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Contrarian Investing On Bad News: The Warren’s Approach

by Abhishek   ·  June 21, 2014   ·  

Everyone hates bad news. Nobody wants to hear bad news. All wants to hear good news that soothes their ears. But many times bad news provides us the wonderful opportunity which can make our future  more good. This is very true for stock market. Share market is a place where the reactions of news is greatest. You get a good news about any company its share price goes up. You get a bad news its share price goes down. If the news is too much negative news the stock price falls like a rock rolling down from the mountain.

In stock market people get in panic and sell their stocks. Even Mutual fund houses that are managed by trained professionals gets in panic and sells their holding which takes the prices further down. But this could be an excellent opportunity to buy such stocks and they can give your huge returns in less time. Lets see it with some past examples.

Maruti

Maruti was trading at 1800 levels in May 2013. Then strike by its workers at Manesar plant started taking the stock price down. The strike happened multiple times and this whole strike drama continued for around 3 months. Negative news related to strikes where continuously flashing on the screens of various news channels and stock price continuously went down until this whole issue was permanently solved. The stock went down from 1800 to 1200 levels in August 2013. Because of the strike the production was badly hit and all analysts were predicting further more down side targets. But the stock started moving up recovered all loses and made a high of 1850 in January 2014. Those who have bought the shares of Maruti at 1200 when stock crashed due to bad news  have made 50% profit in just 4-5 months time.

The same stock again crashed 15% t0 1550 in Mid January in two days because of negative news of new Gujarat plant. Stock recovered in the following week and now trading at 2500 levels.

IRB Infra

The stock price of IRB Infra dropped by 30% from 104 to 68 levels, in a month when there were negative news of MNS attacking their road toll booths in Maharastra. The stock immediatly recovered after the news effect was over and tripled from that level in 4 months time.

Infosys

It fallen many times owing to bad news of resignation of top management people and recovered from all bad news making a new highs.

Satyam Computers

The stock crashed from 300 levels to 15 rs in a month on the bad news of scam and recovered 15 rs to 130 levels in a very short time, those who invested at 15 Rs levels made a very good money.

Like wise you can find so many example where stocks which fell down due to bad news gave good return in quick time. This doesn’t means you start buying any falling stock. Going contrarian in fundamentally good stocks is beneficial.

Warren Buffet is a great investor who loves contrarian investing strategy. In fact he made most of the money by doing contrarian investment only.  Stock Market buys on good news sells on bad news , Warren buys on bad news.

There are to ways to do contrarian invesment

1. Normal Contrarian Investment Strategy

In this strategy investor buys stocks that have recently performed poorly due to some reason. 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. In this strategy investors does not pay much attention to fundamentals or long term business economics of the companies. So long as the share price has recently fallen, the stock is a candidate for purchase.

contrarian investing on bad news

2. Selective contrarian investing strategy Warren Buffet approach

This the Warren Buffet’s approach, who 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 company. This strategy differs from the traditional contrarian investment 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.

Adopting the same strategy, Warren Purchased 1.7 million shares of Washington post at the price of  $6.4 in 1974 and sold it at the price of $500$ after 27 years on the profit of  8468% . This  gave him CAGR return of 17.8%

The stock of Satyam Computers is a good example of this kind of approach. Satyam was a very good company, the 4th biggest IT company of the country.  The stock price fell from 300 to 15 Rs due to the expose of scam. The 15 Rs was a very attractive price  to attract other companies to acquire this company which is at throw away price of 15 Rs . And that happened also Tech Mahindra acquired Satyam and from 15 Rs it made a high of 130 and later merged with Tech Mahindra. Those who bought it at 15 made a huge profit of above 800% in  a very short time. Warrent Buffet keep looking for such kind of opportunities for profitable investment.

Going contrarian doesn’t mean buying any fallen stock. One with good fundamentals and future growth prospectus can be good for investment. When good companies stock price falls due to bad news , scams or any other negative things they give us the excellent opportunity to make good money.

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