Contrarian investing is about a strategy of going against prevailing market trends or sentiment. It is based on the idea that markets are subject to herding behavior, fear and greed, and periods of over- and under-pricing. Contrarian investors can profit from market panics, such as the crash of 1987, the Sept. 11 attacks, and the Black Monday1.
In this blog post, I will explain how to apply contrarian investing to individual stocks, industries, or markets, and give some examples of famous contrarian investors.
What is Contrarian Investing?
Contrarian investing means holding a viewpoint on the market that is out of favor, and then doing the necessary research to determine if there’s an investment opportunity. Contrarian investors are not influenced by the opinions of the majority, but rather by their own analysis and judgment. They believe that the market is often wrong, and that they can exploit the inefficiencies and irrationalities that arise from the collective behavior of investors.
Contrarian investing is not the same as simply being a rebel or a naysayer. Contrarian investors do not oppose the market for the sake of opposing it. They have a rational basis for their decisions, and they are willing to change their minds when the facts change. Contrarian investing is also not a one-size-fits-all approach. There are different types of contrarian strategies, such as value investing, growth investing, momentum investing, and sector rotation.
The concept of contrarian investing was summed up best by famed contrarian investor Warren Buffett when he said, “Be fearful when others are greedy, and greedy when others are fearful.”2
How to Use Contrarian Investing
To use contrarian investing effectively, you need to follow these steps:
- Identify the prevailing market sentiment. You can use various indicators, such as market indexes, price-to-earnings ratios, volatility measures, media coverage, analyst ratings, and investor surveys, to gauge the mood of the market. You can also look at the performance of different sectors, industries, and stocks, to see which ones are overbought or oversold.
- Develop a contrarian view. You need to challenge the assumptions and expectations of the market, and look for evidence that supports a different outlook. You can use fundamental analysis, technical analysis, or a combination of both, to evaluate the intrinsic value, growth potential, competitive advantage, and risk profile of a stock, industry, or market. You can also use historical data, trends, and patterns, to compare the current situation with past scenarios.
- Find undervalued or overvalued opportunities. You need to compare your contrarian view with the market price, and identify the gaps or discrepancies. You can use various valuation methods, such as discounted cash flow, dividend discount, earnings multiples, or asset-based valuation, to estimate the fair value of a stock, industry, or market. You can also use relative valuation, such as comparing the price-to-earnings, price-to-book, or price-to-sales ratios of different stocks, industries, or markets, to find the ones that are cheap or expensive.
- Execute your contrarian strategy. You need to act on your contrarian view, and buy or sell the stocks, industries, or markets that you have identified as undervalued or overvalued. You need to have a clear entry and exit plan, and set your target price, stop-loss, and time horizon. You also need to have a strong conviction and discipline, and stick to your strategy regardless of the short-term fluctuations or noises in the market.
- Monitor and review your contrarian strategy. You need to track the performance of your contrarian investments, and evaluate the results. You need to measure your returns, risks, and costs, and compare them with your expectations and goals. You also need to update your contrarian view, and adjust your strategy accordingly, if there are any changes in the market conditions, fundamentals, or technicals.
Examples of Contrarian Investing
Contrarian investing has been used by some of the most successful investors in history, such as Warren Buffett, George Soros, John Templeton, David Dreman, and Peter Lynch. Here are some examples of their contrarian moves:
- Warren Buffett bought shares of American Express in 1964, when the company was hit by a fraud scandal that caused its stock price to plummet. He believed that the company had a strong brand and loyal customers, and that the fraud issue was temporary and manageable. He was right, and he made a huge profit from his investment.
- George Soros shorted the British pound in 1992, when the currency was under pressure from the European Exchange Rate Mechanism (ERM), which pegged it to the German mark. He believed that the British government would not be able to maintain the peg, and that the pound would devalue. He was right, and he made a billion dollars from his trade.
- John Templeton bought shares of Japanese stocks in 1974, when the country was in a deep recession and its stock market was at a 14-year low. He believed that Japan had a strong economy and a competitive edge in technology and manufacturing, and that its stock market was undervalued. He was right, and he made a fortune from his investment.
- David Dreman bought shares of Exxon Mobil in 1989, when the company was involved in a massive oil spill in Alaska that damaged its reputation and caused its stock price to drop. He believed that the company had a solid balance sheet and a diversified business, and that the oil spill was a one-time event that would not affect its long-term prospects. He was right, and he made a handsome return from his investment.
- Peter Lynch bought shares of Taco Bell in 1982, when the company was struggling with declining sales and profits, and facing stiff competition from other fast-food chains. He believed that the company had a unique product and a loyal customer base, and that it could turn around its performance by improving its operations and marketing. He was right, and he made a killing from his investment.
Conclusion
Contrarian investing is a powerful strategy that can help you beat the market and achieve superior returns. However, it is not easy to implement, and it requires a lot of research, analysis, patience, and courage. Contrarian investing is not for everyone, and it is not a guarantee of success. You need to have a clear rationale, a strong conviction, and a disciplined approach, to use contrarian investing effectively.
If you want to learn more about contrarian investing, you can read some of the books written by the experts, such as:
- The Intelligent Investor by Benjamin Graham
- Contrarian Investment Strategies: The Next Generation by David Dreman
- The Templeton Touch by William Proctor
- The Alchemy of Finance by George Soros
- One Up on Wall Street by Peter Lynch
You can also follow some of the blogs and podcasts that cover contrarian investing, such as:
- The Contrarian Investor Podcast by Nathaniel Baker
- The Contrarian Edge by Vitaliy Katsenelson
- The Contrarian Value Blog by Tobias Carlisle
- The Contrarian Income Report by Brett Owens
- The Contrarian Trader by Robert Desmond