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Air Canada shares began to take off early in September. By January of this year they were cruising just under $2.50 share – a rise of 150 per cent from their summer lows – and providing a good return for contrarian investors. (Andrew Vaughan/The Canadian Press)
Air Canada shares began to take off early in September. By January of this year they were cruising just under $2.50 share – a rise of 150 per cent from their summer lows – and providing a good return for contrarian investors. (Andrew Vaughan/The Canadian Press)

Value

How three contrarians found value in unloved stocks Add to ...

They are two of the best-known companies in Canada. One is a 75-year-old institution with a leading position in the country’s transportation sector. The other is an international leader (and cultural phenomenon) in mobile communications. And last summer they were completely out of favour with the investment community.

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Air Canada’s stock was trading below $1 per share. There were rumblings the company could be forced to go through another restructuring under bankruptcy protection. By the end of July, more analysts rated the company a sell or hold than a buy – an extremely rare situation on Bay Street.

Research In Motion Ltd. shares had slipped below $8 apiece. The BlackBerry maker had reported hundreds of millions of dollars in losses and was laying off thousands of workers. Analyst sentiment had turned overwhelmingly negative on the company. Of 46 researchers tracking RIM, no less than 43 had either a hold or sell rating. Only three lonely voices thought it might be a good time to buy Research In Motion shares.

So what happened to these unloved stocks?

Air Canada shares began to take off early in September. By January of this year they were cruising just under $2.50 share – a rise of 150 per cent from their summer lows.

RIM shares started moving around the same time, and while they had some ups and downs, by mid-January they had approached $18, for a 125-per-cent return on investment for those who bought at the bottom.

Of course hindsight is 20-20, and there are thousands of out-of-favour stocks that stay that way. But the examples of Air Canada and RIM show the returns can sometimes be outstanding by going against the grain, and practising what some call contrarian investing.

Benj Gallander is widely considered to be Canada’s top authority on contrarian investing. He has literally written the book on the subject (in addition to two other bestsellers). He has 35 years of experience in the investing industry and has run his “Contra the Heard” investment letter for 18 years. His model portfolio enjoyed a return of 30.4 per cent last year, and has a 15-year annualized return of 14.9 per cent.

“My style has always been contrarian,” Mr. Gallander says. “I guess it’s just how my brain works.”

Mr. Gallander’s approach is to look for companies that have been around for at least 10 years, and have been successful in the past. Then he buys them only when they are available at a deep discount to their historical trading price, with an expected upside of at least 100 per cent for the stock. Mr. Gallander tracks a company for a minimum of six months, and often as much as two to three years, before making a purchase.

There are some key criteria he is looking for when evaluating a company. They include minimal or no debt, a strong management track record, and an industry that is not in decline.

It can seem easy when you look at Mr. Gallander’s approach – but independent equity researcher Chris Damas has a blunt warning.

“Contrarian investing is like holding a loaded gun. If you don’t know what you are doing, you can blow your foot off.”

Mr. Damas is principal of BCMI Research, an independent equity research and trading company based in Barrie, Ont. Despite that warning, he says contrarianism almost always has better returns than buying a popular investment, because when sentiment turns from negative to positive, there is more room for the depressed stock to swing to the upside.

Unlike Mr. Gallander, who most often buys stocks trading at less than $10 per share, Mr. Damas recommends individual investors reduce risk by practising contrarianism only on the top 60 or 100 companies in size – and usually not in commodity sectors. He cites Yellow Media Inc. and Poseidon Concepts Corp. as two recent examples of possible small-cap contrarian plays that would have burned investors.

Larry Sarbit also keeps risk top of mind. Mr. Sarbit has 27 years of experience in the investment industry, including managing mutual funds for Investors Group and AIC. He now manages the IA Clarington Sarbit Equity Trust. He is a value investor – and for him that often includes a contrarian approach. “That’s where the opportunities are. You don’t find bargains where everyone’s happy.”

Mr. Sarbit seeks out overlooked stocks, then looks at the company’s fundamentals, growth prospects and sustainable advantages. He then talks to company management, and considers the outlook for the company’s industry. Finally, he determines whether the company’s stock is reasonably priced – or even better, trading at a “cheap” price.

“You lower risk when you meet these qualifications,” Mr. Sarbit says. “You also should ask yourself what can go wrong? And not how much can I make, but how much might I lose? If at every step you ask the right questions, you reduce your risk.”

Another key part of the contrarian plan is an exit strategy – that is, one must plan when to sell a stock to lock in profits. Mr. Gallander says having an exit strategy “is huge.” He makes sure to set a target selling price for his investment when he buys a stock. When the target is reached, he will sell half or even all of his investment.

Mr. Damas says he finds rules such as selling half your investment when it doubles “too robotic. If it is a cyclical industry, you need to have an idea about the industry and its past, and exit when the sector is peaking.”

Mr. Damas was one of the contrarians who took a flyer on Air Canada. He bought the stock (and recommended it to his clients) as it broke above $1 per share. However, he cautions that airlines are high risk and most “do-it-yourself” investors would have no clue how to properly analyze an airline company and its financials.

Mr. Gallander is generally not a fan of airlines, though he made a classic contrarian play in the sector: he bought KLM Royal Dutch Airlines shares not long after the attacks of 9/11. The stock eventually quadrupled from his purchase price.

As for RIM, it got the attention of all three contrarians when it traded for only slightly more than the net cash on its balance sheet. Mr. Gallander bought some for his fund at two times late last year, and still holds it – despite its rally, the shares have yet to reach his target price. When you are an experienced contrarian investor, patience is just as important as independent thinking.

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