Contrarian Investing Versus Value Investing

The contrarian investor goes against the crowd!



Contrarian investing requires the investor to invest opposite to the crowd.

It takes an approach that differs from the conventional wisdom, when that 'wisdom' appears to be wrong.

The motto for this type of investor can be best summarized by the following statement ...

Be fearful when others are brave, and be brave when others are fearful

Pessimism among investors about a stock may lower the stock price of a company to a point at which the company's risks are exaggerated.

Hence the prospects of the company returning to profitability may be understated.

By identifying and purchasing such out-of-favor stocks, and selling them after the company recovers, this type of investor may generate above-average returns.

The same may occur in the situation where the market places unjustifiably high valuations that will eventually lead to price reductions when those high expectations don't eventuate.

By avoiding these flavor-of-the-month (or year) stocks, investors avoid the risk of severe price reductions.


The Contrarian Mindset

Contrarian investors do not necessarily have a negative view of the overall stock market.

Rather, they look for opportunities to buy or sell specific contrarian stocks when the majority of investors appear to be doing the opposite, to the point where that stock has become mis-priced (too high or too low).

This type of investing is related to value investing in that the contrarian is also looking for mis-priced investments and buying those that appear to be undervalued by the market.

However, this strategy, compared to value investing, places less emphasis on fundamentals of the company in question and is more concerned about market sentiment.

Websites such as 'dogs of the Dow' and 'down under dogs' provide examples of this type of strategy.

But as someone has commented ...

... if you sleep with the dogs, be careful that you don't catch fleas!

Companies with high dividend yields often fit into this 'dogs' category not because dividends have risen, but because their share price has fallen.

The assumption is that the fall in share price is due to an overreaction by the market because of bad news, or that there has not been any news, or whatever; leading to a price drop.

When the company returns from an 'unloved' to a 'loved' status, the investor can take profits and wonder at the stupidity of the crowd.


To Conclude ...

This strategy has its advantages, in that it focuses on buying low and selling high, which is a simple rule of thumb that naive investors take time to learn.

So it pays to be somewhat contrarian when it comes to finding the best stock investments.

I try to keep in mind that because a company is cheap, it may not be undervalued. There can be worrying reasons why a company is cheap.

A value investing approach, which also involves a fundamental analysis of the company, provides additional protection of capital.



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