You can contact the author (Teguh Hidayat) by email, teguh.idx@gmail.com. The author live in Jakarta, Indonesia.

See my pictures in Instagram, @teguhidx.

Did I Said, Contrarian?

In the article of two weeks ago, I mentioned that Lo Hong Kheng is a contrarian investor, which he did what other people don’t, like buying stocks that most people regard it as junk. Well, based on my own experience, the term 'contrarian' is actually interesting, and we will discuss it here.

By the term, contrarian means 'against'. Investopedia defines the strategy of contrarian as a style of investing which is against the direction of the market, by buying assets/shares that have poor fundamentals, and sell it later when the company’s financial performance becomes better (at a higher price, of course). The rationale is that we can only buy stocks at a really discounted price, if the company itself had poor performance, or if the stock market was down. However, since the stock market does not go down every day, then in the conditions of sideways or bullish market, the option to buy stocks at low prices is limited to stocks with average or even poor fundamentals. Because if we want to buy a stock of well-known companies with brilliant financial performance, then we would likely have to pay at premium price, ie the price that reflects high PER and PBV, and it's certainly not in line with the concept of value investing.

However, be careful with the phrase 'stock with poor fundamentals', because we were not talking about a really poor stock or company here. Here’s the explanation: Sometimes a company with a long brilliant historical performance may experience periods where the business was difficult, where the sales down, profits down, and its stock also down. Well, that’s the kind of company we were talking about! For example, take a look at Manchester United: Though MU was the greatest football club in Premier League and also had won the Champions League title, but their current performance is really bad, particularly after the retirement of Alex Ferguson.

But does it make the club immediately turned into a mediocre football club? Unless you are a supporter of Arsenal, Chelsea, Liverpool or Manchester City, then of course the answer is, no! MU remains a big club, only it is having a hard time.

Now, if MU has it shares listed on the stock exchange, then the stock will almost certainly plummeted, maybe even since David Moyes was appointed as manager. But for contrarian investors, they may see that this is actually the opportunity to buy the stock of Manchester United at a low price, because sooner or later, the achievements of the club shall be restored.

Note: Manchester United Plc, the owner of Manchester United Football Club, is actually listed on the NYSE since 2012. You can see the price movement of the stock in Yahoo Finance by ticker ‘MANU’. In the last year the stock had dropped 10.3%, with striking fluctuations (it looks like the stock will rise if MU win, but immediately dropped if the club lost the next game).

But of course, there are the stakes here which, first, no one knows when MU will back to lead the standings of Premier League, and second, what if the club cannot restore its past performance? We never know about it, right? Yup, and that's why we have to go back to the valuation thing. If MU turns into a really mediocre football club, then it's like a company that after its business collapsed, it was unable to recover and to restore its earnings power.

In football, there is only one condition in which a club has a decreasing performance, where it can be seen from their position in the league table. But in real business, there are at least three conditions of the declining fundamentals/performance of the company, which usually causes the shares went down. First, the company is still have good earnings, its equity are also still growing, but the growth was not as high as before, usually because of the golden years of the company/industry is already passed. If the stock was highly priced by the market due to the excellent performance of the company in the past, then this condition will cause the stock to go down to its normal/fair price.

Second, the company’s earnings grew negatively aka decline, and it is usually causes the stock to down, even lower than its normal price. This is the condition that the so-called 'contrarian' investors like the most, because even though the company’s earnings were down, but the company's equity is still increasing due to the addition of retained earnings. So in this case, even though the price of the stock in question is fell because the valuation is looked higher in terms of PER (because its EPS was down), but in terms of PBV the valuation is likely to remain, even become cheaper. So that is actually the opportunity to acquire the stock, of course if it came to an undervalued price. The point here is that the company’s real value (its equity, or net asset) is still growing.

Based on my own experience, there were cases where a stock is highly priced (its PBV is high, reaching 4 or even 5 times), because the performance of the company is very good with a large and highly increased net income. Examples? Erajaya Swasembada (ERAA). In 2012, ERAA recorded an excellent financial performance, and as a result its stock continue to rise until peaked at 3,500, representing approximately 4.5 times of PBV which, according to myself, it was simply overvalue. But after the company experienced a decline in earnings in early 2013, the stock had slashed to 940, before then stable in the positions of 1,000’s. Well, do you know why the declining of stock’s price is stopped at 1,000's? Right! That because at these prices, the valuation is already discounted for ERAA was still a profitable company (ERAA’ ROE at the third quarter 2013 was 12%, still better than the interest of retail bond) At the price of Rp1,000 per share, the PBV was only 1.1 times. Unless the rate of Rupiah continued to decline to Rp15,000 per US Dollar, so ERAA is ultimately suffered a loss, then the shares will not fall deeper.


And by that I mean, if you are those who believe that the performance of ERAA will eventually recovered, it's actually the right time to get in, and then see the result about 1 - 2 years later. Not only ERAA, on the Stock Exchange there are many other stock/companies who also had an outstanding performance in the past, but their performance in last year of 2013 was poor, so their stocks are extremely down. But for particular investors, it is an opportunity for shopping at the great sle.

Third, the company’s earnings are not only down, but turned into a big loss, not only in one year/particular period, but prolonged. So the equity of the company is eventually decreasing because of deficit. And this is the worst possible condition, in which investors can then assume that the company would even bankrupt, despite the company’s excellent historical performance. This is the condition that only certain contrarian investors dare enough to enter, because even though the price of the stock is down until its PBV below 1 times (which means that price is already less than the value of the whole net assets of the company), but the growth of the assets is negative, even might lead to capital deficiency such as the case of Bumi Resources (BUMI).

However, history proves that this extreme type of contrarian investors (who acquired the shares of a loss company), are often successful in the end, even though they had to wait for years. Make no mistake, some of well-known and rich investors such as Sandiaga Uno, are also this kind of investor, where he bought several dying or even totally bankrupt companies in 1998, but then in the end he had great success as the performance of these companies was recovered, so he could sell it at premium prices.

Anyway, if you are a passive investor just like me (who does not participate in the management of the company), then this strategy (buy a nearly bankrupt company) is not recommended. Note that Mr. Uno did not buy the company for then sit back all day, but got busy in the management, or in other words, he took care the companies. And sometimes there are also certain companies that Mr. Uno failed to restore its earnings power, although he did all he could. This means that this type of contrarian strategy has a high risk, as well as requiring expertise in managing the company, plus a large amount of funds, because if you want to be a controlling shareholders of a company, then of course you have to buy it shares in majority.

Or, if you are not intending to control the company (say, because you’re just a small shareholder), you have to have a strong assumption that the management is capable to bring back the company to its normal performance. And for some reasons, if in Indonesia, this is never easy.

Contrarian strategy, in terms of market behavior

The above discussion of contrarian strategies is related to the fundamental/performance of the company concerned, where contrarian investors buy the stock with not-so-good fundamentals, as long as the valuation is reasonable. Because the stocks that have good fundamentals are often overpriced by the market, along with the high expectations about the bright future of the company.

Beyond that, there is also a contrarian strategy that utilize the market fluctuations, in this case the bear period of Jakarta Composite Index (JCI). Note that under normal or bullish conditions, we often need a little 'give in' to acquire an average quality stock if we focus on effort to acquire stocks at a lowest possible price, because the good stuff are all labeled 'best seller', so the prices are exorbitant. But what if the market is bearish? Well, that’s when we may buy a small piece of diamond at a price of fake pearl, is not it? Thus, in conditions like this, we do not need to budge about the fundamental quality of the stocks that we buy.

Therefore, if most investors are having their euphoria when the JCI was high, then the euphoria of value investors is precisely when the index fell! And that's why they came to be called 'contrarian', because their behavior is completely different from the behavior of the market in general.

In fact, they are not deliberately behave differently with the market, but only behave appropriately. Now use the logic: A month ago, Pertamina suddenly raise the price LPG to Rp140,000 per 12 kilograms of size. Then how was the reaction of consumers? Are they happy? Of course not! There were housewives, the restaurant owners, and the general public that strongly protested the hike of the price. And after a bit of drama, Pertamina eventually lower the price to be Rp117,000, though it was still higher than its initial price before the hike.

While in the stock market, things are exactly the opposite! In April 2013, the stock prices continue to rise, so the JCI was also continue to rise until had breached the psychological level of 5,000. And what about market reaction at the time, ie when almost there was no stock that is cheap enough to buy? Was somebody held the protest for demanding lower price of the stocks??? You know the answer.

However, of course, it is not easy to be different. If you are the only sane person amidst a bunch of insane people, then like it or not, you are the insane! The hardest part in running a contrarian investment strategy as already discussed above, both in terms of company fundamentals and market fluctuations, is the lack of support from anyone around you, for you might be completely alone. In 2007, Gita Wirjawan had a big fight with his ​​colleagues at JP Morgan, because he insisted that the JCI has been very irrational and will fall soon, while his colleagues continued to drown into madness of the market euphoria. This is what ultimately led Gita to get out of JP Morgan in April 2008, and then set up his own investment company, Ancora Group, in the same year. And yes, he then took a huge success after acquired a lot of undervalued stocks when the market fell apart in the global crisis of 2008.

Well, now what about you? Are you the contrarian?

No comments: