Contrarian Investing Strategy: How Well Does It Work?
Ganesh Adhikari
“Be fearful when others are greedy, and greedy when others are fearful” -Warren Buffett
The theory of contrarian investing revolves around the above quote by Warren Buffett. Contrarian investing is similar to value investing where both types of investors search for undervalued stocks. In this investment style, investors act against the existing or prevailing market trends to make profits i.e. selling when others are buying and buying when others are selling.
Following the path shown by Benjamin Graham, the writer of the popular book, ‘The Intelligent Investor’ the contrarian investors look for the companies whose market value is less than the intrinsic value of the company. There is less faith in the company’s progress and eventually the fear of people to bet on the company’s stock. These unattractive-looking stocks can be bought on bargains. As time passes they turn out to be a real gem with the change of emotions among the investors (fear converting to greed). Every beaten-down company has the last puff left making a good profit for the investors.
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The strategy to put in simple investing words is to look for buying opportunities in a bear market and selling in a bull market. Patience is the key to this investing strategy. In the context of NEPSE, those who had bought the undervalued hydropower shares before the Bull Run of 2020 made huge gains. The hydropower shares traded below Rs 100 are now traded above Rs 500. This is an impressive gain of over 500% in a very short time. These investors had followed a contrarian strategy. Many new investors who think the market is overvalued now might have been thinking to follow the same approach when the bears eventually return. They might be wondering, how often does this strategy work?
If the right choices are made, this could get you into the top spot of your game and achieve your financial goal. The example is Warren Buffett who was the world’s richest person on the planet (topping the Forbes 2008 rankings of global billionaires) in 2008 using the contrarian investing strategy. During the 2008 financial crisis, when the market was most fearful with the wave of bankruptcy filings, Warren Buffett saw an investment opportunity. He bought equities of the American companies. In 2018 when S&P 500 rose by 130 percent, his investment in investment bank Goldman Sachs Group, Inc. (GS) grew by more than 196 percent beating the market by a fair margin.
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Key To Contrarian Investing
The key to contrarian investing is:
1. Identify opportunities when others are fearful and sell when greed takes over. Recessions can be the ideal time to invest for these types of investors.
2. Long-term investment vision is important since you are playing the waiting game here. Doing nothing after making a buy-at bargain makes the difference.
3. Selecting companies with sound financial fundamentals always help. Fundamentally strong companies often prevail against temporary market emotions and trends.
Some famous investors who made fortunes with contrarian investing strategy include Jim Rogers, Warren Buffett, Marc Faber, Bill Ackman, George Soros, etc.
Conclusion
Contrarian investing is the opposite of momentum investing strategy. So there is a chance of missing out if the Bullish trend continues having the contrarian investors already sold their position or little chance for undervalued investment to out-perform the market if the bearish sentiment remains. A Contrarian investment strategy is to act against the herd instinct. A contrarian investor believes that the investment made by following the crowd can turn against us at any time without any prior information and thus making the momentum investment riskier.
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