Mike Rivers' Blog Headline Animator

Friday, August 20, 2010


My daughter, like her mama and daddy, is a tad bit independent. 

Being terribly independent myself, I have little problem with that.  But, it can be a bit difficult at times, especially as a parent trying to get a three-year-old to brush her teeth or get dressed in the morning.

One of her teachers, Ms. Karen, was very delicate in communicating this predilection to us.  She used the sandwich approach, saying that Vivian was 1) self-directed, 2) independent to the point of being difficult, and 3) more likely to be a leader than a follower.  Mama and daddy were quite proud despite the obvious and nerve-fraying meat of the sandwich.

Like most parents, we tend to amuse ourselves with our child's tendencies.  So, to prove Vivian's independence to others, we simply ask her if she is a contrarian.  Naturally, she proudly states that she is NOT a contrarian (missing the irony of the statement).  Mama and daddy are quite amused, even if at her expense.

The investing world, too, is filled with it's own Vivians--contrarian to a fault.  They don't see themselves that way, of course.  In fact, they credit their contrarian approach for their investing success.

Don't get me wrong, I think a contrarian approach makes a lot of sense, but not as a principle to action.  It makes sense to look at what everyone else is selling; the contrarian trash pile is an excellent place to look for bargains.  But, everything thrown away is not of value, and doing the opposite of everyone is not by itself the best approach to picking investments.

I was reminded of this when I saw how many big, smart, and vastly more-successful-than-me investors had invested in British Petroleum (BP) during the second quarter.

Did they invest in BP simply because everyone was selling?  This makes some sense because it's obvious that many sellers were irrational, simply selling to get it off their books no matter at what price.  As a trading strategy, I suppose I follow that reasoning.

If you had followed BP for years, understood its value, and then bought when the price tanked, I can understand that, too.  That shows an appreciation for the nature of the investment, the risks involved, and the price to value relationship.

But, to buy it as a long term investment simply because others are selling makes little sense.  As Warren Buffett put it, if you aren't willing to own an investment for 10 years, why would you want to own it for 10 minutes? 

I didn't buy BP because I thought it was a terrible company before the Horizon rig blew up in the Gulf of Mexico.  It had been carefully cultivating its green image and spouting "beyond petroleum" blather while racking up lousy returns and the worst environmental record in big oil (just for reference, the most profitable company, Exxon, has one of the best). 

Not only did I judge BP poorly, I also thought its long term risks were almost incalculable.  Few thought Three Mile Island would halt one of the cleanest, most efficient energy sources in America, but it did.  Knowing how irrational people were about that, why would I think a huge oil spill in the Gulf would be different?

Contrarians buy what others are selling without necessarily  understanding their purchase.  The strategy works like a charm...until it doesn't.  That's why a lot of contrarians tout their records as proof.  But, investing has a huge element of luck as well as skill, so both short and long records can be deceiving. 

Exhibit 1 is Bill Miller's record at Legg Mason Value.  He beat the market every year for 15 years, then got crushed from 2006 to 2008 (down -56% vs. the market's -23%).  I'm certain he did more research than a pure contrarian, but he also owned Bear Stearns, Countrywide Credit, Fannie Mae and a host of other companies with terrible business models.  After all, he had made a fortune and his reputation buying lousy banks in the early 1990's that were bailed out by the government.  Not surprisingly, he was cursing the government for not bailing out his investments in 2008.

A contrarian approach works as a good starting point, but it's not the whole enchilada.  You need to do a lot more research and be very honest with yourself (if you don't really know, you'd better walk away). 

Excellent long term investment results are as much about not stepping on landmines as buying good investments.  A pure contrarian approach will eventually find landmines and lead to a blow-up.

Now, if I could only convince Vivian that contrarianism isn't its own end...

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

No comments: