Five considerations for the contrarian investor – it’s all about risk and reward!

“If I argue with you, I must take up a contrary position”, said John Cleese in Monty Python’s ‘Argument’ sketch from the early 1970s. The sketch is centered on a clinic where people can come in off the street for an argument: argument for argument’s sake…

You’d be forgiven for thinking that contrarian investors might do something similar. But rather than simply taking a contrary position, contrarians must also assess whether it’s the right time to differ from popular opinion.

Read on for five key considerations contrarian investors should remember in their quest to buy low and sell high.

1) Don’t follow the crowd 

Markets and stocks can become overbought or oversold, a consequence of the cycle of ‘greed and fear’ when news is at its best or worst. It’s important not to get sucked in or out of investments at these points, especially when everyone is chasing or avoiding the same theme or sector. The contrarian investor challenges the wisdom of the crowd and looks for the maximum opportunity when fellow investors are at their most despondent. A rational, evidence-based approach, divorced from subjective emotions, is essential.

2) What can improve? 

Being a contrarian is not just about seeking out the most hated stocks. These can only be of interest where there is a catalyst for change. This can come from a host of factors: a change in management, strategy or business model, activist involvement or merger and acquisition activity. A contrarian hones in on signs of improvement that have been overlooked and underappreciated. Often these can result in positive share price reactions in underloved and overpenalised stocks.

3) Emotions matter

Investors are human and can make behavioural errors while investing – these range from falling in love with stocks to favouring information that supports their entrenched views. Contrarian investing seeks to take advantage of this in an objective way, identifying companies for whom investor sentiment results in them being over or underloved. When a stock is universally loved, there can be little margin for error and it’s harder for updates to surprise positively.

4) Belt and braces

It’s important to be comfortable with the financial fundamentals of an unloved stock. For example – is there asset backing? Can the company pay a dividend? Is the balance sheet overly stretched? Can the company survive whilst the cycle improves? The contrarian investor should always look for evidence that management have control over their destiny. A sustainable dividend can also be rewarding while you wait for your thesis to unfold.

5) When to sell

This can also be one of the most difficult, but essential, decisions an investor makes. Having a strong sell discipline is the corollary to a disciplined buying process. It means avoiding behavioural biases and it allows money to be recycled into new ideas with better risk and reward profiles.

Rigour, patience and a long-term time horizon are requisites of a contrarian investor. It may not be easy to ignore the draw of the crowd or the momentum trade, but following the steps above could help uncover an unloved profitable contrarian opportunity.

Look out for our next article in the new series on how to be a contrarian investor – coming soon…

Please remember that past performance may not be repeated and is not a guide for future performance. The value of shares and the income from them can go down as well as up as a result of market and currency fluctuations. You may not get back the amount you invest.

Please note that SIT Savings Ltd is not authorised to provide advice to individual investors and nothing in this blog should be considered to be or relied upon as constituting investment advice. If you are unsure about the suitability of an investment, you should contact your financial advisor.