Can offer the potential for high returns. But before you dive in, here's what you need to know about the principles, strategies, and risks of contrarian investing.
Introduction to Contrarian Investing
The idea behind contrarian investing is that the market is often driven by emotion and herd mentality.
And that by going against the crowd and identifying mispriced assets, investors can potentially achieve high returns.
However, contrarian investing is not without risk. Going against the prevailing view can be difficult, and there are no guarantees that a contrarian position will pay off.
It is important for contrarian investors to carefully evaluate the risks and rewards of their investments and to have a well-thought-out strategy in place.
In this article, we will explore the principles and strategies of contrarian investing, as well as the risks and rewards of this approach. We will also look at examples of successful contrarian investors and the lessons we can learn from them.
By understanding the basics of contrarian investing, you can decide if this strategy is right for you and how to incorporate it into your investment portfolio.
Identifying Mispriced Assets
A key aspect of contrarian investing is the ability to identify mispriced assets. Mispriced assets are those that are undervalued or overlooked by the market.
And they can offer the potential for high returns if they are eventually repriced to their fair value.
There are several ways to identify mispriced assets, including:
- Analyzing financial statements and ratios (such as the price-to-earnings ratio or the price-to-book ratio): Then using these to conduct a fundamental analysis, and to begin a thorough analysis, I recommend starting with a comparable company analysis. Since it's the easiest solution that can net the highest reward.
- Looking for market inefficiencies: Markets are not always perfectly efficient, and there may be opportunities to profit from mispricings or inefficiencies. For example, an investor may look for companies that are underfollowed by analysts or that have been neglected by the market. Due to various reasons, these companies are often unpopular and may become greatly undervalued as a result.
- Evaluating market trends and sentiment: By considering market trends and sentiment, investors can identify assets that may be mispriced due to over-optimism or pessimism. For example, if a market is experiencing a bubble, contrarian investors may look for assets that are being overlooked or undervalued amid the hype.
Identifying mispriced assets is a crucial aspect of contrarian investing, and it requires careful analysis and research. By understanding the factors that can contribute to mispricings, investors can better position themselves to profit from these opportunities.
Developing a Contrarian Investing Strategy
Once you have identified mispriced assets, the next step is to develop a contrarian investing strategy. There are a variety of strategies that can be used in contrarian investing, including:
- Value investing: Value investing involves looking for companies that are being undervalued by the market and purchasing their stocks at a discount. This strategy is often associated with contrarian investing, as it involves going against the crowd and identifying mispriced assets.
- Momentum investing: Momentum investing involves buying stocks that are experiencing strong price momentum and selling them when their momentum slows. This strategy can be contrarian if it involves going against the trend or selling stocks that are still experiencing strong momentum. It is often best to use it in combination with value investing or other fundamental techniques. Since momentum can be based on speculations in the short term and you want a investment thats strong in the long-term.
- Trend following: Trend following involves identifying and following trends in the market and adjusting investments accordingly. This strategy can be contrarian if it involves going against the trend or investing in assets that are out of favor with the market.
It is important to carefully consider your goals and risk tolerance when developing a contrarian investing strategy. Different strategies may be more or less appropriate depending on your investment horizon and the level of risk you are willing to take on.
It is also important to be flexible and willing to adapt your strategy as market conditions change.
Adopting a contrarian investing strategy can be mentally challenging, as it requires going against the grain and potentially betting against the majority. It is natural to wonder if you have missed something or to second-guess your decisions when others disagree with you. However, it is important to trust your own analysis and due diligence, rather than blindly following the consensus.
Managing Risk and Reward
Contrarian investing involves going against the grain and taking on the risk of investing in undervalued or overlooked assets.
While this strategy can potentially offer high returns, it is important for investors to carefully consider the risks and rewards of their investments.
Some of the risks of contrarian investing include:
- Market risk: Market risk is the risk that the value of your investments will decline due to changes in the market. Contrarian investing may be particularly vulnerable to market risk if the assets you have invested in do not eventually reprice to their fair value.
- Liquidity risk: Liquidity risk is the risk that you will not be able to sell your investments when you want to. This can be an issue in contrarian investing if the assets you have invested in are not widely traded or are not in high demand.
- Reputation risk: Reputation risk is the risk that your reputation will suffer due to your investment decisions. Contrarian investing can be controversial and may not be well received by others, which can affect your reputation. This can be especially true if you are going against popular opinions and investing in less favored assets.
To manage these risks, it is important for contrarian investors to have a well-diversified portfolio, to carefully evaluate the risks and rewards of each investment, and to have a long-term perspective.
By taking a thoughtful and measured approach to contrarian investing, investors can potentially achieve high returns while minimizing their risk.
Contrarian Investing in Practice
Contrarian investing requires a willingness to go against the crowd and make counterintuitive investment decisions. While this approach can be mentally challenging, it has the potential to pay off handsomely.
To implement a contrarian investing strategy, it is important to identify opportunities for contrarian investments, conduct thorough due diligence and analysis, and manage risk through careful portfolio construction.
One way to identify opportunities for contrarian investments is by keeping an eye on market trends and looking for assets that are out of favor or undervalued.
This may involve analyzing financial statements, studying industry trends, and seeking out the opinions of experts. It is also important to conduct thorough due diligence and analysis to ensure that the investment is fundamentally sound and to assess the potential risks and rewards.
In addition to conducting a thorough analysis, it is important to manage risk through careful portfolio construction. It is also essential to have a long-term perspective and be willing to hold onto your investments through market fluctuations.
While implementing a contrarian investing strategy can be challenging, there are numerous examples of successful contrarian investors who have reaped the rewards of going against the grain.
By studying their approaches and learning from their successes and mistakes, it is possible to gain insight and develop a successful contrarian investing strategy of your own.
The Role of Patience in Contrarian Investing
Contrarian investing often requires a long-term perspective and the patience to hold onto investments that go against the trend. It can be difficult to stick to a contrarian position when the market is moving against you, and it is important for contrarian investors to have the discipline and resolve to stay the course.
One key to success in contrarian investing is to remain focused on your long-term investment goals and not to let short-term market fluctuations deter you. It is also important to have a solid investment plan in place and to stick to it, rather than reacting impulsively to market movements.
Of course, there will be times when contrarian positions do not work out as planned. It is important to be prepared for setbacks and to have a plan in place for dealing with them. This may involve reassessing your investment strategy, diversifying your portfolio, or seeking the guidance of a financial advisor.
Despite the challenges, there can be significant rewards for those who are patient with contrarian investments. By being willing to go against the trend and hold onto undervalued or overlooked assets, contrarian investors can potentially profit from the eventual revaluation of these assets. So, if you are considering a contrarian investment strategy, it is important to be patient and to have the discipline to stick to your plan.
Example of a Contrarian Investment
I have a contrarian investment right now Citycon Oyj and it's a real estate company that owns the majority of real estate in malls.
The fear of malls being obsolete by online shoppers has been a reality even before covid. And when covid happen people couldn't go to malls at all, so people sold it like crazy.
Then after covid, great inflation happened and interest rates have gone up while at least people in the nordic countries are not buying that much from malls anymore (the lowest in at least 20 years).
And the interest rates have made all real estate companies valued way less but malls/shops, hotels, and possibly offices are the absolutely most sold ones.
But I know that they should sell for about 40% below their real estate worth (and it has been decreasing).
While they have a price / net rental income of below 6. Before corona, the cheapest I ever saw was maybe 12 (less = better).
They have more than 50% own equity and their rents and assets have been steadily increasing over the past 10 years.
Read more about why I think it can be a good investment over here. But this is essentially it, I looked at the numbers and think people are exaggerating.
An 7% drop in net rental income shouldn't mean a 40% drop in the stock price, it just doesn't make sense to me.
Contrarian investing is a strategy that involves going against the grain and investing in undervalued or overlooked assets.
By identifying mispriced assets and developing a well-thought-out strategy, investors can potentially achieve high returns through contrarian investing.
However, it is important to carefully consider the risks and rewards of this approach and to have a long-term perspective.
By understanding the principles and strategies of contrarian investing, investors can decide if this approach is right for them and how to incorporate it into their investment portfolio.
By going against the crowd and looking for mispriced assets, contrarian investors can potentially profit from market inefficiencies and benefit from the revaluation of undervalued assets.