Contrarian Investments

September 15, 2014


Contrarian Investing

If you simply do what everyone else is doing, is it not rational to come to the conclusion that your end result will be the same as everyone else?

1. For the twenty years ending December 2013, the S&P 500 Index averaged 9.22% a year. An excellent historical return, meanwhile the average equity fund investor earned a market return of only 4.20%. Keep in mind a 9% would double your money approximately every 8 years while a 4% return would double your money every 18 years.

2. In 1960 the average holding period for a stock was 8 years and today it is approximately 5 days. This statistic shatters all hopes of building long term wealth in the stock market for individual investors.

So how do you fly above the majority? How do you set yourself apart from the crowd? It’s actually quite simple, do what others are not or occupy the space that is empty. It’s not that hard of a concept to grasp right? Well think again because for decades countless numbers of investors have piled into the markets only to lose their shirts time and time again. It’s like watching a rerun of your most hated tv show (Dance moms, my wife loves it but I hate it!) over and over again.

You Don’t Believe Me?!

Let’s dig into some behavioral analysis of the stock market on multiple occasions throughout history. Here are a couple of examples of when the majority of individuals loved an asset class and the result.

TSP May 2014 - 2000 crash

Prior to this stock market crash people who had no idea of fundamental stock valuation let alone proper asset allocation were getting rich in the stock market. Look at this excerpt from CNN Money magazine dated March 1, 2000.

Rosario Maiolino gambled his savings on a single stock. One tiny, obscure tech stock that most people had never heard of. Over a few years, he plowed every spare dollar into that one company, until by late 1998 he’d bet a total of $325,000. Other than his house, it was his only major investment. Was this guy nuts? It certainly sounds insane–like some stock market version of extreme sports (kamikaze investing, anyone?). But the gamble paid off: Last year the company–digital wireless communications wonder Qualcomm (QCOM)–staged a breathtaking run, racing from $52 to $212, splitting two for one, then hitting $659. In all, it rose 2,619% in 12 giddy months, making it one of the greatest get-rich-quick stocks of our era.

You mean to tell me that someone risked hundreds of thousands of dollars on a single stock they knew absolutely nothing about?! That’s absolutely insane right! I’m sure Mr. Maiolino feels like he is the smartest man in the room but I sincerely would like to know where he is today because this is how Qualcomm ended up performing during the following years.

QCOM 2000 Crash

Over approximately 30 months Qualcomm ended up losing about 84% of its value. Yes, you read that right, it wasn’t a typo!

Let’s take a look at another example

Housing Crash

In 2006 & 2007 if you spoke to anyone about real estate chances are they were buying or selling for huge profits. I personally was among the hoard of individuals who was under the misconception that housing prices only increased over time. The thought of a decline in home property value never entered my mind or anyone else’s for that matter.

If only I had stumbled upon Peter Schiff at a much younger age…

I love this video and was glad to come across it the other day. If you’re strapped for time Peter Schiff brings up numerous economical facts supporting a housing collapse but is literally laughed at on air by his peers.

Emotional Discipline

Everyone knows the magic formula is to “Buy low and sell high” but if it were that simple everyone would be doing it right? So what is the secret?

Well first step is knowing how to fundamentally value an asset, the next step is having the confidence in your conclusions while the majority is doing something completely different.

I want to show you a prime example of what I’m talking about.

How many people do you know that drink Starbucks coffee? Matter of fact how many people do you know that drink Starbucks coffee on a daily basis? Whenever I walk into the office I am guaranteed to see a Starbucks cup on someone’s desk without fail. With that in mind, let’s all agree that Starbucks is the leading and largest coffee chain in the world.

Take a look at Starbucks during the last stock market collapse.

SBUX 2008 Crash

At the very bottom of the market crash Starbucks (SBUX) was trading for approximately $7.5! I just want to point out how insane that valuation is:

At $7.5 SBUX was trading for just 6 times free cash flow! Remember Free cash flow is the money from net income that’s actually real. It’s the money that’s actually available to you as an owner. It’s the money that’s left from the profits the company brings in after all of the capital expenditures are paid.

This valuation is incredibly insane, in short it means that if you had purchased Starbucks for $7.50 you would have paid 6 times free cash. A franchise like Starbucks typically sales for about 20-25 times free cash. That’s approximately a 75% discount on a major franchise. Truly a once in a lifetime opportunity!

Here is what Starbucks looks like today…

SBUX recovery

While it is sitting at approximately $70 today, Starbucks at one point was trading for approximately $80, literally 10 times its low of $7.5

Key Takeaway

In early 2009, the sentiment towards the stock market was absolute disgust. The majority of people thought the stock market was going to fall even lower and perhaps a U.S. default. Headlines showed no signs of hope…

While many investors couldn’t take any more pain and sold their investments. This time period was a perfect explanation of Warren Buffet’s famous quote:

“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful”

When Starbucks was trading around $7.5 chances are you couldn’t pay someone to invest their hard earned money into this stock and this is my entire point. In order to achieve results like nobody else you have to conduct business like nobody else.

As a contrarian investor you have to develop the inclination to do the exact opposite of what everyone else is doing. It is going to feel like the wrong thing and sometimes it may even make you sick, after all this is your hard earned money you are investing. But this is where you will find the best investments that offer the most lucrative returns.

Here’s to our wealth!

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