The Rare Contrarians

The Rare Contrarians

It isn’t as bad as the cartoon sounds. Contrarian investing is not something that I discovered as a strategy when all else failed. It is in fact a basic tenet of value investing.

The question however is when and how to use it.

It is one of known precepts of sound investment that the best companies for investment are those which show large predictability and stability in earning power. However, these have to be picked up at the right price. Buffett is the super specialist in this and we can look at some of the companies that he has invested in over the years to reaffirm that: Coca Cola, Gillette, Walt Disney Company, Hershey Foods, McDonald’s Corp., Nestle etc. Surely these are great companies, but rest assured that he would have waited till he thought the price was right. The price, as I have written earlier, changes everything.

But as usual there are other ways of making money in the market than by investing only in companies with predictable earning power of the nature shown by such consumer companies as above.

The important part is whether one can keep their cool and think the contrarian way.

Sir John Templeton was ofcourse famous for scouring for bargains when the rest of the investors were running for cover. One of his famous quotable quotes was “If you want to have a better performance than the crowd, you must do things differently from the crowd.’

Oh, that’s easy! Not really..

Because this may happen when the entire market has spasms (more vivid at this point in time) or it may happen when a company is hit due to business cycles. In both situations most of the market participants are frozen into inaction (or worse since they may be selling). Not Buffett who proclaimed to Forbes after the 1974 crash that he felt like an oversexed guy in a whorehouse.

A private business might easily earn twice or maybe even a higher multiple in a boom year as against in poorer times, but its owner would never think of correspondingly marking up or down the value of his capital investment. This is one of the most important lines of cleavage between the stock market and the canons of ordinary business. Contrarian investment is all about having an asymmetrical perspective; to be able to look beyond the prevailing current views and look at the longer term.

Graham has noted in his classic book, Securities Analysis (1951) that the market level of common stocks has been governed more by their current earnings than by their long term average. This fact accounts in good part for their wide fluctuations in prices.

Funny, how these things haven’t changed over time.

There is another aspect that can co-exist with the above and this is something that I would like to bring out additionally in this article. Graham noted in the same book that that low priced common stocks appear to possess an inherent arithmetical advantage arising from the fact they can advance so much more than they can decline.

It is a common place of the securities market than an issue will arise more readily from 10 to 40 than from 100 to 400. This fact is due in part to the preferences of the speculative public, which generally is much more partial to issues in the 10-40 range than to those selling above 100.

This however may mean different things to different people. If not applied properly this may mean investing in penny stocks which are trading at those levels for all the right reasons – example a smart promoter may have sub-divided the stock into smaller face value or else the company may be selling out of date products (like buggy lights in the age of super fast cars) and hence does not have good prospects. Or else a company may be going into extinction for legal or other reasons etc.

It is important, therefore, to understand what the true meaning of ‘low price’ is.

In my view, the price should be low in relation to the company’s assets; its sales and its past and prospective profits under favourable business conditions. It also should have sold repeatedly in former years at many times the current low price.

Ergo, the current conditions bad conditions should be non-permanent.

Please see comparison the financial performance of 2 companies: Eveready Industries and Nippo Batteries. They are in the same industry, viz., manufacture and sale of dry cells. While the former is the leader in the field, the latter had better managed financials and was a ‘safer’ company to invest in.



While Eveready has had ~3X the sales of Nippo Batteries, it has been dogged by overall poor financials driven by high interest charges and depreciation charges. As compared to this, Nippo has been a zero debt company with, in fact, excess cash lying on their balance sheet. In 2007 when prices of their main raw material began to go up, Nippo managed to bring its PBDIT back at earlier levels by better cost management and because it did not have any interest liability. Eveready’s capital structure with high debt levels (they were also investing in building a Greenfield plant) did not allow it to do that. Resultantly, in 2007 and 2008, they lost money.

So far so good. But as I said earlier, its the price which is the main thing. So let us compare the financial performance of the companies to their price movements.






As is clear, when the markets crashed, Eveready was punished even more by the markets, with their price falling from a high of 130 levels in 2005/ 2006 to a low of 13 or so in 2008.

On the other hand, Nippo fell only from 400 to around 300 in the same period. The markets clearly did the right thing by not punishing a steady performer like Nippo. But is there a case that there was an over-reaction on Eveready?

Well, the company did make losses in 2007 and 2008. Question is, was it a permanent situation?

It wasn’t very difficult to see that the price of Zinc, a critical raw material for the industry would come down eventually, especially with the world’s economic aspects not appearing too bright. Secondly, it was trading at a fraction of its book value, but it was holding its sales pretty well by entering into low priced products. Thirdly, it’s management was trying very hard to bring down the debt levels by selling excess land. And fourthly, its product was not getting out of fashion anytime soon. In a place like India where shortage of electricity is perennial, there are places where flashlights are a way of life – and that means battery usage. Newer electronic equipments mean more remotes, and by implication more batteries. And they have a massive distribution set up, a hallmark of a good retail company. It was just a question of waiting for the margins to start looking healthier.

What caused its recent price performance? Their recent quarter was a very good one, aided by low raw material price, good sales and a break by the government on industry’s excise duty charge. In just one quarter, 2 years of wait came to an end.

The market is usually preoccupied with looking at the better performers. There is truly very little patience for the non-performer. Therein lies the major opportunity.

We had written about Eveready Industries in our Blog in October 2008, when the price was around Rs 20. It ofcourse further fell to a low of Rs 13, but recently it touched a high of mid 60s, which is when we exited the stock fully, having achieved our price objective. Don’t get me wrong – I had started buying when the price was much higher than Rs 13. However, I continued to buy as the price kept dropping with the result that by the time the stock reached its nadir, this was THE worse dog in the portfolio (now you see the logic of showing a cartoon with a dog talking). But by the time it reached its recent high price, it more than made up for the lost time.

A classic example of both contrarian investment as well as the power of investment in a true low priced stock. With results like these, why listen to your dog and end up changing your investment style?

No disrespect to dogs ofcourse. I love them too.