Markets
Extreme Contrarian Investing
Nearly every investor claims to be a contrarian, in pursuit of value the market does not recognize. But who has the nerve to buy what the market truly detests?
By James K. Glassman, Contributing Editor
From Kiplinger's Personal Finance magazine, June 2006
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Things change. That phrase, the title of a fine 1988 David Mamet movie about a shoeshine man who passes as a Mafia don, is one of investing's most important lessons. It inspires courage to persevere with companies you love and to buy stocks the rest of the world hates.
Take steel. Over five years, starting in 1998, steel prices fell to 20-year lows, triggering 47 bankruptcies. Stocks plummeted. Shares of AK Steel Holdings Corp. -- which makes flat-rolled steel for the auto, appliance and construction markets -- dropped from $29 to $1.70 between 1999 and 2003; U.S. Steel, the largest domestic manufacturer, skidded from $34 to less than $10; and even Nucor, the best-run company in the sector, fell by nearly half.
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Foreign competitors, bad management, overbearing unions and the economic slowdown that followed the 9/11 terrorist attacks battered the U.S. steel industry. No wonder many investors never wanted to see a steel stock again.
Then things changed.
The comeback. Strong companies bought out weaker ones, management improved, unions chipped in, and President Bush imposed tariffs that thwarted competition for 21 months. Most of all, the global economy got better, boosting demand. Stocks revived -- spectacularly in many cases. For the three years ending March 31, 2006, Nucor's shares rose from $18 to $105, and Cleveland-Cliffs, the world's largest producer of iron-ore pellets, jumped from $9 to $87. Many steel stocks hit record highs, including U.S. Steel, which grew sixfold in three years.
With perfect hindsight, we can see the obvious: An industry as important as steel was not going down the tubes, and prices of many excellent companies had become absurdly cheap. The market capitalization of Nucor dipped to just $2 billion in 2000 -- despite its remaining profitable, with a return on equity of 15%, minimal debt and a rising dividend. Nucor's market cap is now $16 billion.
Buying shares of Nucor in the late 1990s during the steel crash, investing in a coal company like Joy Global in 2002 amid an energy glut (Joy Global has since gone from $3 to $60) or purchasing shares of AMR Corp., American Airlines' parent, in 2003, with a persistent passenger shortage and rising fuel prices (AMR has since gone from $1.41 to $27), is what I call Extreme Contrarian Investing.
Nearly every investor claims to be a contrarian, in pursuit of value the market does not recognize. But who has the nerve to buy what the market truly detests?
As I write, what the market detests is chicken. Worldwide, there have been 191 confirmed human cases of avian flu -- a virus that infects birds and is rarely transmitted to people. Half the cases were in Vietnam, none in the Western Hemisphere. You can't get the disease from eating cooked chicken. Nonetheless, American exports have plunged, and prices of chicken legs at the Georgia dock have dropped from 32 cents to 17.5 cents a pound. "Nobody has ever seen anything like this," says John Tyson, who runs Tyson Foods.
Game of chicken. Few stocks present pure chicken plays. The best, writes James Grant in Grant's Interest Rate Observer, is Gold Kist (symbol GKIS). Although it has a solid balance sheet (more cash than long-term debt), its stock has fallen to $13, from a high of $23 last June. Other, nearly pure choices whose shares are down by about half are Sanderson Farms (SAFM), based in Laurel, Miss., and Pilgrim's Pride (PPC), of Pittsburg, Tex. Tyson (TSN), which has diversified into pork and beef, is down by only about one-third.
Grant, one of Wall Street's most famous bears, says, "To come right out with it, we are chicken bulls." He recently wrote in his newsletter that he is continually "decrying complacency in the face of risk." But in the case of the chicken bear market, "the risk is manifest, the crisis has broken, and the bad news (or at least some of it) is out and the relevant stock prices have reacted (or at least have begun to react)."
