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What "contrarian investing" means to us

February 2016
5 mins. To Read

Our investment philosophy is fundamental, long-term, and contrarian. We are fundamental because we view our investments as a business owner would, and we are long-term because we have a multi-year time horizon. But what does it mean to be contrarian?

Being a contrarian investor involves taking views that others might oppose and looking for opportunities in places others fear to tread. But a dictionary will say that being contrarian means opposing popular opinion, and that isn’t always the case for us. For one, it is difficult to know exactly what popular opinion is. Every trade has a buyer and a seller, so at the market price, the bulls and bears must be matched. A stock will not trade at a price where only bears are present—its price will fall until bulls and bears are balanced.

For this reason, it’s also common to think of contrarian investing as buying only stocks that have underperformed. This is also too simplistic. If we believe an outperforming stock or one with an above-average multiple trades at an attractive discount to intrinsic value, we will buy it. When we say “contrarian”, we mean an independence of mind, and the willingness to stick with high-conviction positions even when doing so is uncomfortable.

It has been uncomfortable over the past two years, as momentum has driven markets through a narrower and narrower subset of stocks. We have responded to this environment by doing what we always do—focusing on the relationship between the price and value of individual securities, and making changes to keep your capital in those that we believe offer the best balance of risk and reward.

Two examples are Barrick Gold, a miner, and QUALCOMM, a developer of smartphone technology. Both stocks lagged world stockmarkets by over 30% last year, and both were bought by the Orbis Funds over that time. Beyond that, they have little in common. By remaining focused on long-term fundamentals as markets swung, we were able to take advantage of both opportunities.

Gold miners are often viewed as proxies for an investment in the metal itself. But just like other companies, gold miners’ profits are the difference between their costs and the value of what they sell.

Maintaining that perspective has been rewarding in Barrick’s case. A key number for any miner is its “all-in sustaining cost”—the cost per ounce, including capital investments, to maintain gold production. Since 2012, Barrick has reduced its all-in sustaining cost from US$1,014 to $830/oz. We built a position in the stock in early 2015, and it detracted from performance through much of the year as the gold price fell. We remained focused on the long-term value of the business. In September, we estimated that equity and debt markets valued Barrick’s reserves at $200/oz, which we considered an undemanding price to pay for the “option” of extracting those reserves for $830/oz and selling them for $1,125/oz. We substantially added to the Funds’ positions.

Gold has risen to $1,240/oz so far this year, and Barrick has outperformed sharply. We are not counting on the recent price acceleration continuing, and if enthusiasm for the share or the metal reverses, Barrick could underperform again. We have little idea where gold prices will go, especially in the near-term, but with continuing fundamental improvements, we believe Barrick continues to offer a reasonable balance of risk and potential long-term reward.

QUALCOMM has two businesses. The company’s licensing arm collects royalties from smartphone manufacturers who use its technology. This is a steadily profitable business, but it looked to be under threat in 2015. Despite an agreement with China’s regulator, some smartphone manufacturers there stopped reporting unit sales to QUALCOMM, making it difficult to collect royalties. At the same time, the anti-trust regulator in nearby Korea issued an early-stage report recommending that QUALCOMM change its licensing practices. The company’s chip business got tough news in 2015 as well—for its flagship Galaxy S6 smartphone, Samsung Electronics used an internally-developed chip rather than one from QUALCOMM.

The Samsung chip loss, Chinese royalty issues, and Korean anti-trust report put a dark cloud over QUALCOMM’s shares, which lost over a third of their value in 2015. In our view, the Samsung and China issues would prove temporary. We believed QUALCOMM would reach agreements with major Chinese manufacturers, helping it to properly collect its royalties. Samsung was well positioned to use its own chip for the S6, but we believed using a QUALCOMM chip for the S7 was in both companies’ interests. We were less sure about the Korean inquiry, but in our view the company’s net cash, low valuation, and other sources of revenue provided a margin of safety. We added to the Funds’ positions through the second half of 2015, though we trimmed the position slightly in mid-January to take advantage of selected opportunities elsewhere.

Deals with major Chinese manufacturers have come through, and in February Samsung announced that its Galaxy S7 range would use QUALCOMM chips. The stock has performed well recently, although the Korean regulatory issue remains a risk. We believe QUALCOMM continues to offer reasonable long-term value.

Markets have been particularly volatile and indiscriminate of late. During these times, we believe we can garner additional value for our Funds by staying disciplined and having confidence in our analysis. While in hindsight the best moments to invest appear obvious, doing so is almost never easy. It is our ability to make contrarian decisions at times like these that can make a real difference for our fellow Orbis Fund investors.

This Report does not constitute advice nor a recommendation to buy, sell or hold, nor an offer to sell or a solicitation to buy interests or shares in the Orbis Funds or other securities in the companies mentioned in it (“relevant securities”). It has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Orbis, its affiliates, directors and employees (together, the “Orbis Group”) are not subject to restrictions on dealing in relevant securities ahead of the dissemination of this Report. Subscriptions are only valid if made on the basis of the current Prospectus of an Orbis Fund.

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