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I’m sure you have heard the expression “swimming against the tide”, well basically contrarian investing is the same thing. It is an investment strategy that is characterized by buying and selling stocks in contrast to the prevailing sentiment of the time.
A
contrarian thinks that certain crowd behavior in the stock market can lead to
large scale mispricing of the stocks. For example, in 2014 when the price of oil
fell from $100/barrel to $35/barrel the crowd sold off oil stocks by the
thousands driving the price really low.
The overdone selling of the oil firms overstated the company’s risk and understated their prospects for returning to profitability. Finding and buying such distressed stocks and selling them after the company recovers can lead to above average gains. For example, Port Wren Capital found an undervalued oil related firm called PBF Energy Inc. (NYSE: PBF) and bought share in 2014 and in 2016 has prices declined even further. We sold the 2014 shares in 2018 with a 5.92% (APY) gain and sold the 2016 shares for a 51.80% (APY) gain in 2018. On the flip side of the coin, when the crowd is overly optimist it results in overly high valuations that will lead to major falls. Thereby avoiding buying over priced stocks reduces the risk of experiencing these risks.
This picture below depicts the market cycle and as you can see most investors buy at Euphoria, the point of maximum risk, when prices are the highest and sell at Despondency, the point of maximum financial opportunity, when prices are the lowest. However, to get above average returns, they should do just the opposite.
A contrarian investor can always find opportunity in both a bear and a bull market. Typically, there are more in a bear market. In a bull market there are always opportunities to buy or sell specific stocks when the majority of the investors appear to be on the opposite side. This crowd mentality always leads to an investment being mispriced. Thus, buy opportunities are likely to be found when market declines and raises.
As noted by Humphrey B. Neill the author of “The Art of Contrary Thinking” that was published in 1954,”It is easy to find something to go contrary to, but difficult to discover when everybody believes it. When everybody thinks alike, everybody is likely to be wrong.”
The contrarian investment approach is related to value investing in that the contrarian is looking for mispriced investments and buying those that appear to be undervalued by Mr. Market. Some say that the two are not the same. Value investor looks at certain financial variables like P/E, P/B, P/S and other items. In contrast, a contrarian investor might look at those, but mainly focuses on the sentiment about a stock in relation to other investors. Pointing more towards, media coverage, trading volume and the firms overall prospects.
On the flip side of the argument, value investors like Benjamin Graham seek excessive pessimism to find a “margin of safety” to buy stocks at a discounted price to their intrinsic value. Therefore, finding that margin of safety after the stock has dropped a lot which is found to be correlated by negative news and sentiment in general surrounding the stock. We believe the two go nicely hand in hand to help find mispriced stocks in the market regardless of the debate. There are a number of contrarian investors today and they include: Warren Buffett, Sr. John Templeton, Jim Rogers, David Dreman Jim Neff, Bill Ackman and Paul Tudor Jones among others.
At Port Wren Capital, LLC, we specialize in picking specific undervalued U.S. stocks using fundamental analysis developed by Benjamin Graham using a five step process. We have beaten the S&P500, DJIA and NASDAQ benchmarks since we started 5 years ago on our own investments. Discover the difference for yourself. To learn more contact us today.
Published: 2/1/19
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