Thursday, December 28, 2006

Opportunistic and Contrarian Investing-Be An Idiot!

The Wall Street Transcript regularly presents interviews with analysts, corporate managements, and portfolio managers. In a recent Wall Street Transcript interview (subscription required) Gary Furukawa describes his firm's approach to investing:

We have a strong contrarian bias that helps us be opportunistic in our approach. While we recognize that the market is very efficient in discounting information, investors as a group can form incorrect opinions, biases, or assumptions regarding the prospects for a particular company. We like to question those core assumptions and assess how we would view those assumptions differently than how the Street might be viewing them. At some point in time, whether it be through an internal catalyst, through some type of exogenous event, or whether it just be through the passage of time, sentiment usually begins to swing back toward the company.

Mr. Furukawa and his firm are quite right. Isn't this the essence of buying a turnaround situation or optimizing the short-sale of an expensive stock? Very early in my career there was an unshakable belief in the ever-present threat of inflation and the inevitability of higher energy prices. Those 1970's and early 80's beliefs were congenitally implanted into portfolio managers' DNA. You were an idiot, not to accept those assumptions.

I was an idiot...thank God, I built a career out of questioning what was a ubiquitous mainstream assumption. The ability of the consensus to delude itself entirely and miss the obvious is one of those features of human behavior that you can overcome and master to create investment performance.

Assess the critical assumptions that you endorse when you select a security. How reasonable is a 30% or 40% growth rate when that represents the consensus? What would the valuation look like if a more "normal" 10-15% growth rate were the future growth rate? What can go wrong in your assumptions?

Here is a screen of companies that have high estimated growth rates greater than 20% and have appreciated YTD greater than 30%: Spreadsheet link

Bottom line, know what you own and why. Don't deceive yourself into accepting assumptions that are arbitrary or indiscriminate.

In yesterday's (subscription required) Henry To presents my post on self-deception. I think one of the keys to successful portfolio management is the ability to avoid self-delusion. If all of us are operating with the same assumptions in thinking about a business, why would any of us expect to garner an advantage?

As I say in the article,

Guard yourself against the possibility of self-deception. Wishful thinking is not a subset of thinking; it is merely a substitute for thinking. Don't succumb to the seduction of conventional wisdom and elegant theories. Remember, mankind has subscribed to a belief in a flat earth for much longer period of time than the modern viewpoint. But for many years, the prevailing wisdom assumed the tenets of flatness! Theories tend to rely on simplifying assumptions…theories represent an approximation of reality.

More on this topic in a later post and book review!

Happy New Year to All!


At 4:53 PM, Blogger Spreadsheet said...

Good post. I agree. While its easy to read books and interviews of fund managers regarding contrarian investing, its much more difficult to do in practice. If you have the nads and can think independently, it oftentimes pays off substantially. The Fortune article about Ken Heebner illustrates this point fabulously:

Again, nice post!



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