Interactive Investor

Why it's rarely wrong to buy out-of-favour stocks

4th November 2016 15:59

David Liddell from interactive investor

Interactive Investor is 21 years old. To celebrate, our top journalists and the great and the good of the City have written a series of articles discussing what the future might hold for investors.

From Major to May, from the "end of history" and the post-Cold War peace dividend to Brexit via Blairism, internet boom, terror, war, Goldilocks, the great financial crisis and its hangover: 21 years with plenty of contrarian opportunities.

Contrarianism, of course, works best when most investors have strong views that lead them in one direction, whether effervescently exuberant or deeply despairing. This leads share prices to overshoot and lose touch with reality. And that is when the contrarian gets interested.

There are plain dull periods, of course, but contrarians also like dull because it often means value is overlooked.

Property play

This was perhaps the case with our opening trust. In 1995 I was failing to sell a reasonably attractive four-bedroom house in Clapham, south London, and commercial property was only just recovering from the trauma of the late-1980s recession and interest rates that reached nearly 15% in 1990.

So there was an element of contrarianism in buying into property. In September 1995 TR Property investment trust could be bought for 29.5p on a discount, which was probably about 15% (coincidentally not too far from the current level of 13% - although in these post-Brexit vote times the validity of the current net asset value [NAV] of property trusts should be questioned).

Since then, however, the share price has increased by nearly 1,000%. And this is this just the capital growth story: the dividend was 0.94p in 1995 and 8.35p for the latest 12 months, an almost ninefold increase.

Pacific Assets trust managed to double its NAV over the year to September 1999In contrast, the FTSE 100 has not quite doubled over that period. Not so dull were the Asian tigers. They were all the rage in the mid-1990s, but it all went wrong when Asian currencies and equity prices collapsed after the July 1997 plunge in the value of the Thai baht.

Excessive risky lending nearly brought the region to its knees, and share prices struggled through 1998. But for the contrarian, there were opportunities: the underlying potential of these economies remained, even amid what seemed like financial disaster.

Thus Pacific Assets trust managed to double its NAV over the year to September 1999 and notch up a similar increase in its share price. Subsequently, the shares have risen by 300%.

Interesting times

The end of the 20th century brought in perhaps one of the most interesting - and difficult - periods for contrarian investors. The technology and telecoms boom of the late 1990s, culminating in the internet or dotcom bubble, saw stratospheric valuations of favoured stocks.

At the same time, good old-fashioned businesses that were actually quite profitable were derated. The US NASDAQ index was the most obvious example of froth. Having already more-than-doubled between March 1996 and March 1999, it doubled again in the year to March 2000.

For contrarian investors who paid attention to valuations, these were times of great anticipationFor UK fund managers, stocks such as Vodafone and Logica were the test. If you didn't own these, you were likely to underperform. Vodafone's share price increased by nearly five times in the three years to March 1999.

At the beginning of 1999 it and Logica were on a price/earnings ratio of more than 60 times. Logica went on to more than double in price by March 2000. Over the same time, the solid and boring British American Tobacco halved in price.

For contrarian investors brought up to pay attention to valuations, these were times of great anticipation.

Many were licking their lips over undervalued stocks with good cash flow. It was widely believed that stocks had never been cheaper. But contrarian investors also came under pressure because of their underperformance against the indices.Some caved in and bought stocks they wouldn't normally have gone near.

One who did not was Chris Burvill, then manager of Temple Bar investment trust.

So when the bubble burst at the end of March 2000 and the FTSE 100 fell by 20% over the next two years, Temple Bar's price increased by more than 20%. This was a classic example of a contrarian being rewarded for keeping his nerve.

For those who distrusted the "Goldilocks" economy in the run-up to the great financial crisis of 2008, it would be hard to match Ian Rushbrook (who sadly died almost at the moment of his triumph) and Robin Angus of Personal Assets trust. Angus commented thus in the July 2007 annual general meeting: "Is the financial world sleepwalking into disaster? No. It's worse than that. It's walking into disaster wide awake."

By and large the period since the financial crisis has been a difficult one for contrariansThanks to raising liquidity and avoiding bank shares prior to the crash, in the two years from July 2007 - while the West's financial system seemed to be falling apart and the FTSE All-Share fell by nearly 30% - Personal Assets' NAV fell by just 8%. Healthy cynicism and detailed analysis of valuations are perhaps the tools of the trade for the successful contrarian.

The world has not completely fallen apart - at least not yet - but by and large the period since the financial crisis has been a difficult one for contrarians.

Value stocks have been out of favour, and momentum, quality and low volatility have been the order of the day. It seems to have taken a long time for value to show its head, although there are some signs it may be happening now.

What seems like a huge bubble in bond markets - supported by central banks' increasing use of quantitative easing - has arguably distorted relative valuations between stocks and "risk-free" assets. So the yardstick of the 10-year gilt yield has become less useful for determining whether equities are expensive or not.

Fruitful approach

Contrarians probably avoided the emerging market boom of 2010, but they may well have been fishing in emerging market waters since then.

History shows that it has rarely been wrong to buy out-of-favour stocks with good yieldsDuring the height of the angst about China in January 2016, JP Morgan Emerging Markets Income fund could be bought for 73p. It has since recovered by more than 50%. Other areas of interest to the contrarians have been energy, mining and financials.

BlackRock World Mining could have been bought for 170p in January 2016. It is currently up more than 60%. Polar Capital Global Financials was available for 89p in February 2016. It is now priced at 107p. Both stocks have decent yields.

All three may just be enjoying false dawns. But history shows that it has rarely been wrong to buy out-of-favour stocks with good yields and wait for the market to come your way. That is the essence of being contrarian.

David Liddell is director of Ipsofacto Investor.


This article was first published in our special publication 21: Twenty-one years of Interactive Investor. Download your digital copy for free here.


This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.