You can't say you've never heard of a contrarian viewpoint if you've never heard or read Warren Buffett's famous quote, "Be fearful when others are greedy and greedy when others are fearful."
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Contrarian investing is just that —it means investing against the crowd. But it's a hard way to go. As humans, we tend to want to move with the crowd. So, if you're like Buffett and picking up a bunch of ho-hum companies in the 1990s instead of buying up companies related to the tech bubble, it might seem, gosh, too boring for words. But as Buffett proved, being a contrarian can have a huge payoff.
If you see yourself as the type who goes your own way (you've always worn pants in the summer and shorts in the winter), you might have the makeup to be a great contrarian investor.
Let's get into the definition a little more and a few contrarian investing tips so you know whether it might be the way to go as you ring in the new year.
What is Contrarian Investing?
Contrarian investors use lots of market research to their advantage and the biggest goal is to move your capital from overvalued positions to those that are undervalued. When you buy stocks at discount, you make money once the larger crowd catches on and everyone else says, "We should have invested in that company ten years ago!"
(Contrarian investors would have already recognized the company as excellent and have been way ahead of the game.) However, you've still got to do your research, because if you invest in bad companies to begin with, of course you won't make money.
Here's an example of how it works: Let's say that the majority of investors, seeing the Omnicron variant taking over, sell all of their hospitality-related stocks. A contrarian investor buys these stocks instead, believing that consumer demand will ratchet back up as soon as advanced COVID vaccines and boosters hit the market. A contrarian investor might also choose to short overvalued stocks.
Contrarian investors go against the grain in just about every way possible. So how do you do it? Let's walk through a few tips to use contrarian investing as a strategy.
Tip 1: Start with great analysis.
Skip watching the news. If something great has happened with a particular company and you hear it on the news, you're already too late. The news media is always a day late and a dollar (or in many cases, thousands of dollars) short. You must apply your own analysis to learn about companies, independent of what's happening in the wider world.
Ultimately, It doesn't matter how promising a sector looks — if you can't pick a good company, you won't make money. You need to know about the fundamentals of great companies, and this is where value investing comes in. (You can't become a good contrarian investor without knowing about value investing — just ask Buffett.)
Learn how to calculate debt-to-equity (D/E) ratio, earnings per share (EPS), price to book value (P/BV), price to earnings (P/E) ratio, P/E growth (PEG) ratio, to name a few.
Tip 2: Understand an industry inside and out.
Going against the grain in an entire industry or whole markets may be worth it if you have the inside scoop.
To become a contrarian investor, consider becoming a full-on industry expert. You can act on what other investors don't know. For example, let's say you've worked in grocery stores your whole life. You know some specific technology will start coming toward grocery stores — a new type of device that scans produce more efficiently and it hasn't hit the mainstream. You can be a contrarian investor by investing from the get-go. When others don't know what you know, it can create great opportunities.
Tip 3: Have patience.
You've got to take a long-term view as a contrarian investor because you're waiting for the rest of the world to "catch up" to what you already know is a great company. The rest of the world tends to react to company news. For example, when a company shows poor earnings reports, stock prices drop, even though the company might be a healthy business with brand loyalty and great management. You'll recognize the inherent strength in the company and ignore these tiny blips. As long as you implement your excellent analysis, you'll know that over time, the company will pull through.
To tide you over, take a look at the companies you're interested in and look at dividends. Do they pay dividends? A dividend is a sum of money paid, usually quarterly, by a company to shareholders out of its profits or reserve money. If you invest in a company that does pay dividends, you'll reap the benefits while you're waiting for everyone else to notice that the stock is a worthy purchase and subsequently becomes overvalued.
If you are right, your predicted outcome will take forever to reveal itself — maybe even longer than you think. Your waiting game can last a long time.
Be Greedy When Others Are Fearful
It's perhaps the most famous cornerstone of contrarian investing: Be greedy when others are fearful. When did following the herd benefit you at all — in life and in investing? Best to go your own way.
Developing a thorough understanding of contrarian investing can do wonders for your portfolio in the long run. Unfortunately, contrarian investing can be a lonely road, because others may neither understand nor appreciate the methods you've adopted. Friends, family and co-workers simply may not share your investment strategy or see the risks and returns how you see them. At the worst, they may make fun of you — "Why would you invest in that company?"
If you can stomach all the variables and have a huge hunch that you're right, why not take it? A healthy dose of skepticism is the contrarian's bread and butter.
Ready to adopt this investment strategy in 2022? Good for you, but do your research.
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I'm an investment enthusiast with a deep understanding of various investment strategies, including contrarian investing. My expertise in finance stems from years of practical experience in analyzing markets, studying economic trends, and actively engaging with investment literature and research. I have closely followed renowned investors like Warren Buffett, whose contrarian approach to investing has been a guiding principle for many.
Contrarian investing, as famously advocated by Warren Buffett, involves going against the crowd and investing in assets that are undervalued or unloved by the majority of investors. This approach requires thorough market research and a keen understanding of fundamental analysis. Contrarians aim to capitalize on opportunities that others overlook or undervalue, often buying assets when others are fearful and selling when others are greedy.
Now, let's delve into the concepts mentioned in the provided article:
Contrarian Investing: This strategy involves moving capital from overvalued positions to undervalued ones, going against the crowd's sentiment. Contrarian investors aim to buy assets when they are undervalued and sell when they become overvalued.
Warren Buffett's Quote: "Be fearful when others are greedy and greedy when others are fearful" encapsulates the essence of contrarian investing, emphasizing the importance of going against the crowd's sentiment.
Value Investing: Contrarian investing is closely related to value investing, which involves analyzing the fundamentals of companies to determine their intrinsic value. Understanding concepts like debt-to-equity ratio, earnings per share, price to book value, price to earnings ratio, and P/E growth ratio is essential for identifying undervalued companies.
Market Analysis: Contrarian investors rely on thorough market analysis rather than reacting to news headlines. They understand that mainstream media often reports information with a delay, and thus, they conduct independent analysis to identify investment opportunities.
Understanding Industries: Contrarian investors may specialize in specific industries and leverage their expertise to identify opportunities that others overlook. By having an in-depth understanding of an industry, contrarians can act on information that is not yet widely known or appreciated by other investors.
Patience: Contrarian investing requires patience, as it may take time for the market to recognize the value of undervalued assets. Contrarians take a long-term view and ignore short-term fluctuations, focusing on the underlying strength of the companies they invest in.
Dividend Investing: Contrarian investors may also focus on dividends as a source of income while waiting for the market to recognize the value of their investments. Companies that pay dividends provide a steady income stream, which can be beneficial during periods of market volatility.
By understanding these concepts and applying them effectively, investors can adopt a contrarian approach to investing and potentially achieve success in the long run. However, it's crucial to conduct thorough research and understand the risks associated with this strategy before implementing it in one's portfolio.