, it provides a chance of strong returns on the upside. However, it is extremely critical to identify whether the problems are temporary or are long-term in nature. The list below shows the five stocks from the 'BSE A' group that have lost the most in the last one year.
| Company |
Price in
April 07 (Rs) |
Price in
April 06 (Rs) |
%
Change |
52-Week
H/L (Rs) |
| TVS Motor |
61 |
161 |
-62.1% |
173 / 53 |
| Arvind Mills (ARMI.BO, news) |
45 |
102 |
-55.9% |
103 / 42 |
| Engineers India |
474 |
811 |
-41.6% |
840 / 392 |
| Visual Soft |
74 |
124 |
-40.3% |
127 / 58 |
| Nirma |
164 |
269 |
-38.9% |
300 / 145 |
Trading below index P/E: This strategy can be used to unearth index heavyweights. As the name suggests, this method involves looking at stocks that are trading below the benchmark index's P/E multiple based on TTM earnings. As is known, the P/E multiple of say 'Nifty' is based on the mean multiple of all the index constituents and hence there are certain stocks that for some reason are at the lower end of the average. If further research on these stocks reveals that the problems with them are just temporary, then these heavyweights can also turn out to be attractive investment candidates from a long-term perspective, without the associated risk of having to lose too much if the rebound does not turn out to be along expected lines. The table below lists out five heavyweights that are currently trading at below market P/E multiples. Though the P/E multiple may not be a correct valuation tool for some of these stocks, it nevertheless can be used to good effect in the case of most of the companies.
| Company |
P/E multiple* |
| HPCL |
2.9 |
| STERLITE IND |
6.4 |
| NALCO |
6.8 |
| HINDALCO (HALC.BO, news) |
7.0 |
| IPCL |
7.4 |
| Nifty avg |
19.4 |
While these methods do not guarantee success, they can be important guides in zeroing in on stocks at current market levels, where it is difficult to come across a good stock available at reasonable valuations. After all, the problems associated with the company whose stock has been beaten down might be just temporary and it could throw open a very good opportunity to take a long-term position at attractive valuation levels. Further, if the nature of the problem is correctly identified, then the downside risk is also very limited or in other words, there is an adequate 'margin of safety' involved.
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