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What is Contrarian Investing?

Andrew is a self-educated business owner and entrepreneur with plenty of free advice (which is worth exactly what you pay for it!).

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Against the Grain

While there are loads of different investing styles out there, most of the successful long term investing strategies have one thing in common: they don't really care what the herd is doing. This doesn't mean that value-oriented investors don't pay attention to what the fed is doing to bail out the markets, for example, but as more and more people are hopping on an idea train, we tend to get really nervous. Although apocryphally attributed to Buffett, "be fearful when others are greedy" remains incredibly easy-to-follow, effective advice today. Let's take a look at five different categories of contrarianism in the investing world: swimming against the stream in order to avoid being a lemming going off of a cliff to its death (which doesn't really happen, but I'm still going to propagate the myth by using the analogy here).

The Boring

Our first category of contrarian stocks: boring ones. You've no doubt heard how the GameStop saga unfolded in dramatic fashion to start 2021, and you're probably well aware of the tech sector's meteoric rise during the coronavirus pandemic. This ultimately means that a great deal of money is flowing into the likes of Tesla, Apple, and Netflix at a record pace, since index fund flows are self-reinforcing. As more cash is invested in individual tech companies, their market capitalization (value of the company in terms of stock price times number of shares) rises, and since index funds generally use the size of the business relative to the others in the index in order to determine how much of its stock to buy, this means that the stock price will go up even more. If you're holding a share of a stock in a market-weighted index fund, you might be really happy to see the value of your shares rising as more and more stocks are purchased for index funds. However, if you're looking for stocks to buy today, the contrarian approach is to shy away from stocks that the market is valuing too highly. This means staying away from the aforementioned sexy stocks, and instead looking at boring, unloved securities nobody seems to be interested in right now. If you can buy something nobody is currently paying attention to, you can probably find it for a better deal, like when you go to the back of the flea market to find the best deals and hidden gems.

Sin Stocks

Sin stocks have long been a bastion for value investors and contrarians. You should be sure that you're comfortable with whatever sin industry you pick, but since a non-zero percentage of investors simply won't buy stocks they believe to be morally unpalatable, this means there is less competition for these bargains. At various times, I've seen the following sin plays at very, very good prices:

  • tobacco
  • alcohol
  • sex
  • gambling
  • processed food/refined sugar
  • luxury

I personally think that you shouldn't invest in things you're not comfortable with, but since everyone's moral compass is a little different, you can often comb through ideas like this and find things on sale simply because some people will never buy them.

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The Ugly

Ugly stocks can be defined as shares of businesses who have fallen from grace in one way or another, which ultimately precludes a prudish group of investors from buying them, even when they're on sale. Like with the sin stocks, you'll have to be your own moral guide here, but there are always opportunities to buy things like this at a discount, and there's plenty to dig through:

  • oil and energy (coal)
  • producers of non-sustainable goods like plastics
  • animal biproducts like meat or leather
  • weapons (guns, defense stocks)
  • companies based in an out-of-favor country like Russia or China

Fallen from Grace

If you're looking for companies to buy, one way to do it is to take a look at new public companies, like buying at their IPOs or relatively early on, or to look at stocks that just haven't become super expensive yet... but you anticipate that they will at some point. This can work really well for some folks, but you might have a much, much easier time just taking a look at stocks that were on top of the world in the past, but are now selling at a mere fraction of their all-time highs. This can be a really useful strategy, since there has already been a great deal of professional analysis and valuation, but since the stock has fallen so much, only a fraction of people are even looking at the company now. Sometimes, a company like that is selling for way too cheap, since the market has already punished the stock, and too few people are interested in buying it now to drive the price up to its fair value. These can be some of the easiest stocks to find, since Mr Market is often just overreacting to overhyped expectations, and some of these stocks get punished far, far more than they really should be. Intel (INTC) is a great example of a stock that has fallen from grace, and although there's plenty of competition, Intel is still a very valuable company that briefly traded well below what I perceive to be its fair value. If you're interested in my buying and selling methodology, you can read about that here.

Out of Fashion

Although this category is a close cousin to the fallen stocks, there's enough of a distinction for another classification to be practical here. One example of an out-of-fashion sector was value investing itself, which underperformed growth for about a decade. "Growth stocks are so hot right now," or so goes the mantra that drove the price of the FAANG stocks to nosebleed P/E ratios throughout the late 2010s. Simply taking a look into less favored sectors can benefit from a regression to the mean, as whatever's currently in favor becomes overbought (it always comes back to supply and demand!). Mortgage backed securities fell like lead sinkers to the bottom of a pond after the Great Financial Crisis, and then there were some absolutely phenomenal deals. Scandals and political scrutiny can aid in the "sinking lead" phenomenon, blurring the line between out of fashion and ugly at various times, putting individual companies—and sometimes entire sectors—on sale.

Swimming Upstream

There's definitely a time when going along with the herd will yield very good results, and there's a reason herds exist in the animal kingdom in the first place. If you're contrarian 100% of the time, you're not likely to do very well in investing. However, if you can find some really good contrarian bets and make them at the right times, you can often find phenomenal deals in the market. Being a contrarian can be a terrific source of initial ideas, and while you should always follow up with plenty of research on any ideas you have before investing, you can often find a large number of ideas very quickly by taking this route.

This content reflects the personal opinions of the author. It is accurate and true to the best of the author’s knowledge and should not be substituted for impartial fact or advice in legal, political, or personal matters.

© 2021 Andrew Smith

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