Being a contrarian investor is a no-brainer for many of the world’s top investors. It’s just the nature of the business. But being a contrarian isn’t always a good idea, nor is it always necessary in order to be a successful investor.
Value for money
When I go shopping (a rare event), I want value for money. Value investing and value for money share the word value for a good reason: Value investing is value-for-money investing.
If there are two shops selling the same shoe, I buy the cheaper one. If there are two stocks offering the same dividend and the same growth rate, I buy the cheaper one (the one with the higher yield, in other words).
But you don’t have to be a contrarian to buy tomatoes on the cheap, nor do you have to be a contrarian to buy the cheaper pair of shoes. You just have to watch out for bargains and to know the difference between value and price.
Cheap and value are not the same thing
A pair of shoes may be cheaper because they are lower quality or damaged goods. The same is true in investing. Some companies are cheap simply because they are low quality and may be fragile (likely to go bust). Cheap is a starting point, but it’s really value for money that we’re after.
This is a lesson I’ve had to learn over and over through life. As a tightwad, at least most of the time, I tend to buy cheap things. Then they break, and I end up buying a much higher quality item which lasts for years and ends up being far cheaper on a total cost of ownership basis. Everything that is cheap is not value for money.
Fashion and value rarely go together
And then there’s fashion. Fashion and contrarianism do work together outside of investing and inside it too. I don’t remember the last time I bought a fashionable item of clothing, and I know that my clothing is cheaper because of it. No £100 trainers for me. Fashion in the investment world is Apple, Facebook and LinkedIn. Although I haven’t looked at these companies in detail, I’m pretty sure their valuations are high and their value for money is low.
That’s because, in the investment world, prices are driven by short-term demand, either for buying or selling. When something’s fashionable, everybody buys it, and the price goes up, which, assuming nothing in the company changes, pushes down the amount of value that each investor gets.
Going against the crowd is not always a good idea
A lot of people in the value investing crowd talk about going against the crowd and the madness of the crowd. I am one of those people, and I must admit that bashing the crowd can give you a nice feeling of superiority, and in the world of investing, going against the crowd is often the best course of action. Often, but not always.
If you were in Pompeii in AD 79 and everybody started running like crazy away from Mount Vesuvius, you would be a good contrarian but a bad insurance risk if you decided to stand still, purely on the grounds that you were doing the opposite of what the crowd were doing.
In a similar way, just because everybody had ganged up on RBS back in 2008, were selling like crazy, and the shares had fallen from 600p to 200p, it didn’t mean that all free-thinking, independent contrarians should stampede in and hoover up the shares. At around 20p today, it should be clear that no matter how far a share has fallen, zero is always a long way down.
Economists = Weathermen
It’s all about cycles. The weather is probably my favourite analogy for the stock market. If I ask you what the weather’s going to be like, in detail, on Wednesday two weeks from now, I’m pretty sure you won’t have a clue. You might be able to say something vaguely reasonable based on the time of year, like “it’s May, so it’ll probably be wet and cold”, but any trace of specifics is missing.
However, if I ask you what the weather’s going to be like in summer or winter, you’re probably going to come up with a half-decent description because every year, we get more or less the same sort of thing in each season. The weather goes in roughly predictable cycles, and there are stock market cycles too.
The history of finance is, to some extent, a history of cycles. When it’s the end of the world, and all news is bad (much like these past few years), then the markets get cheaper, just like sun cream in the rain.
Since we’re all here, the end of the world hasn’t happened yet, and history shows that it hasn’t happened in the past, either. All previous crises have ended, following the famous words, “This too shall pass”, and so far, it always has.
One day the sun will start shining, and it will be time to sell the sun cream at a profit and to start buying umbrellas because, with cycles being cycles, another storm is never too far off.
Certainty is not complacency
Although I’m virtually certain that this recession/depression/Euro crisis will end at some point, that does not mean I’m complacent about it. In fact, I’d say the opposite.
Knowing (or as near as you can know anything) that there will be crises in the future is exactly why it’s a good idea for active investors to own a diverse group of financially strong, global companies that are at the front of their industries, and at the same time to stay away from over-indebted, weak and small companies that have no competitive strengths.
Knowing that there will be good times at some point in the future also means that it’s easier not to panic, not to sell into cash at the worst possible moment, and instead to stick to a sensible investment plan through thick and thin.