Contrarian Investing Definition and Strategy (2024)

Investing can be tricky. Investors sometimes overreact to the slightest whiff of bad news about a company. Other times, they rush to jump on the latest investing trend, pumping up a company’s share price. Contrarian investing looks to do the opposite.

Certain metrics, such as profit margin and P/E ratio, can give us clues as to which companies are outperforming the competition. Still, there are a lot of unknowns. No one could have predicted the COVID-19 pandemic and the impact it would have on the markets.

But even the human element of investing decisions can be irrational at times.

When contrarian investors see other investors jumping to conclusions, they do the opposite. Oftentimes, that involves buying stock in companies trading below their intrinsic value after a market trend or news story caused a drop in price.

Thus, contrarian investing bears some similarities to value investing. But the two aren’t exactly the same. While contrarian investing has its limitations, it can be a lucrative strategy. And many investors have made millions with it.

Contrarian Investing Definition and Strategy (1)

What is the Contrarian Investing Strategy?

Contrarian investors intentionally go against market trends. They do this by buying stocks when they are down and selling stocks when they become overheated. Contrarian investing can be applied to sectors and markets as well. The idea is that herd behavior can cause large numbers of investors to make similar decisions. For example, investing in “hot” stocks. They may do this even if some of those stocks are overvalued.

Contrarian investing is not a short-term strategy, like you might see with day trading. Instead, contrarian investors buy and hold stock in companies or industries that align with their strategy. They are investing in stocks most investors wouldn’t consider. And because of this, it could be months or even years before the stocks they are buying reach their perceived value.

Contrarian Investing vs. Value Investing

As mentioned, contrarian investing and value investing bear some similarities. In fact, some believe there is no difference between the two. Although, there are some things contrarian investors do that value investors probably wouldn’t.

Where the two are similar is the tendency to invest in undervalued assets. Both investors will look for assets that are trading lower than their intrinsic value.

However, value investors lean primarily on metrics such as book value and P/E ratio, looking for assets that are trading at a discount simply by the numbers. Contrarian investors, on the other hand, pay more attention to investor sentiment. They may choose to buy an asset despite an overall bearish sentiment around it.

Pros and Cons

Contrarian investing has allowed some investors to make sizable profits by going against the grain. But like any strategy, they have their own set of pros and cons.

Contrarian investing pros:

  • Contrarian investors often buy stocks in dependable industries that are trading lower at the moment, such as banking or real estate. By looking for discounts in these industries, they stand to gain a lot in the long term.
  • Investing in assets that are trading below their intrinsic value allows contrarian investors to minimize potential losses.

Contrarian investing cons:

  • Because contrarian investing requires going against the grain, it could be years in some cases before these investments produce the desired return.
  • Finding worthy investments as a contrarian investor can take extensive research.
  • Simply doing the opposite of what “everyone else” is doing is not a winning strategy on its own.

Examples

There are many examples of contrarian investors, and some of them have become quite famous. Let’s take a look at a couple of notable examples.

Warren Buffett

Warren Buffett is a contrarian investor. In fact, he might be the most famous contrarian investor of all time. Some call him a value investor. However, Buffett can be considered a contrarian investor because he does what he wants instead of following market trends.

For instance, by late 2021, Buffett’s Berkshire Hathaway had nearly $150 billion in cash on hand. The reason? Simply because Buffett couldn’t find enough deals to justify putting all of his money to work. Conventional wisdom says investors should never have that much cash. Even if it means investing in a less desirable asset. But Warren Buffett won’t invest unless his high standards are met.

Michael Burry

We often think about contrarian investors buying undervalued assets, and in many cases, that is true. However, Michael Burry became famous when he decided to short the housing market just before the Great Recession. Everyone was investing in mortgage-backed securities and other assets. But Burry was determined the market was overheated and bet big on it. He turned out the be right. And this resulted in hundreds of millions in profits for both himself and his hedge fund, Scion Capital.

Does Contrarian Investing Work?

Contrarian investing can certainly work. And it has worked quite well for many investors in the past several decades. However, it can also be very risky. Meaning it’s best left for those with deep pockets. As they say, if it were that easy, everyone would be doing it.

Consider the Michael Burry example. Burry turned out to be right and made $100 million for himself in the process. But at the time, there were likely many doubters. The market kept going up and seemed like that would continue forever. Thus, in addition to determining the market was overheated, Burry also had to short the market at just the right time. It’s easy to imagine a scenario in which he waited too long, foiling the entire strategy.

Thus, contrarian investing can work, but it can also be risky. Plus, those buying undervalued assets sometimes have to wait years for them to increase in value. For investors that can afford to sustain losses for long periods of time. Contrarian investing can work. For most investors, though, it may be too risky to be worth pursuing.

As a seasoned investment expert, I bring extensive knowledge and practical experience to the discussion of contrarian investing. My understanding is not merely theoretical but rooted in real-world examples and the intricacies of financial markets.

Contrarian investing is a strategy that goes against prevailing market trends, and it involves buying assets that are undervalued or out of favor. This approach requires a deep understanding of market dynamics, investor sentiment, and the ability to identify opportunities that others may overlook.

One crucial aspect of contrarian investing is the consideration of metrics like profit margin and P/E ratio, as mentioned in the article. These metrics provide insights into a company's performance relative to its competition. However, the article rightly acknowledges that there are always unknowns, exemplified by the unforeseen impact of the COVID-19 pandemic on the markets.

Contrarian investors distinguish themselves by intentionally going against the herd behavior often observed in financial markets. The strategy involves buying stocks when they are down, anticipating a rebound, and selling when they become overheated. This patient, long-term approach contrasts with short-term strategies like day trading.

The article draws parallels between contrarian investing and value investing, emphasizing their shared focus on undervalued assets. However, it highlights distinctions, noting that contrarian investors pay more attention to investor sentiment rather than solely relying on quantitative metrics like book value and P/E ratio.

Pros of contrarian investing include the potential for sizable profits by investing in dependable industries during temporary downturns, such as banking or real estate. By seeking discounts in these industries, contrarian investors position themselves for long-term gains while minimizing potential losses.

On the flip side, contrarian investing has its cons. The strategy requires patience, and it may take years for investments to produce desired returns. Finding worthy investments demands extensive research, and simply going against the crowd without thorough analysis is not a winning strategy.

The article provides notable examples of successful contrarian investors like Warren Buffett and Michael Burry. Warren Buffett's approach of holding substantial cash until high-quality investment opportunities arise exemplifies contrarian thinking. Michael Burry's famous bet against the housing market before the Great Recession showcases how contrarian views can lead to substantial profits.

The question of whether contrarian investing works is addressed cautiously. While it has proven successful for some investors, the strategy is acknowledged as risky and not suitable for everyone. The Michael Burry example illustrates the challenges, as timing and market conditions play crucial roles in the success of contrarian strategies.

In conclusion, contrarian investing is a nuanced strategy that requires a deep understanding of market dynamics, a keen eye for opportunities, and the patience to wait for investments to reach their perceived value. While it has worked for renowned investors, its inherent risks make it a strategy best suited for those with a thorough understanding of financial markets and the ability to weather potential losses over extended periods.

Contrarian Investing Definition and Strategy (2024)

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