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Good news from the contrarian side of the stock market

These Canadian contrarians are critical of market shenanigans, but true to their convictions, they can find hidden gems among the wreckage.

This is the first time we have seen a parallel drawn between the credit crisis and Harry Potter.

“Like the feared guards of Azkaban, the Debt Dementors arrive with little warning and suck the happiness out of their victims, who thought making money was the inevitable result of their financial acumen, perhaps because they were confusing a bull market with brains.” (For those who have managed to avoid both the books and the movies, Azkaban is a prison for wizards.)

This unstinting criticism comes to us from the staunch contrarians at Contra the Heard, who publish their observations four times a year from their bastion in Toronto. And despite the grim picture painted in the quote above, they have not fared badly at all in the past few months.

We will see how they have done with several of their selections (they offer no buy, sell or hold advice, but simply invest in stocks and comment on their progress). But first, a few more words on the state of the markets from the contrarian side of the fence.

Implode-O-Meter

There is a web site called Implode-O-Meter, the Contra Guys point out, that tracks mortgage failures in the United States. It listed 249 major lending operations, 22 home builders and 74 hedge funds that had failed at the time their report was published.

Checking the site this morning, we discovered that four more lending operations have since imploded, as well as one more home builder. No more hedge funds have failed (although we’re not entirely sure that’s good news, given the role these funds have played in the whole mess).

The authors are not kind to the wizards of Wall Street: “As long as Wall Street was swimming in money and homeowners blithely tapped the rising equity in their homes, popular sentiment echoed the famous credo of Ronald Reagan: ‘Government is not the solution to our problems; government is the problem.’ How things change. Seeing these paragons of capitalism collectively pleading for a bailout is something to behold.”

Short of stuffing these miscreants into Azkaban, there is a way to deal with all of this market madness.

Bringing back the empties

“In such weird circumstances, it is more important than ever for investors to be well diversified. The notion of absolute safety is an illusion. Even cash, which we like a lot, is not without risk.”

Consider Zimbabwe, they add. “A year ago Z$1,000,000 would get you a few cases of beer. Now, just bringing back the empties would net you Z$140,000,000.”

The Contra Guys put their money where their convictions are, with a portfolio that covers small, medium and large companies. Beyond these stocks, each holds other property and assets that “comprise a mosaic of risk tolerance.”

To be sure, the stock portfolio has both winners and losers. That is the nature of taking such an approach: not all the pumpkins will turn into golden carriages, but the ones that do should more than compensate for the ones that lag behind. Last year that did not happen: the portfolio lost 15.5 per cent. Yet over the last five years, it has gained 15.4 per cent — and over 10 years (which covers the bear market of 2000-2002) it is up 16.2 per cent. It’s an interesting ride, to say the least.

We will look at several entries in the portfolio that have done well for these investors.

A lovely little money spinner

Hartco Income Fund (TSX-HCI.UN) “has continued to be a lovely little money spinner,” say the Contra Guys. “Since its inception, the fund has steadily pumped out distributions of 60 cents a year, which is extraordinary given that the units are trading at $3.40. Evidently, the market doesn’t think that yield is sustainable, but that has consistently been its view from day one.”

Hartco has been in the computer business for over 30 years, when it began as a personal computer resale business. It distributes and franchises information technology and also has a number of limited partnerships in the industry.

Last year it closed its ComputerSmart retail division. This cut into earnings and took a bite out of shareholder equity, but also relieved the company of a weak link. And with no debt outstanding, the book value is still $4.40 a unit, add the authors.

A slowdown in IT spending would certainly make it more difficult to keep up the distributions, but since net cash flow in 2007 was almost double the $8 million paid out, there’s plenty of room left. “This one appears to remain a bargain,” say the Contra Guys.

Yippee yiy-yo kiy-yay

In a very different region of technology lies Norsat International (TSX-NII), which makes satellite ground station equipment. The Contra Guys are very happy with the results since president and CEO Dr. Aimee Chan took over in 2006. In fact, they’re this happy: “Yippee yiy-yo kiy-yay, galloping all the way, here comes Norsat International.”

Under Dr. Chan, the enterprise has adopted a new strategy. “It’s no longer chasing the $100 million megadeals that rarely reach fruition,” say the authors. “Instead it’s looking at smaller transactions such as the $1.1 million contract signed with the Irish Department of Defense.”

Brought into the portfolio a quarter ago at $0.65, the stock has more than doubled. In the midst of the high-tech craziness, this stock traded as high as $46. “While that number has a slightly better chance of being hit than Ralph Nader has of being elected president,” add the Contra Guys, “if the turnaround continues as efficiently as over the past year under the able stewardship of Dr. Chan, it would not surprise us to see this stock cruise past our target [$1.84] to perhaps $3.00.” It opened today at $1.41.

We should add that the Contra portfolio is not all technology. One of its most interesting entrants is Viterra Inc. (TSX-VT), formerly known as the Saskatchewan Wheat Pool. It was purchased to take advantage of what Contra the Herd correctly predicted would be an agricultural boom.

Although it passed their sell target, the Contra Guys sold off only 55 per cent of the position. They are holding the rest. “It would not bother us too much if the party in this sector, after so many years of famine, was just getting started.” Purchased at $5.67, it now stands at $13.76.

To be sure, some evil spells have been cast on the markets these past months. But as far as these contrarians are concerned, there is always magic in the markets for those who are willing to go where others fear to tread.