1. Shareholders Scrambled For Exit
Today, LC Titan reported a profit of RM11 mil, significantly lower than the previous quarters’ RM300 mil plus (per quarter). The poor result was mostly due to margin squeeze, caused by high inventory cost and low selling price due to drop in demand. Many investors panic and rushed for the exit. Share price declined sharply from RM4.60 to as low as RM4.14, a drop of 10%. As a contrarian, I scrambled in the opposite direction, picking up some shares at RM4.15.
Why did I do that ?
Contrarianism does not mean that you think the OPPOSITE of others. When a building is on fire and everybody is rushing out, you are not a contrarian if you rush in. It just doesn’t make sense.
Contrarianism, means that you think DIFFERENTLY from others. When something happens, the crowd will move in one direction. They are not necessarily wrong, but the state of commotion will sometime give rise to opportunities. If you can stay calm and think rationally, you might be able to exploit and benefit from the nuances (if they exist).
One good example is BIMB. Due to spate of recent bad news related to Tabung Haji and 1MDB (not even directly related to BIMB), the stock has been sold down from RM4.20 to RM3.60 despite reporting sterling set of result. The crowd thinks like this : there must be a lot of skeletons in the closet waiting to be uncovered, better play safe just in case NPL spikes in the future. As a contrarian, I take into consideration the exceptional quality of our own banking regulatory system, led by ex governor Zeti. I chose to believe that BIMB’s asset quality should be quite ok. Afterall its NPLs are only 2% plus. So I added some to my portfolio at RM3.60.
It is still early to say that I am right and the crowd is wrong, but BIMB is an example of how contrarian thinks and acts.
3. Structural vs. Cyclical Factors
When companies get into difficulty, the problem they face can be broadly divided into two main categories - structural vs. cyclical.
Let’s take George Kent as an example. The day after GE 14, George Kent share price dropped from RM4.00 to RM2.50. Are you a contrarian if you rush in to buy at RM2.50 ? No, you are not. You are merely a fool. The crowd is not always wrong. In George Kent’s case, the share price melt down is justified. The problem confounding the company is STRUCTURAL in nature. This kind of problem is very difficult to be rectified. There is almost no more hope. Rushing in when others are getting out is suicidal.
Cyclical issues, on the other hand, are caused by industry related cycles. It could be due to lower selling price, lower demand, or higher operating cost. For the latter, it was mostly due to rising raw material cost or labour cost, etc. Unlike structural issues, cyclical issues tend to go away in a relatively short period of time, from few quarters to two, three years.
In my opinion, share price collapse due to cyclicality is perfect opportunity for contrarians to act.
4. Be Selective
On 20 January 2019, I wrote an article “What is Investing ?”. In the article, I mentioned the following :
“Anything bought based on careful evaluation of value and proper reasoning, and in the event that things turn sour, can be held until recovery, is considered investing.”
Yup, the key word is “held until recovery”. When you buy a stock, especially when you are acting contrarian, always ask yourself this question, “will the stock ever recover within maximum of two to three years ? Does it have the requisite qualities to do that ?” (According to my definition, longer than three years means you have made a mistake).
To answer the question, you need to take into consideration the following :
(a) (once again) is the problem structural or cyclical ?
(b) is the balance sheets strong enough to withstand the down cycle ?
(c) Is the stock near all time low?
If the answers are yes, then you can consider buying some.
But you must be prepared for more pain to come. Famous investor Seth Klarman, who wrote the book “Margin of Safety”, pointed out that “contrarian investors are always wrong initially”. What he means is that after the initial decline, share price is likely to further go south. It will take some time for the stock to stabilise and ultimately recover. You need to have holding power.
5. Concluding Remarks
What is the main message of this article ? Is it about the benefit of acting contrarian ? No. The main message of this article is that if you ignore the negative impact of cyclical factors, a whole new world will open in front of you. This is especially true for raw material cost.
Let’s take 3A as an example. In the past two quarters, its profit has dropped due to higher raw material cost (tapioca). Before this, I will react to this adverse development and sell 3A. But now I think differently. I will ignore it and hold on. As a matter of fact, I will monitor tapioca price closely and jump in to buy more when there are signs that tapioca price is heading south (it is already happening).
Why should you behave in such a way ? Because you are an investor - you buy good quality companies, ignore cyclical noises **, hold on to them until they recover, then sell for a profit.
( ** Why should you ignore cyclical noises ? Because you have no choice !!! Things happen all the time in the world of business. If everytime a minor hiccup happens to the company and you cut loss, how many times you can do that ? Have you ever heard of death by thousand cuts ?)
The benefit of doing so is that you no more need to track latest quarterly result closely. The company's profit can drop, but since you know it can recover, you don’t need to do anything. It is just paper loss. One day you will make money when the upcycle returns.
Once you think and act like that (especially ignoring raw material cost fluctuation), you will suddenly find many stocks becoming investible. Can you imagine the difficulty of predicting the profitability of LC Titan over next few quarters ? There are so many things in flux. Oil price, demand for chemicals, currency fluctuations, competitive forces, etc. These things are so complicated, most retail investors like us will never be able to fully grasp them, let alone predicting them. However, if you ignore those cyclical factors, hold on to the stock with conviction (of course, must be bought at attractive valuation), there is a fairly decent chance that the stars will align one day and the company's profit will rebound. That is when you can cash out.
The same applies to many other manufacturing companies such as Petronm, Hengyuan, Johotin, Perstima, 3A, Petchem and poultry companies, etc.
(Note : I will be a bit careful if it involves forex factor as currencies once move in a direction, can potentially last for many years. For example : Ringgit's weakening since 2015. For me, major currency changes can potentially be structural. Make sure you are not caught in the wrong cycle).