A Look At Contrarian Investing Approach for Tong Herr.

Taken from Sun Tzu on Investing

Contrarian Investing

Contrarian Investing is a method of moving against the crowd, which relies heavily on a broad understanding of investor psychology, and when done successfully, you will appear to have seen the future. Sun Tzu advised his generals to devise strategies that deceived their opponents, wore them out, and put them at natural disadvantages. Rational investors will have a natural advantage during time of excessive bull market optimism and bear market pessimism. The key to recognizing such dangers and opportunities is to remain loyal to your Sun Tzu-style assessments, continue screening stocks one at a time and remain focused on determined business value. Your discipline will help you avoid paying too much during bull markets and enhance your confidence to buy bargains during bear markets. You will become a rational contrarian and your peers will think you have seen the future (or lost your mind).

Contrarian Investing is one of those terms often misunderstood. A contrarian investor doesn't move against the popular crowd simply for the sake of being different. The true contrarian is a strategic investor whose disciplined approach to stock selection is often at odds with the current trend. If you stick to any particular investing style, be it based on low asset valuations, high earnings growth rates, or high dividend yields, there will be period of times when your style will be in line with the popular thinking, and other times when it will run contrary to the style of the day.

The more long-term focused your strategy, the more likely it will be at odds with popular market trends. Contrasting styles of investing often result from investors' perspectives of the stock market. Chartists, technical analysts and speculators are looking at the short term price movement patterns in the hope they can glean some sense of a trend, able to predict what other investors are thinking. They are trying to understand the emotions of other investors and profit by anticipating their next move. As their guessing game becomes more sophisticated and everyone is observing the same charts - the professional guessers must now predict how the other predictors are guessing about how emotions of the majority investors will affect short-term price movements - this quickly becomes a frustrating guess-what-the-guessers-are-guessing game with no likely winners.

Taken from Mary Buffett's The New Buffettology

CONTRARIAN INVESTMENT STRATEGY VERSUS SELECTIVE CONTRARIAN INVESTMENT STRATEGY

In a contrarian investment strategy, the investor buys stocks that have recently performed poorly and have fallen out of favor with investors. This strategy is based on the stock research of Eugene Fama and Kenneth French, who figured out that buying companies that have had their stock prices beaten down in the two previous years are likely to give investors an above-average return over the next two years. This strategy focuses on falling stock prices and pays little mind to the underlying economics of the companies. With the traditional contrarian investment strategy investors don’t discriminate between price-competitive-type businesses and companies that possess a durable competitive advantage. So long as the share price has recently fallen, the stock is a candidate for purchase.

A selective contrarian investment strategy – Warren’s approach – dictates that investors buy shares only when a company has a durable competitive advantage, and only when its stock price has been beaten down by a shortsighted market, to the extent that it makes business sense to purchase the entire market. This strategy differs from the traditional contrarian investment strategy in that it targets specific companies that have an identifiable strategy in that it targets specific companies that have an identifiable durable competitive advantage over their competitors and are selling at a price that a private business owner would find attractive.

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In a contrarian investment strategy, the investor buys stocks that have recently performed poorly and have fallen out of favor with investors. This strategy is based on the stock research of Eugene Fama and Kenneth French, who figured out that buying companies that have had their stock prices beaten down in the two previous years are likely to give investors an above-average return over the next two years.

As you are very well aware that the market is full of risks.

And the success of an investor or even a trader depends on how well they acknowledge and manage their risk.

Let me give you some of my views. Not sure you would agree but here goes...

So firstly i would try to understand the theory.

The main assumption in this strategy is that all beaten down stocks will one day rise again.

Which basically saying is that all stock price movements are cyclical. Stocks will have their up and their down days.

So where could one go wrong?

1.How safe is our purchase price? What if the beaten down stock gets more beaten? Or simply put... is it time to buy now?

2.Yes, in general ... most stocks that get beaten down... will rise again... but what if it rebound does not past my purchase price? Meaning will the recovery be worthwhile? Will it be profitable?

3.What if the selected stock in the beaten down industry does not rise?

4.What if shit happens? Beaten down stock gets beaten down because it is so poor fundamentally. And the real danger is what if it turns into a real disaster? Yes what if the stock really goes DOWN under?

5. How long would it take for this recovery to happen? Say if we buy the stock now.. seeing that the stock price is beaten down... what if this recovery takes much longer than we expected? Will the stock price hold?

Well these are the questions I think that require much thinking.

In fact, me myself, cannot give you a logical answer to all of it because the bottom line is that the answers to the questions is itself unpredictable.

Which is why, in my opinion, I find what Mary Buffett wrote in her book, The New Buffettology , about her ex-father-in-law is a rather more useful approach.

A selective contrarian investment strategy – Warren’s approach – dictates that investors buy shares only when a company has a durable competitive advantage, and only when its stock price has been beaten down by a shortsighted market, to the extent that it makes business sense to purchase the entire market. This strategy differs from the traditional contrarian investment strategy in that it targets specific companies that have an identifiable strategy in that it targets specific companies that have an identifiable durable competitive advantage over their competitors and are selling at a price that a private business owner would find attractive.

Which basically means that the beaten down stocks must represents companies which has a durable competitive advantage.

Companies that are of good quality.

This, I believe will help the investor safeguard themselves versus the issues that I had written earlier.

This would be my contrarian approach.

Being contrary just for the sake of betting against the crowd is rather silly isn't it?

There's no need to go and get ourselves killed for the sake of being different yes?

Let's do a current example on Tong Herr.

• In a contrarian investment strategy, the investor buys stocks that have recently performed poorly and have fallen out of favor with investors. This strategy is based on the stock research of Eugene Fama and Kenneth French, who figured out that buying companies that have had their stock prices beaten down in the two previous years are likely to give investors an above-average return over the next two years.

Now based on Fama and French theory, we now have a stock which had a 3 month high of around 3.40 and a 12 month high of around 4.25 (adjusted for bonus issue).

Price of Tong Herr is now 2.85, off 1.40 (or 32%) from its peak last July. And Tong Herr does have a rather better than average balance sheet.

So would one be influenced just because of the low price to adopt a contrarian investing approach on Tong Herr?

Let's see, Tong Herr stock has performed poorly and surely one would say that the stock has fallen out of favor.

So would one consider Tong Herr as a candidate under this contrarian theory approach?

If so, let's put a marker at 2.85 and do a review on it maybe a year later? Ok?

Now compare the other contrarian approach. The selective contrarian approach.

• A selective contrarian investment strategy – Warren’s approach – dictates that investors buy shares only when a company has a durable competitive advantage, and only when its stock price has been beaten down by a shortsighted market, to the extent that it makes business sense to purchase the entire market. This strategy differs from the traditional contrarian investment strategy in that it targets specific companies that have an identifiable strategy in that it targets specific companies that have an identifiable durable competitive advantage over their competitors and are selling at a price that a private business owner would find attractive.

Simple reasoning.

Does Tong Herr, a producer of stainless steel fastener (bolts), have a durable competitive advantage?

My answer would be NO.

This is clearly a cyclical stock which had enjoyed tremendous fortune recently due to a couple of reasoning. Back in 2002, the removal of trade barriers (there were early accusations of price dumping in this industry) helped. But the biggest factor in my opinion that the management was simply brilliant when they stocked up their raw material inventory before the amazing bull run in the nickel started. Margins were fantastic and great profits were made in the early days. But all advantage from the brilliant hindsight of the management to stock up the inventory has passed.

And as stated in the company's recent quarterly earnings:

• The higher revenue and lower profit before income tax for this quarter are due to higher demand for the product and higher cost of raw materials purchased in the preceding quarters.

And when you compare the quarterly earnings, the negative impact caused by higher raw materials is showing. Compare the recent announced earnings versus the same period last year.

And based on these facts, I would question the long term competitive advantage of Tong Herr's product.

And when you factor in the current massive changes in the local business economic environment, where the petrol and power tariffs had been increased, I feel that perhaps NOW is not the time to adopt the selective contrarian investing approach and buy Tong Herr at 2.85.

That's my opinion which obviously could be faulty.