A book is to a mind, what a sword is to a warrior. It is often said that books we read make us. And, when I came across doctor writer Atul Gawande’s critically acclaimed book, The Checklist Manifesto, in 2009, markets around the world were amidst an economic crisis.
Though this book lays emphasis upon the importance of creating checklists as applied in the field of aviation, medicine, etc. I decided to apply this checklist format to aid my investment decisions. The beauty of having an investment checklist in possession is that you will never make the same mistake twice, thereby, paving an effective way of removing mistakes; and the lesser the mistakes, better the results!
In stock market, an investor is bound to face different types of marketbull, bear or sideways. While it is not possible to accurately predict market’s behavior, experience has taught that strictly adhering to a well-thought checklist can go a long way in helping one stay grounded in different cycles of the market, more importantly in extreme situations.
Many think that having a checklist slows the investment research process down. However, it has become increasingly evident that a checklist improves efficiency. This leaves more time for a fund manager to evaluate newer options which could be the next potential multi-bagger.
Based on my experiences as a contrarian investor; for a good part of my investment journey, I created a checklist of what works for contrarian investors. Given forth are some of the factors that a novice investor who wishes to take a contrarian bet can consider. (Please note the listed pointers are not sacrosanct)
As you might have observed in the given points, having a checklist alone is not enough. One should carry a calculator as well, while relying on the checklist. In essence, a checklist ensures that your investment decisions are not emotional, but are backed by logic and makes sure you have looked at all parameters. Because of these, no two person’s investing checklist may look similar.
My checklist as a contrarian investor
- Look at the market cap while investing
Lower the market capitalisation of the company/sector that you are looking to invest in, the better it is for your portfolio. For example: If you go back to second half of 2015, or early 2016, when the market caps of the sectors linked to oil were very low, investors were negative on the sectors and the margins of oil companies had fallen. Virtually, there was no interest in oil stocks in 2015-16. This made a case of contrarian investing.
- Check for investment positions of institutional investors
Are institutional investors underinvested in a particular company or sector as compared to the benchmark? It may just be the suitable contrarian pick you have been meaning to invest in.
- Keep track of the profit margin trends
When profit margins come down significantly in a sector, it is a suitable time to make a contrarian investment. In fact, I believe that the best contrarian investments are made when you bet on low valuations for cyclically lower margins.
- Take note of how leveraged is the company
In 2008, a set of contrarian investors invested in global financial companies like Washington Mutual, Bear Stearns (had to be merged), Lehman Brothers etc., which were highly leveraged companies, and their stocks dipped significantly amidst the financial crisis. Our key lesson from this should be to avoid investing in companies, which are highly leveraged.
Advantages of checklist
- Provides first line of defense against failures in minimum necessary steps
- Discipline in conducting in-depth research
- Improves efficiency in stock picking
- Improves investment outcome without any significant increase in investing skill
- Important parameters to be considered: Market cap, margins, positioning and leverage
S. Naren is Executive Director & Chief Investment Officer, ICICI Prudential AMC
