Buy stocks ignored by markets but have potential to gain
Would you have invested in Tata Motors in the early part of the last decade, when it was down in the dumps and shunned by everyone? Most likely you wouldn't have; in which case you would have missed out on a phenomenal rally of over 1,300% in its stock price. As equity investors, our tendency is to go with the prevailing market sentiment.
You may not be willing to accept it, but what others feel has a strong influence on your decision taking. If a particular stock or sector catches the fancy ofDalal Street , you may find yourself itching to get in on the action too. This 'herd mentality' is so ingrained in our psyche that, sometimes, it stops us from taking a rational view of the situation.
Ask anyone who bought into the technology euphoria at the turn of the millennium or those who chose to ignore the commodities boom that kick-started in 2002-3. It takes firm conviction and a lot of nerve to swim against the tide and pick (or avoid) stocks that are otherwise ignored (or coveted) by others. But this is the essence of contrarian investing. It is also the theme of an often sidelined category of mutual funds- contra funds. Let us examine whether it is beneficial to be a contrarian.
How does contrarian investing work?
Primarily, a contra fund or investor will invest in out-of-favour stocks that may hold promise not yet discovered by the overall market. Their task is to pick stocks that are wrongly shunned by the larger investor community. These may be companies that have sound operations and potential for a turnaround.Vetri Subramaniam
Contrarians thus place bets according to what is rational rather than what is in vogue. In the current scenario, for instance, it would involve seeing through the widespread pessimism and picking out stocks whose low valuations do not reflect the true business potential and strength.
Contrarian investing need not be limited to a particular market situation; it can be profitably implemented in any circumstance. In most situations, there will be stocks that are trading at unfair valuations. The market would have either overbought some companies or neglected some it believes are not worth the risk. The contrarian investor has to judge where the broader market is missing the true story.
However, contra investing is not easy. An investor should have the ability to tune out the noise and murmurs coming from the marketplace. You should be able to stand firm in your conviction no matter what others are saying. You will also need to think out of the box to identify the opportunities that others may have missed.
You may not be willing to accept it, but what others feel has a strong influence on your decision taking. If a particular stock or sector catches the fancy of
Ask anyone who bought into the technology euphoria at the turn of the millennium or those who chose to ignore the commodities boom that kick-started in 2002-3. It takes firm conviction and a lot of nerve to swim against the tide and pick (or avoid) stocks that are otherwise ignored (or coveted) by others. But this is the essence of contrarian investing. It is also the theme of an often sidelined category of mutual funds- contra funds. Let us examine whether it is beneficial to be a contrarian.
How does contrarian investing work?
Primarily, a contra fund or investor will invest in out-of-favour stocks that may hold promise not yet discovered by the overall market. Their task is to pick stocks that are wrongly shunned by the larger investor community. These may be companies that have sound operations and potential for a turnaround.
Contrarians thus place bets according to what is rational rather than what is in vogue. In the current scenario, for instance, it would involve seeing through the widespread pessimism and picking out stocks whose low valuations do not reflect the true business potential and strength.
Contrarian investing need not be limited to a particular market situation; it can be profitably implemented in any circumstance. In most situations, there will be stocks that are trading at unfair valuations. The market would have either overbought some companies or neglected some it believes are not worth the risk. The contrarian investor has to judge where the broader market is missing the true story.
However, contra investing is not easy. An investor should have the ability to tune out the noise and murmurs coming from the marketplace. You should be able to stand firm in your conviction no matter what others are saying. You will also need to think out of the box to identify the opportunities that others may have missed.
What a contrarian can gain
For a contrarian investor, the payoff can be potentially rewarding. If your bet turns out right, the returns can be very high. This is because you are buying low and could, subsequently, sell high. The contrarian invests in a stock when it has a valuation gap. Gradually, as the market gets wind of the true potential of the company and makes a beeline for it, the stock price will rise.
For instance,Bharti Airtel
Just like most investors move in herds, fund managers tend to mimic each others' portfolios, thus offering little differentiation. Investors may find a way out of this herd mentality with the help of contra funds. This could be the ideal solution for someone willing to take on greater risk.
The problems of being a contrarian
Contrarian investing can be highly risky.Tarun Sisodia
If your call doesn't work out, your money could go down the drain. For instance, airline stocks have been out of the market's radar for a while now and justifiably so. With rising air turbine fuel prices and heightened competition, most players have been piling on losses with no turnaround in sight. In this scenario, it wouldn't make sense to place faith in airline stocks.
Returns can be also very slow to materialise in this strategy. It is not likely to yield quick returns since a turnaround, if any, can take a lot of time. Patience is a virtue required of any investor, but is especially true for the contrarian.
Vetri agrees, "It requires a patient approach because very often one has to tolerate some degree of underperformance from the stock as the market may be slow to reward the change in the fundamentals of the company or the sector." You may have to stay invested in the fund or stock for a reasonably long period (at least 2-3 years). So if you are looking at building wealth fast, this is not the right option for you.
For a contrarian investor, the payoff can be potentially rewarding. If your bet turns out right, the returns can be very high. This is because you are buying low and could, subsequently, sell high. The contrarian invests in a stock when it has a valuation gap. Gradually, as the market gets wind of the true potential of the company and makes a beeline for it, the stock price will rise.
For instance,
Just like most investors move in herds, fund managers tend to mimic each others' portfolios, thus offering little differentiation. Investors may find a way out of this herd mentality with the help of contra funds. This could be the ideal solution for someone willing to take on greater risk.
The problems of being a contrarian
Contrarian investing can be highly risky.
If your call doesn't work out, your money could go down the drain. For instance, airline stocks have been out of the market's radar for a while now and justifiably so. With rising air turbine fuel prices and heightened competition, most players have been piling on losses with no turnaround in sight. In this scenario, it wouldn't make sense to place faith in airline stocks.
Returns can be also very slow to materialise in this strategy. It is not likely to yield quick returns since a turnaround, if any, can take a lot of time. Patience is a virtue required of any investor, but is especially true for the contrarian.
Vetri agrees, "It requires a patient approach because very often one has to tolerate some degree of underperformance from the stock as the market may be slow to reward the change in the fundamentals of the company or the sector." You may have to stay invested in the fund or stock for a reasonably long period (at least 2-3 years). So if you are looking at building wealth fast, this is not the right option for you.
Performance of contra funds
People who invest in contra funds believe that as they are paying fund managers to take risks and bet against the market, this is exactly what they are getting. Unfortunately, this may not be the case. Some of the contra funds available today are contrarian only in name. They are not pure contra funds because they hold stocks that can be found in any ordinary equity fund's portfolio, making them no different from the rest.
If you are considering investing in a contra fund rather than doing it on your own, check how these funds have fared. SBI Magnum Contra, the first of its kind to be launched in the country, has delivered stellar returns (21.76% compounded annual growth rate) since its inception in 1997. However, it has witnessed a slide in performance of late.
Tata Contra has performed exceptionally over the past one year (16.4%), while Religare Contra has emerged the top performer over the 3-year period (13.5% CAGR). On the whole, however, contra funds haven't fared well as compared to multi-cap equity funds. In the past year, for instance, contra funds have averaged 5% returns while the broader category has yielded 8%. Over three years, where multi-cap schemes have delivered a CAGR of 7.38%, contra funds have only averaged 6.44%.
Consider these bets
If you are willing to take a higher risk and want to take some contra bets, here are some of them. Though the market, as a whole, is experiencing weakness currently, there are specific themes that are less favoured by investors.
Another sector that has witnessed a fall in share prices is sugar. The surplus in domestic sugarcane production has limited the pricing power of sugar manufacturers. However, this domestic sugar balance is tighter than what the market believes, which could provide a support for sugar prices, says Morgan Stanley Research, whose preferred stock pick in this industry is Shree Renuka Sugars.
According to Morgan Stanley Research, consumer discretionary stocks, such as automobile and retail also seem to be bottoming out as the interest rate cycle reaches its peak. Its India Strategy report mentions: "Consumer discretionary stocks tend to trough with peaking rates. The RBI has taken us closer to the end of the rate cycle".
Sisodia believes that cement demand could pick up as construction activity improves in the future. Grasim Industries and ACC are his top picks in this sector. He is also positive on the prospects of the capital goods segment where he expects a recovery aided by a jump in the industrial capex.
Sisodia also believes that real estate stocks, which have been hammered by the markets largely due to corporate governance issues, could provide some specific opportunities where governance is not a problem. Godrej Properties is his pick in this category.
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