Crash, Crisis, and Contrarian Investing – by Philip MacKellar and Benj Gallander

At Contra the Heard, we have noticed that unlike merry shoppers during the post-holiday season, investors do not generally enjoy bargains when they arise. Perhaps this is because stock market deals do not present themselves at regular intervals and do not have defined time lines. More importantly, it could be because when markets are beaten up, fear cautions people to avoid markets, rather than to take advantage of opportunity.

Market corrections, sharp downturns, bear markets, and recessions – while largely unpredictable as far as exact timing is concerned – are routinely associated with negative world-shaking news. This most recent downturn is no exception. The Euro-zone is a mess, protests continue in the Middle East, the US housing market remains down and out, and unemployment in the developed world is stubbornly high. Inflation is forcing emerging economies to tighten monetary policy, Chinese manufacturing is slowing, and members in the Senate and Congress have acted more like patients in an insane asylum than democratically elected officials. On Friday, Standard & Poor’s knocked down the American credit rating and it could do so for some EU members too – and these are only the headlines! Long story short, things stink – bad!

Yet bad odours and doomsday scenarios can also signal opportunity. The best investment prospects come and go amid ferocious storms. Sadly, to date, no investor has consistently been able to predict when the storm is at its worst or, in other words, when the market has “bottomed”.

Though stocks look cheap today, they could be cheaper tomorrow. Heck, prices might fall for another week, month, six months, who knows? At Contra the Heard – like other investors – we cannot predict when the market will bottom. We can, however, capitalize on the opportunities presented, even without buying at the bottom, or selling at the top.

Unlike many investors, we do not day trade or trade based on quarter-to-quarter earnings. In fact, our average hold period is about three and a half years. Therefore, the coming weeks and months could be an optimal time to buy quality, out-of-favour positions.

How do we choose what to buy? Well for a quick and dirty version of our investment philosophy, we purchase companies that have the financial strength to weather long storms. Low debt loads, high interest coverage, a sustainable dividend payout, and low relative valuations are critical to us. Furthermore, we only consider companies that have been listed for at least ten years. Although there are many reasons for this, one of the more important is that we like to see companies that have been able to pull through and recover from past downturns. But surviving the chaos is only half the battle – thriving during the recovery is the rest. With that in mind, we like companies that would make attractive acquisitions, and have historically traded at much higher levels; normally at a minimum of 100 per cent above what we pay. In addition, we look for organizations with good historic valuations, margins, and rates of return, as well as necessary products or services, and a solid management team. Although this formula is no guarantee for success, it has performed magnificently over the long-term.

“Benj Gallander is co-editor of the Contra the Heard Investment Letter. The 10-year annualized return is 19.6 per cent.