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How to succeed as a contrarian investor

21112019_contrarian investing

How to succeed as a contrarian investor

Contrarian investing, according to Investopedia, is an investment strategy characterized by purchasing and selling in contrast to the prevailing sentiment of the time. A contrarian believes that certain crowd behaviour among investors can lead to exploitable mispricings in securities markets. But just how do you become a successful contrarian?

The crux of contrarian investing is one that has been quoted by many famous investors over time and is perhaps one of the most commonly touted points of investment philosophy. Recently it can be noted that investors today have shifted to a more binary or black-and-white thought process. As humans, we are attracted to extreme statements as they capture our attention and they simplify the world around us. Similarly, instead of trying to create and stress-test our own ideas, many investors today are comfortable in assuming and believing blanket statements, for example “retail is a dying industry”. These statements are often divisive, lack analytical substance and can lead us to glossing over attractive investment opportunities.

Binary thinking is described as a situation in which a person only considers two (usually extreme) possibilities and can be thought of as “black and white” thinking. For example, if someone has time to kill, they might ask themselves a question like “Should I read a book or watch TV?” There’s nothing wrong with that question, but it doesn’t allow for the possibility of the occurrence of other events. In the real world we know that the decisions that we make are more complex, grey, counter-intuitive and contradictory, hence binary thinking is often problematic.

Why exactly are investors and society today becoming more binary in their thought processes? The answer is that binary thinking simplifies the options available to us – reducing our workload. We see the same over-generalisations and binary thinking in a lot of the key trends within the investing world – “brick-and-mortar retail is dead” “European banks are too risky” “low interest rates are bad for all financial institutions”  “defensives are too expensive” “electric vehicles will displace conventional cars.” What all these claims have in common is that they are sweeping generalisations that fail to recognise any supporting or disproving evidence. By speaking in absolutes and echoing market sentiment, we fail to recognise the value and probability of unpopular outcomes for these businesses.

As successful investor Whitney Tilson said, “To succeed as a contrarian you must recognize what the crowd believes, have concrete justification for why the majority is wrong, and have the patience and conviction to stick with what is, by definition, an unpopular bet”. We must be able to see through the noise of the market and extremist news in order to create our own bottom up thesis’.

At Montaka, we practise contrarian investing by utilising our expectations-based framework. In viewing prices as a function of market expectations, we deduce the narrative implied within the security’s current share price and then judge whether these expectations are conservative or not. This framework allows a direct comparison between our ground-up thesis and the market implied expectations – enabling us to act upon any evident mispricing. Other ways to practise contrarian investing would be to avoid or pay less attention to flashy news headlines and reduce reliance on the research of others, instead relying on your own primary research about the nature of the industry and businesses themselves.

In conclusion, the core of investing is assessing probabilistic outcomes and so by thinking in binary outcomes or following market sentiment, it is possible to miss out on great contrarian opportunities.

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Phillip joined MGIM in May 2019 as a Research Analyst and is currently completing a double degree in Actuarial Studies and Commerce at the University of New South Wales. Prior to joining MGIM, Phillip’s experiences included several investment banking internships.  

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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2 Comments

  1. Phillip Namara
    :

    I agree, Michael. Often “boring” stocks with supposedly uninteresting business models can be significantly mispriced and hence provide attractive investment opportunities. Glad to see you are having success.

  2. MICHAEL BARRETT
    :

    Another great article. I particularly like the line about not paying attention to flashy news headlines and reduced reliance on the research of others. Extending this idea a little further, I have found that I have had some success with stocks that are considered to be “boring” by much of the mainstream business media and are often researched by brokers but the research is not promoted as it doesn’t fit into their “sexy stocks of the month”. Two examples: UK based Halma a manufacturer of safety equipment (+49% in the last 12 months) and American Tower (mobile phone towers), up 44% in the last 12 months.

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