“The way to make money is to buy when blood is running in the streets.” ~ John D. Rockefeller
Contrarian investing believes that the worse things seem in the market, the better the investing opportunities are for profit.
Contrarians, as the name implies, try to do the opposite of the crowd. They get excited when an otherwise good company has a sharp but undeserved drop in share price. They swim against the current and assume the market is usually wrong at both its extreme lows and highs. The more prices swing, the more misguided they believe the rest of the market to be. (For more on this, read “Finding Profit In Troubled Stocks.”)
Bad Times Make for Good Buys
Contrarian investors have historically made their best investments during times of market turmoil. In the crash of 1987, the Dow dropped 22% in one day in the U.S. In the 1973-’74 bear market, the market lost 45% in about 22 months. The terrorist attacks of Sept. 11, 2001, also resulted in a major market drop. Those are times when contrarians found their best investments.
The 1973-’74 bear market gave Warren Buffett the opportunity to purchase a stake in the Washington Post Co. at a deep discount (the company could have “sold the [Post’s] assets for not less than $400 million.” Meanwhile, the Post had an $80 million market cap), an investment that has subsequently increased by more than 100 times the purchase price–that’s before dividends are included.
Sir John Templeton, founder of the Templeton Growth Fund, was also a serious contrarian investor, buying into countries and companies when, according to his principle, they hit the “point of maximum pessimism.”
As an example of this strategy, Templeton bought shares of every public European company at the outset of World War II in 1939, including many that were in bankruptcy. He did this with borrowed money. After four years, he sold the shares for a very large profit.
But there are risks to contrarian investing. While successful contrarian investors put big money on the line, swam against the current of common opinion and came out on top, they also did some serious research to ensure the investing herd was indeed wrong.
So, when a stock takes a nosedive, this doesn’t prompt a contrarian investor to put in an immediate buy order, but to find out what has driven the stock down and whether the drop in price is justified.
While successful contrarian investors have their own strategy for valuing potential investments, they all have the one strategy in common–they let the market bring the deals to them, rather than chasing after them.
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