I have 7 rules with contrarian investing and buying badly-out-of-favour stocks:
- Focus on the company’s future rather than its past. That sounds obvious, but too many investors succumb to “anchoring bias”. They anchor their value assessment to past prices and believe a stock that falls from $5 to 50 cents must be cheap, when it is a trap.
- Identify a re-rating catalyst within the next 12 months. It’s no good holding an undervalued company for years, hoping the market will re-rate it. You must have a view on what the market is overlooking and what will spark the stock’s recovery.
- Ignore bullish recommendations from house brokers. As the company’s share price falls, the likelihood of an equity capital raising (and broker fees) increases. I’ve seen too many broking firms act as cheerleaders for stocks that sink lower, to earn capital-raising fees.
- Watch the smart money for clues. Company “insiders”, such as directors, buying stock in a fallen company is usually a good sign. So too is a savvy fund manager who has a knack for picking contrarian stocks appearing on the share register.
- This relates to the balance sheet. Contrarian investing is hard enough without choosing companies that need a (potentially dilutive) equity capital raising to survive, or are close to breaching their debt covenants. Stick to those with a solid capital position.
- Buy contrarian stocks that have formed a share-price base and are turning higher. Few stocks have v-shaped recoveries after they nose-dive. Survivors often serve their penance through a period of sideways price consolidation that forms the base for recovery. It’s usually here where the market loses patience and frustrated investors throw in their chips.
- Understand risk. Deep contrarian investing suits experienced active investors who have high risk tolerance. Most investors are better off sticking with large-cap equities or high-quality mid- and small-cap companies that are rising.
Caveats aside, here are 3 deep contrarian ideas worth consideration:
1. Myer Holdings (MYR)