Sunday 22 July 2012

Contrarian Investing Today

My last post on contrarian investing highlighted the need for individual investors to distance themselves from the prevailing herd mentality if they want to achieve market beating returns.

With this post I intend to go a little more in depth about my feelings about the current situation and how best to position yourself to profit from it.

For current buyers/holders of equities, the good news is you are already acting in a contrary way. Pension funds have their exposure to equities at an all time low, and many private investors are standing at the sidelines waiting to see how the Euro crisis and various debt crises around the globe pan out. This lack of participation is creating substantial value almost across the board.

I do think that there is a sizable chance that equity markets may fall substantially in the short term if there are further Eurozone (or general) debt problems. But if there are dips i believe they should be treated as a prime buying opportunity for those with a long term investment horizon (10yr+)

To be truly contrarian you must be willing to invest your money where others fear to tread, this may involve choosing companies that are currently going through difficult times and as such pose inherently high risk investments. Currently i have apportioned around 35% of my portfolio to 'turn around' stocks of this nature. The remainder being in high yielding 'safe' mega cap stocks.

The sectors that have suffered the most during the fall out of the financial crisis have been house builders and banks, with insurers and retailers also showing above average capital losses.
It is the job of the contrarian to find businesses within these bombed out sectors that offer deep value to the prospective shareholder, and have the ability to survive the difficult times and rebound when the macroeconomic backdrop improves.

As house building is a reasonably generic industry, rather than bet on one or two stocks i have bought small amounts of each company thus holding most of the UK's biggest building firms and negating some of the company specific risk. I have held these stocks for a couple of years now and they are all showing capital gains of between 10%-60%.
Even after these gains, many of these companies’ shares are trading at a substantial discount to net asset value (NAV) and as such still make great investment prospects. Barratt Homes still looks particularly cheap at the moment, trading at roughly half of their NAV.

On the back of the house building investments, one of my favourite bank stocks is Lloyds Banking Group. Even after their forced sell off of many branches to the Co-Op they still retain an almost monopolistic grip on the UK mortgage market. They also are the UK's fourth biggest house builder in their own right, owning many house builders across the UK, with a very large share of the Scottish market. Their shares are much unloved, baring the brunt of the financial crisis and mis-selling scandals, and are still trading close to all time lows. I've been drip feeding money into Lloyds shares on the dips in price and my average purchase price is around 31p which is showing a slight capital loss. I'm confident though that this will turn out to be a good investment in the long run and it is encouraging to see that many of Lloyds' directors have also been snapping up their own companies' shares, usually a good sign.

I will cover insurers and retailers in a later post.