Question: I hear there is a lot of money to be made in contrarian investing. So, when I see a stock that is badly sold down, is that the time for me to buy? And when a stock is so sought after that its price is so high, is that the time for me to sell?
Answer: Let us get our definitions straight first. According to Investopedia, “contrarian investing is an investment style in which investors purposefully go against prevailing market trends by selling when others are buying and buying when most investors are selling.”
Mark Messier was quoted as saying that: “Bravery is not the absence of fear, but the action in the face of fear.” Contrarian investors know that there are huge risks in going against markets. That is why they need compelling reasons to do so. The true contrarian investor does not really focus on when to sell or buy. In essence, a contrarian investor takes action to answer the question of at which price to buy or sell. He will look at hard evidence to determine if indeed a company’s intrinsic value is not at what other investors are trading it. That evidence will come in the form of company valuations combined with investor psychology. That psychology may in turn be reflected in technical charts or the general sentiment of investors and analysts. And by doing all of these, the contrarian investor does not confuse the light at the end of a tunnel with that of an oncoming train.
Contrarian investors do not trade as if they are in the Wild West. They do follow precise rules. Warren Buffett comes to mind as one of the most celebrated contrarian investors who follow rules.
Warren Buffett was quoted as saying: “Be fearful when others are greedy, and greedy when others are fearful.” But more than that, the Buffett way involves turning off the stock market, not worrying about the economy, buying a business and not a stock, and managing a portfolio of businesses.
By turning off the market, a contrarian investor—after having done his homework in doing research about the company he buys—will not be bothered by the daily gyrations of the stock market. His study will have identified the right price at which to buy a stock, preferably at a deep discount to what he arrived at as its intrinsic value, and the price at which to sell it, preferably at a level that gives the target annualized return. Contrarian investors do not care if their moves require long periods of time to realize profits. That is why contrarian investors who do not need to present performance on a quarterly basis to a board tend to perform better.
Not worrying about the economy simply means that the contrarian investor would have chosen a stock, the underlying company for which would continue to operate profitably regardless of what happens to the economy. Sustainability of earnings is what the Buffett way is after.
Buying a business and not a stock actually underlines the first two ways. A stock is meaningless by itself. A stock only gains life based on the financial performance of the company that it represents. So, rather than just focusing on stock price movements, the Buffett way focuses on corporate earnings, particularly owner’s earnings (i.e. net income plus depreciation and noncash amortizations minus capital expenditures) on a forecast basis. Owner’s earnings are basically the cash flow that a company ends up with that it can use to pay to funders of debt and equity capital.
Finally, managing a portfolio of businesses is obviously not putting all your eggs in one basket. But it also does not mean investing in too many companies. You will need to find your comfort level in owning the ideal number of businesses.
In the end, do not listen to “Marites” when she says that a stock is good—particularly for contrarian investing, which is far from gambling and is, in fact, its opposite. Perhaps as a final word on contrarian investing, never ask if an investment is good. Instead, ask what good an investment can do for you.
May you enjoy stress-free investing. INQ
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Efren Ll. Cruz is a registered financial planner and director of RFP Philippines, seasoned investment adviser, bestselling author of personal finance books and a Yaman coach. To consult with a Yaman coach, email [email protected] To learn more about personal financial planning, attend the 97th RFP program this August 2022. To inquire, email [email protected] or text 0917-6248110.
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