Contrarian investing

A lot of money can be made if you make investments that are contrary to the current sentiment, if and when eventually the sentiment changes to agree with yours. But mindless contrarianism that simply thinks in opposite terms from the consensus will not pay off. You have to know something that the market does not know or your interpretation of known information must be better. It is unlikely that you would know something that the market does not know and insider trading is illegal. However, it is possible to interpret known information differently, specially when irrational greed and fear grip the market and the interpretations result in exaggerated valuations.

Many successful investors are contrarians. I give below quotes from some of them:

Anthony Bolton

1. It's very unusual to see a significant anamoly and at the same time the catalyst that will correct it.

John Ballen

1. 1 It has gotten easier to beat the market, not harder, over the last five years. The reason is that, in some sense, the market has gotten more irrational and random. There are a lot of new players out there, especially on the momentum side, who create great disparities and huge volatility in the market. You can notice that, with stocks up 50% or down 50%, in one day. Those become opportunities. From volatility emerges opportunity.
   

Fred Young:

1. If you look back over the years, you will note that the times when the gloom was the thickest invariably turned out to have been the best times to buy stocks. Maybe they will continue to decline a while longer after you buy them, but you are not likely to be able to know when the bottom has been reached. So your best bet is to pick a level you are willing to pay and proceed with part of your investment funds. If they go lower, you can buy more at even better prices. If they turn and go up, then you will make a profit on what you have.
   

Benjamin Graham

1. Even though the business may have economic characteristics that are stable, Mr Market’s quotations will be anything but.
   
2. The speed at which a business’s success is recognised is not that important as long as the company’s intrinsic value is increasing at a satisfactory rate. Delayed recognition can be an advantage: It may give us the chance to buy more of a good thing at a bargain price.
   

Jim Rogers

1. The smart investor – the one who does not consider himself to be a financial genius but trains himself to analyse the newspapers and television and to pick tops and bottoms by the extremes in the public’s attitudes – learns to buy fear and panic and to sell greed and hysteria.
   

John Train’s tale about Mr Womack:

1. When during a bear market he would read in the papers that the market was down to new lows and the experts were predicting further drops, he would buy safe, high yielding stock. Then, a few years later, when the prophets were predicting new highs, he would sell all. During a market rise, you can sell too soon and make a profit, sell at the top and make a very good profit, or sell on the way down and still make a profit. So, with so many profit probabilities in your favour, the best cost price possible is worth waiting for. He taught me that you can’t be buying stocks every month and make a profit any more than you could plant rice every month and make a crop.
   

Gerald Loeb

1. Any investment policy followed by all naturally defeats itself. Thus the first step for the individual really trying to secure or preserve capital is to detach himself from the crowd.
   

Peter Lynch

1. A decline in stocks is not a surprising event, it’s a recurring event. If you live in a cold climate, you expect freezing temperatures, so when your outdoor thermometer drops below zero, you don’t think of this as the beginning of the next Ice Age. You put on your parka, throw salt on the walk, and remind yourself that by summertime it will be warm outside.
   
2. A stock market decline is as routine as a January blizzard in Colorado. If you’re prepared it can’t hurt you. A decline is a great opportunity to pick up the bargains left behind by investors who are fleeing the storm in panic.
   

John Neff

1. Windsor’s roller coaster experience with Citi underscored a crucial point: judgment and fortitude were our prerequisites. Judgment singles out opportunities, fortitude enables you to live with them while the rest of the world scrambles in another direction.
   
2. To us, ugly stocks were often beautiful.
   
3. You have to be willing to hang in when prevailing wisdom says you are wrong. That’s not instinctive; more often than not it goes against instinct.
   
4. Windsor participated at first in the glory of dubious growth stocks. Windsor rode the stocks too long and got killed. Worse, panicked management sold its beleaguered growth stocks at the bottom and shovelled the proceeds into “safe” stocks. You don’t bounce back by owning highly recognised goods.
   
5. You have to distinguish misunderstood and overlooked stocks selling at bargain prices from many more stocks and lacklustre prospects.
   

Paul F Miller

1. What worked well in the past is presented as a prescription for the future. In fact, such prescriptions may work for a while and gain a large fan club which ultimately carries some specific concepts to an extreme and then to its downfall, as demonstrated dramatically by the so-called growth stocks of the 1960s.
   

Richard Driehaus

1. There are times when our style is out of favour, and this was definitely one of those. After the first half of the year, I could see our style beginning to work again as some of the stocks we had sold earlier started reversing and turning up. We reversed our position and bought back stocks we had recently sold. And that’s what a lot of money managers don’t do.
   

Philip Fisher

1. Doing what everybody else is doing at the moment, and therefore what you have an almost irresistible urge to do, is often the wrong thing to do.
   

Tim Bond (Barclays Equity Gilt Study)

1. After periods of high volatility, equities become cheaply valued, from which point they then deliver excess returns.
   
2. Behavioural economics shows that investors’ desired risk/return profile is not evenly distributed, exhibiting a much greater sensitivity to losses than might be expected. Such innate caution most probably results in an overweighting of loss probabilities, in turn giving rise to the excessive equity risk premium. The bias is likely to be hardwired into humans as part of a package of reflex reactions to danger that would have provided survival benefits during the early years of human evolution. A well-considered cost/benefit analysis of the probability of being eaten by a nearby predator is unlikely to be an effective survival technique in comparison with running very fast at the first sign of danger. In short, humans are biased by evolution to overreact to danger, since such over-reactions would have generated higher survival – and hence gene succession – rates in the past. And since early human culture was tribal or familial, we are also programmed to react to secondary danger signals in the shape of the behavioural patterns exhibited by other members of the social unit. In short, we are programmed to find panic – and indeed the opposite condition of complacency – infectious. However, while panic may indeed be an appropriate survival technique for the savannah, it does not translate entirely happily to the financial jungle.
   

Warren Buffett

1. Irrationally low prices will periodically be attached to solid businesses.
   
2. Moves like that, however, are what portfolio insurance tells a pension fund .... to make when it owns portions of enterprises such as Ford or General Electric. The less these companies are being valued at, says this approach, the more vigorously they should be sold. As a "logical" corollary, the approach commands the institutions to repurchase these companies ... once their prices have rebounded significantly. Considering that huge sums are controlled by managers following such Alice-in-Wonderland practices, is it any surprise that markets sometimes behave in aberrational fashion?
   
3. Many commentators, however, have drawn an incorrect conclusion upon observing recent events: They are fond of saying that the small investor has no chance in a market now dominated by the big boys. This conclusion is dead wrong: Such markets are ideal for any investor - small or large - so long as he sticks to his investment knitting. Volatility caused by money managers who speculate irrationally with huge sums will offer the true investor more chances to make intelligent investment moves. He can be hurt by any such volatility only if he is forced, by either financial or psychological pressures, to sell at untoward times.
   
4. The most common cause of low prices is pessimism - sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer.
   
5. None of this means, however, that a business or stock is an intelligent purchase simply because it is unpopular: a contrarian approach is just as foolish as a follow-the-crowd strategy.
   
6. Occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics will be unpredictable, both as to duration and degree. Therefore, we never try to anticipate the arrival or departure of either disease. Our goal is more modest: we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.
   
7. Those who invest only when commentators are upbeat end up paying a heavy prices for meaningless reassurance.

William Bernstein

1. High previous returns usually indicate low future returns, and low past returns usually mean high future returns. The rub here is that buying when prices are low is always a scary proposition. The low prices that produce high future returns are not possible without catastrophe or risk.
   
2. The most profitable thing we can learn from the history of booms and busts is that at times of great optimism, future returns are lowest; when things look bleakest, future returns are highest.
   
3. If investors think that returns will be higher in Australia than in Belgium, then capital will flow from Belgium to Australia. This will depress prices in Belgium, which, in turn, will increase future returns. The opposite will occur in Australia. Prices will adjust to the point where the expected returns, adjusted for risk, in both nations will be the same.
   
4. Because of society’s dysfunctional financial behaviour, a rising stock market lowers the perception of risk, decreasing the discount rate, which drives the prices up even further. The same thing happens in reverse.
   
5. Good companies are generally bad stocks, and bad companies are generally good stocks. The average investor equates great companies, producing great products, with great stocks. And there is no doubt that some great companies, like Wal-Mart, Microsoft, and GE, produce high returns for long periods of time. But these are the winning lottery tickets in the growth sweepstakes. For every growth stock with high returns, there are a dozen that, within a very brief time, disappointed the market with a lower-than-expected earnings growth and were consequently taken out and shot.