April 24, 2012

A few contrarian thoughts

The key to superior returns from the market is to hold an accurate, but divergent view from the consensus.
How does this statement sound ? I made it up myself J. This is something, an overpaid consultant would say to his or her client !!
Let me now put it in common English – If you want to make high returns, you need to think differently. If you follow the crowd, you will only make average returns.
I enjoy trying to question the consensus and see if I can hold and act on a divergent view. Here are some of my contrarian thoughts, most of which may turn out to be incorrect (the consensus would be right). Even if you do not agree with them, just give them a thought.
Now is the time to invest
India has been the toast of the world community for the last 5+ years. We have a young demographic, growing population and educated work force …blah blah blah.  Almost everyone thought,  that we could do no wrong (us included). As a result, the stock market took off in the last few years and the valuations reflected the optimism.
The view now is that India is fast turning into a basket case, where nothing can and will be done right. I personally think, that reality is somewhere in the middle. The optimism in the past was overdone and so has been the pessimism. The stock market valuations now reflect the pessimism and more.
I personally don’t like what is happening with our government, but I don’t let feelings influence my investing decisions which should be based on company specific facts and valuations.
Government PSU’s are not bad investments
My previous post on mining companies may have given you an impression that I hate these kinds of companies and would avoid any PSU. In addition, recent incidents such as the recent decision on gas pricing or the recent directive from the finance ministry to banks to cut interest rates, can only re-enforce this view point.
I am not dogmatic about these things – there are no hard and fast rules or likes and dislikes in investing. It is all about the quality of the company and more importantly the price. If the pessimism keeps increasing , the prices may become very attractive and I may end up investing even in PSU stocks.
Consumption stocks are over-rated
I know this statement is going to make some of you feel very uncomfortable and even annoyed !. At the same time, if you invest in a company based on some kind of simplistic ‘story’ , then you may be in for a negative surprise.
The stock market tends to get into these stories from time to time. It was the IT stocks in 2000, infrastructure and real estate in 2007-2008, Indian growth story from 2004-2010 and now the so called consumption stocks
The typical turn of events is quite standard – Some stocks do well.  Investors start noticing the performance and start bidding up the price of these stocks.
 A story is then woven around these stocks with a plausible reasoning behind it (India needs X amount of housing and hence real estate companies will do well). Any stock which can fit into the story, sees a rise in valuations (justified or not). Finally, the valuations run up too high or some part of the story is discredited and the stock price drops.
Will it happen this time? I don’t know. Let’s see how this story plays out.
US markets are a good place to invest
The conventional wisdom is that developed markets are a bad place to invest, due to all the macro –economic problems in these countries.  As a result, large and established companies such as Microsoft are selling at throwaway valuations.
For example, Microsoft with an annual free cash flow of around 22 Billion dollar and excess cash of almost 58 Billion on its balance sheet, is selling for around 10-11 times earnings. This is for a company with a huge moat and expected growth of around 7-8% per annum. There are several such companies in the US and other markets,  available at very attractive valuations.

Will my contrarian thoughts turn out to be true? I don’t know, but I am betting some part of my money on these beliefs. At the prices i am getting, I don’t have to be 100% right to get a decent return on my investment.

Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please read disclaimer towards the end of blog.


mkd said...

Hi Rohit,

As always, thanks for sharing your crystal clear thoughts.

One interesting point that you have mentioned is about great companies being available at compelling valuations in places like US.

If you were to invest in such companies, how would you manage the forex risk?


Karthik Srinivasan said...

Hey Rohit,

Interesting Thoughts. How do we invest in US Markets? what are the tax implications of the same. Are u planning to do it soon?

Rohit Chauhan said...

you are right ...there would some forex risk. however if you pick large or mega caps, these companies have revenues from across the world and hence the risk is reduced

the usd rupee risk is an open risk ..but then that risk present for us in domestic companies too, especially in export or import oriented companies. so one can create an economic hedge by buying into these kind of companies


Rohit Chauhan said...

Hi karthik
you can try with interactive brokers and i think even icici has some options.

i dont have an idea on the tax implications. Any CA should be able to help


Anonymous said...


my understanding is indian residents are not permitted to invest in stocks abroad...
am not aware of latest on this..is there any change in policy..??

Mkd said...

Indian investors are allowed to invest in stocks abroad upto a certain limit (25000$?)

This has been there for 2-3 years. Icicidirect provides the option on their portal. Although I have not tried it yet.

Anonymous said...

Hi Rohit,

Great post and what I like is the timing of this post. I agree with each view of yours. With regards to your US stock mkt investment, how do you do it from India? Can we buy any stocks in the US market? I am in US and I am invested here in MSFT,CSCO and others. Just curious about how to do it from India. Also, I always somehow anticipated that you would post something about BHEL. I am sure it would have come through your radar. Given the current pessimism around this stock and the number of power cuts we have in India, my expectation on this stock is great at this point. Yes, lot of Chinese and private investors have come in the past few years but that does not mean BHEL is going to die. You would very well know in projects of such high cost, its not only cost alone that determines the order, but the quality, consistency in delivery and long support (including other qualitative aspects) that are important.

Guruprasad V said...

On Low PE stuff- I'd recommend you to read How to Make money in markets by William o Neal? How crowd always think that low PE stuff is beautiful and outsmart other investments. Basically I don't like to imitate what Legendary Buffett is doing with his money. His style of investing has to be to find low valued stocks and simply sit for years and once it comes to ample valuation you could sell or if it is worth to hold for ever one could hold. People like us (Investing not more than $5Million) can't follow his style. It simply wont work. Low PE continues to sell in Lower valuations and High PEs would go up. Please don't confuse this to momentum investing. Other things remain constant (Earnings, Products, Future prospects)you can't get growing stock at 10PE or 15 PE. It would trade around 30 and would continue to do till it top out in the market. This is the reality.

Anonymous said...

Good post Rohit.

You're right, a lot of blame has been targeted towards Indian Government, its policy failures etc.

So like you said, we might get good opportunities in areas that are influenced by Govt decisions.

Eventually, the Govt will wake up and do something about it. They always wait till the last moment or when the situation gets out of control.

But at least the current/near term scenario throws some good opportunities at us.


gautham said...

Hi Rohit, I beg to differ on consumption story. In the IT bubble, most of the companies had 3 digit PE and infosys as high as 350. In RE/infra bubble, apart from valuation, the business model,accounting too were suspect. ( 1. They can show sell to their own group companies to show growth. 2. Both the companies and their customers need to leverage). Consumption related stocks are not that overstretched. ( Of course there are exceptions like jubilant foodworks etc). Moreover they have a decent earning visibility and are relatively recession free. As for valuation, most of them are inline or slightly ahead with earnings growth. Of course PE ratio cannot take brand name into consideration. Lets take Nestle as an example from consumption story. Now valuation wise this is way ahead of earnings. Past 5 years it has grown both sales and eps by around 20%. Trading at a P/E of 40. Last quarter was not impressive. Still it didn't fall hard. If you see history, you will notice that the average PE is around 40 and even during march 2009 it was trading at 25. So in my opinion its unfair to compare them to IT of 2000 or RE/Infra in 2007. I would love to hear your views on this.

Disclaimer. I have a very tiny exposure to nestle but have a substantial allocation to consumption stocks. I may be biased.

Rohit Chauhan said...

Hi ravi
yes ...you can invest in US stocks via icicidirect and other brokers. there is a dollar limit to it ..around 25000 usd

regarding BHEL ...i have position in other capital good companies and hence have not invested in BHEL ..but i think the pessimism is over done. BHEL and other companies do have competitive advantage and they should do well


Rohit Chauhan said...

Hi guruprasad

i think PE ratios are just a proxy for value , but i would not use it to make decision to buy and sell

cyclical stocks sell at low PE at the peak and vice versa.

A high PE stock is a bargain only if the growth built into it is exceeded by the company ..if the company performs better you will make money. if the expectations turn out to be worng..we know what happen

same way, low PE stocks are value traps if the assumed performance turns out to be correct

the key is always to find stocks where the price under-estimates the performance. I have found that easier to do in the case of companies selling at 8-15 PE range. that does not mean that all stocks with PE above 30 are over priced.


Rohit Chauhan said...

Hi vic
i think all of us sick of how the goverment and politicians are behaving. but is it any surprise

people forget that our political class has mostly been useless and india has done well inspite of that.

inspite of above, one can always find a few good ideas to do well


Annapurna Shastri said...


I have researched/invested in Govt.PSU stocks in the past,but somehow the basic selection criteria like good fundamentals,low P/E etc which applies to stocks in general do not seem to work here.It doesnt reflect in the returns.Is it because of lack of momentum/investor interest or because the stocks are seldom undervalued,even in a bear market?