The Art and Science of Contrarian Intrinsic Value Investing

The Art and Science of Contrarian Intrinsic Value Investing

Contrarian value investors have to yin when others yang. But the key is to buy quality at value prices, not junk at clearance prices, said Rupal Bhansali, Chief Investment Officer of Global Equities and Portfolio Manager at Ariel Investments.

Low-quality businesses will compound your problems, not your returns, the longer you hold them, she said at the CFA Institute’s annual conference in Montreal on Monday.

But contrarian investing is hard to do; humans are not wired to invest this way because it requires the path of most resistance. 

“When you’re marching to your own tune, no one but you can hear that music,” Bhansali said. She tells her clients that they will look foolish, but there’s a difference between looking foolish and being foolish.

The ridicule comes first, and you’re guilty until proven innocent. For example, in 2006 Ariel sold down its bank stocks, and the manager looked foolish for doing so. Then in 2008, these stocks looked cheap, but their quality was deteriorating quickly.

Patience, Bhansali said, is also key to contrarian value investing.  

“The biggest advantage we have is time,” she said. “The easiest way to get excess return is to be long-term in a world dominated by short-termism.”

This is difficult for clients, who want to see results right away. Clients may not see the outperformance of this strategy initially, putting you on performance watch or even firing you.

What’s today’s contrarian trade? When junk bonds are glorified as high yield and equities are vilified as volatile and overvalued, that’s a signal to invest in stocks, Bhansali said. The Nasdaq, for example, has been the best-performing market in the world over the last 10 years by hundreds of basis points. Equities have proven themselves over and over again through wars, political change and other factors, while alternatives have disappointed.

“It’s time to go back to the classics,” Bhansali said.

But, she cautions, there are harsh penalties for wrong answers. A 90 percent loss, for example, requires a 900 percent gain to break even. If you can protect well in big drawdowns, you can grow your capital and develop a big lead.

“Avoiding losers is really important in investing,” she said.

An optically cheap stock is one loser to avoid. “Valuations are a red herring,” she said.

Like a magician’s trick, they are designed to fool you into focusing away from the quality of the business, she added. Know the value of the business before deciding what to pay for it.

Also, watch out for accounting chicanery. Management teams know how to report numbers that flatter them.

Be very vigilant of companies with weak balance sheets. It’s amazing how many companies leverage themselves, she said.

You also want to look for companies with high barriers to entry and difficult-to-replicate products. Take camera companies, such as Canon and Nikon. The reason people pay thousands of dollars for these cameras is that the picture quality is extremely good, Bhansali said. 

But people have misunderstood these companies’ business models; there are actually a lot of barriers to entry to make these lenses. They’re made with image processing software that is hard to replicate, she said. Ariel bought these stocks a decade ago, and they’ve done really well. 

TAGS: Equities
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