Value Investing and the Contrarian Approach

Distinctions are made between the philosophy of investing and trading (like the contrarian approach) and the kinds of investments themselves (like value or growth investments, for example). However, the contrarian approach contains some elements that make it compatible with value investing.

So you can be a value investor, seeking companies with excellent management, competitive position, and fundamentals, and at the same time act as a contrarian in how and when you buy shares. In a widespread market price decline, for example, many excellent value companies will experience dips in their stock price, which from a value investment point of view is the best time to buy.
At such times, though, many investors and traders are fearful of further declines so they do not act.

Key Point

Value investors often are also contrarians, because they recognize bargain prices at the moment when most people have an unfavorable view of a company.
Even if a stock's price could fall more, the value investing ideal is to buy shares when they are priced at bargain levels. Even if they decline further, they are still bargains. A mispriced stock is valuable because the market as a whole, with its tendency to exaggerate price movement, has driven the price unreasonably low. Value investors tend to rely on metrics to measure bargain pricing, among which the P/E ratio is prominent. The relationship between market value and book value is an additional test. In the most extreme market declines, it is possible for a stock to fall temporarily below reported book value, meaning it is selling at less than the actual net value of the company's balance.

Book value includes intangible assets, so a conservative adjustment to book value is to remove intangible assets and calculate the tangible book value per share. Stock prices rarely fall below a company's book value, but extreme bad news can cause this. The news may relate to the company specifically, to a sector, or to the market as a whole.

A value investor seeks bargain pricing based on the fundamentals and a contrarian looks for price disparity above or below fair value to time entry or exit.

The primary difference between value investing and the contrarian philosophy of investing is one of indicators that are used. A value investor relies on the metrics, and a contrarian is more attuned to market sentiment at the moment. The ideal value investment is purchased at a discount from its tangible book value (or from a calculated intrinsic value based on measurements like P/E, for example). The ideal contrarian move takes place whenever a stock's price is well above or below fair value based on sentiment. The common sentiment is either greed on the way up, or fear on the way down; a contrarian exploits the market's tendency to exaggerate these temporary opinions and reactions, buying when everyone else is selling and selling when the 'crowd' is buying.

Key Point

Value investors rely on fundamental indicators to pick companies, and contrarians rely more on market sentiment and exaggerated price movements.

By Michael C. Thomsett
Michael Thomsett is a British-born American author who has written over 75 books covering investing, business and real estate topics.

Copyrighted 2020. Content published with author's permission.

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