Apologies for the delay of part two of Contrarian Investment Strategies. It had been a really busy and tough week out for business trip. Anyway, continue from the previous post of Contrarian rules, below
you will find the complete rules from 22th to 41st.
I tend to agree with most
of the rules. To elaborate some of the points, I had also added comments, info and
examples either from the author or myself in italics blue.
you will find the complete rules from 22th to 41st.
I tend to agree with most
of the rules. To elaborate some of the points, I had also added comments, info and
examples either from the author or myself in italics blue.
Invest Long Term
Rule 22: Look beyond obvious
similarities between a current investment situation and one that appears
equivalent in the past. Consider other important factors that may result in a
markedly different outcome.
similarities between a current investment situation and one that appears
equivalent in the past. Consider other important factors that may result in a
markedly different outcome.
During the 1987 financial crash,
many people compare it the to 1929 depression due to many similarities. It is
incorrect. The 1929 depression lasted for more than ten years into 1940s, on
the other hand, throughout the ten years after the 1987 crisis, market
recovered fast and actually quadruple in 1997.
many people compare it the to 1929 depression due to many similarities. It is
incorrect. The 1929 depression lasted for more than ten years into 1940s, on
the other hand, throughout the ten years after the 1987 crisis, market
recovered fast and actually quadruple in 1997.
Rule 23: Don’t be influenced by the short-term (3 or 5 year) record of a money
manager, broker, analyst or advisor, no matter how impressive; don’t accept
cursory economic or investment news without significant substantiation.
manager, broker, analyst or advisor, no matter how impressive; don’t accept
cursory economic or investment news without significant substantiation.
Rule 24: Don’t rely solely on the “case rate.” Take into account the
“base rate“ – the prior probabilities of profit or loss.
“base rate“ – the prior probabilities of profit or loss.
The past outcomes are
prior probabilities and not necessary reflecting the current practical
situation. Instead, we need to evaluate the fundamentals a company and compare
it with similar companies within the industry.
prior probabilities and not necessary reflecting the current practical
situation. Instead, we need to evaluate the fundamentals a company and compare
it with similar companies within the industry.
Rule 25: Don’t be seduced by recent rates of return for individual stocks
or the market when they deviate sharply from past norms (the “case rate”). Long
term returns of stocks (the “base rate”) are far more likely to be established
again. If returns are particularly high or low, they are likely to be abnormal.
or the market when they deviate sharply from past norms (the “case rate”). Long
term returns of stocks (the “base rate”) are far more likely to be established
again. If returns are particularly high or low, they are likely to be abnormal.
Rule 26: Don’t expect the strategy
you adopt will prove a quick success in the market; give it a reasonable time
to work out.
you adopt will prove a quick success in the market; give it a reasonable time
to work out.
It was mentioned: “One of most common questions is if the stock is
so good why it don’t go up?” Contrarian explains that in most situations, it
will take some time for the value (the input) of the stock to be recognized in
the price (output) by the market. If investors demand immediate, though
incorrect feedback, they can make serious mistakes as a consequence.
so good why it don’t go up?” Contrarian explains that in most situations, it
will take some time for the value (the input) of the stock to be recognized in
the price (output) by the market. If investors demand immediate, though
incorrect feedback, they can make serious mistakes as a consequence.
Rule 22 to 26 seems easy but it is a lot harder to
follow than we think. This is because of the cognitive psychology of biases indicated that even when
people are warned of such biases they appear not to be able to adjust to the effects.
It takes lot of concentration and effort and understanding to avoid these
pitfalls.
follow than we think. This is because of the cognitive psychology of biases indicated that even when
people are warned of such biases they appear not to be able to adjust to the effects.
It takes lot of concentration and effort and understanding to avoid these
pitfalls.
Rule 27: The push toward an average rate of return is a fundamental principle of
competitive markets.
competitive markets.
Psychological
Reactions
Reactions
Rule 28: It is far safer to project a continuation of the psychological reactions
of investors than it is to project the visibility of the companies themselves.
of investors than it is to project the visibility of the companies themselves.
Crisis Management
Rule 29: Political and financial crises lead investors to sell stocks. This
is precisely the wrong reaction. Buy during a panic, don’t sell.
is precisely the wrong reaction. Buy during a panic, don’t sell.
Rule 30: In a crisis, carefully analyse the reasons put forward to
support lower: stock prices-more often than not they will disintegrate under
scrutiny.
support lower: stock prices-more often than not they will disintegrate under
scrutiny.
Source: Yahoo Finance
The above charts show Singapore STI Index from 1995
to current & US S&P500 Index from 2008 to current.
to current & US S&P500 Index from 2008 to current.
After the 1997 Asian Crisis, STI rose from below
1000 to 2500 points in 2000. Likewise after SARs 2003, STI rose from below 1500
to above 3500 points in 2007/08. Again after the Global Financial Crisis 2008/09,
STI rose from 1600 to above 3000 points now in 2014. Similar trend is observed
in the S&P 500 index. After GFC, it rose from below 800 to above 1900
points now in 2014.
1000 to 2500 points in 2000. Likewise after SARs 2003, STI rose from below 1500
to above 3500 points in 2007/08. Again after the Global Financial Crisis 2008/09,
STI rose from 1600 to above 3000 points now in 2014. Similar trend is observed
in the S&P 500 index. After GFC, it rose from below 800 to above 1900
points now in 2014.
Therefore it is not difficult to understand why we
should buy during situations of panic and sell during euphoria.
should buy during situations of panic and sell during euphoria.
“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful”
– Warren Buffett
It is also noteworthy that during crisis, even
great companies will see its PE or PB ratios taken a hit and fall drastically. It
is common. A good way to radar good stocks is to identify those that are still
having sustainable dividend payouts. The better stocks even increase their
dividend pay outs.
great companies will see its PE or PB ratios taken a hit and fall drastically. It
is common. A good way to radar good stocks is to identify those that are still
having sustainable dividend payouts. The better stocks even increase their
dividend pay outs.
Rule 31: (A) Diversify extensively. No matter how cheap a group of stocks looks,
you never know for sure that you aren’t getting a clinker. (B) Use the value
lifelines as explained. In a crisis, these criteria get dramatically better as
prices plummet, markedly improving your chances of a big score.
you never know for sure that you aren’t getting a clinker. (B) Use the value
lifelines as explained. In a crisis, these criteria get dramatically better as
prices plummet, markedly improving your chances of a big score.
During crisis, sometimes even good company may go wrong.
Contrarian approach advises to have adequate diversification. For instance, a
fund manager has $1million, do extensive research and put $200k (20%) of his portfolio
into the banking industry. He then spread 200k investments into 10 banks or
more such that each bank has less than 20k (2%) of the overall holding. So even
if 1-2 banks collapse due to unprecedented cases, it will not be so bad.
Contrarian approach advises to have adequate diversification. For instance, a
fund manager has $1million, do extensive research and put $200k (20%) of his portfolio
into the banking industry. He then spread 200k investments into 10 banks or
more such that each bank has less than 20k (2%) of the overall holding. So even
if 1-2 banks collapse due to unprecedented cases, it will not be so bad.
Volatility is not
risk
risk
Rule 32: Volatility is not risk. Avoid investment advice based on
volatility.
volatility.
Some investor use volatility index (VIX)
to track risk.
to track risk.
Small-cap Investing
Rule 33: Small-cap investing: Buy companies that are strong financially
(normally no more than 60% debt in the capital structure for a manufacturing
firm).
(normally no more than 60% debt in the capital structure for a manufacturing
firm).
Rule 34: Small-cap investing: Buy companies with increasing and well-protected
dividends that also provide an above-market yield.
dividends that also provide an above-market yield.
Rule 35: Small-cap investing: Pick companies with above-average earnings
growth rates.
growth rates.
Rule 36: Small-cap investing: Diversify widely, particularly in small companies,
because these issues have far less liquidity. A good portfolio should contain
about twice as many stocks as an equivalent large-cap one.
because these issues have far less liquidity. A good portfolio should contain
about twice as many stocks as an equivalent large-cap one.
Rule 37: Small-cap investing: Be patient. Nothing works every year, but when
smaller caps click, returns are often tremendous.
smaller caps click, returns are often tremendous.
Rule 38: Small-company trading (e.g., Nasdaq): Don’t trade thin issues with large
spreads unless you are almost certain you have a big winner.
spreads unless you are almost certain you have a big winner.
Rule 39: When making a trade in small, illiquid stocks, consider not only commissions,
but also the bid /ask spread to see how large your total cost will be.
but also the bid /ask spread to see how large your total cost will be.
Rule 40: Avoid the small, fast-track mutual funds. The track often ends at
the bottom of a cliff.
the bottom of a cliff.
Rule 41: A given in markets is that perceptions change rapidly.
Straits Times Index (STI) comprises the largest 30 companies by full market capitalisation that meets stated eligibility requirements. FTSE ST Mid Cap Index comprises the next 50 companies by full market capitalisation that meet stated eligibility requirements. FTSE ST Small Cap Index comprises of the constituents within the top 98% of the SGX Mainboard by full market capitalisation. They will also need to meet the stated eligibility requirements, but are not constituents of the STI and the FTSE ST Mid Cap Index. As of May 2014, Cambridge Industrial Trust is the largest constituent of STI small cap company with a market capitalisation of approx S$960mil. Refer to link for FTSE ST Index series.
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