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Contrarian investing

Going against the crowd can yield great rewards. Just take it from some of the most famous investors in the world.

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What is contrarian investing?

Contrarian investing is an investment style where the investor deliberately goes against the tide. Contrarian investors believe that market movements are often an over-reaction, so they buy when others sell, and sell when others buy.

Contrarian investing is all about seeking out stocks which others have oversold, or betting against “hot” stocks that have been overhyped and have sky-high valuations.

For example, terrible PR can drive a company’s stock price so low that it actually undervalues the business. On the other hand, hype surrounding a stock can lead to absurdly high valuations that will eventually burst and send stock prices plummeting.

Advantages of contrarian investing

Like any investing strategy, advocates of contrarian investing will tell you that the main advantage is higher returns. Of course, there’s no single investment strategy that always trumps other strategies. All have their pros and cons.

If you buy stocks at bargain prices, and short the market right before a huge crash, you stand to make significant gains.

Figuring out where these opportunities exist isn’t easy. As an investor, you have to “time the market” and have enough emotional resilience to hold your stocks when there’s a strong temptation to sell and sell when you’ve made your profits. You can’t get greedy.

Disadvantages of contrarian investing

If you’re too obstinate as an investor, you could miss out on legitimate bullish tides in the market, which means you could miss opportunities to gain profits.

When investing, it’s hard to stick to your guns and resist the tide while everyone else’s portfolios are looking up. Similarly, contrarians may say a stock is undervalued even while the market disagrees and refuses to back the stock.

Contrarian investing examples

Let’s take a look at some examples of what contrarian investing looks like under different economic circumstances.

Recessions

Investing during recessions is a hallmark of contrarian investing. And buying up stocks when things look bad can pay handsomely.

In the decade following the financial crisis of 2008 and the subsequent market bottom of 2009, the S&P 500—an index tracking some of the USA’s biggest companies—rose nearly 300%.

Overhyped stocks

Tesla and Apple were in the spotlight back in 2020 when both companies’ stock prices were high enough for many investors to conclude that the companies were massively overvalued.

A bolder contrarian investor might see a stock like Tesla or Apple and “short” it—meaning they’d make a bet that the stock price will fall.

Plummeting stocks

Some stocks sink in value despite the company’s value remaining unchanged. When contrarian investors see a potentially underpriced stock, they assess the company’s fundamentals. If the stock appears to be underpriced based on the true worth of the company, they conclude that it’s a worthwhile investment and that investors have sold off too aggressively.

An example of this could be Boohoo, which saw its stocks sink in mid-2020 in response to a scandal about where and how the company’s clothes were produced. Many contrarian investors would see this type of issue as sociopolitical and not the kind of issue that would directly affect the company’s financials in the long run (although some might argue to the contrary). Sure enough, by June the following year, Boohoo’s stocks were up 46%.

Contrarian investing vs value investing

Contrarian investing and value investing share a key similarity: both approaches look for stocks that have a lower price than companies deserve based on objective financial data and fundamental analysis.

Value investing is an investment strategy that centres around finding stocks that are trading for less than their value.

It’s in the same ballpark as contrarian investing, although contrarian investors may also be a bit bolder and look to short, or bet against, markets and stocks.

Famous contrarian investors

  • Warren Buffett is probably the most famous investor with a contrarian streak, known for the phrase “be fearful when others are greedy, and greedy when other’s are fearful.” Buffett has long encouraged investors to buy stocks during downturns. At the start of the most recent market crash in March, for example, Buffett told investors during the Berskhire Hathaway annual meeting that he still bet on America in the long term.
  • Michael Burry. Seen The Big Short? The film is about a man named Michael Burry, who spotted the market crash in 2008. His hedge fund Scion Capital used his insight to short the market, and Michael made obscene profits.
  • Nassim Taleb is another famous contrarian, although some might say this isn’t limited simply to investing. Taleb is known for advocating “tail-risk hedging.” He made a lot of money in the 2008 crash. The hedge fund he’s associated with, Universa Investments, made a huge return during the coronavirus-induced market crash in March 2020.

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