Wednesday, March 29, 2006

Value Investing vs. Contrarian Investing

I said about six months ago that I would post on this.

Basically, I view value investing to be looking for bargain investments by using an objective valuation process. This requires an independent mind to do things different than the market and to use an objective process to value the investment.

Contrarian investing is simply investing in unpopular stocks.

In terms of people, value investing is the man who walks his own path, the people be damned. Think about Verdi, the opera composor, who lived with an unmarried woman in spite of the negative publicity, who ignored the public's contempt and praise, and lived his life.

Contrarian investing is the lone wolf. The man who does everything the opposite of what other people did, simply it is the opposite. I always think of the early punk rock bands who was "anti-establishment".

NoodleFood had a good post on the difference between these two things a few months ago. Diana was quoting Ranil Illesinghe. Here is the relevant litmus test that applies to both investors and people.

I find that the best test to see whether or not someone is an individual is to ask the following question: If the mainstream acted in the same way that he acted, would he:
A. Stay the same OR
B. Do things differently?

If he chooses to stay the same, then he is a true individualist, because it does not matter how many people act LIKE you, as long as you are relying on nothing but your independent judgment. If they start being different for the sake of being different, then that person is the worst sort of coward -- the fashionable non-conformist.

3 comments:

Market Participant said...

I'm not sure I entirely agree. As I see it, value investing is about about investing into situations where your assement of the "true" value of of the investment is different than the broader market's assesment.

This difference could come from many reasons, often unpopular stocks are cheap relative to value as measured by companies ability to generate cash flow and dividends, or it's value to an aquiring company.

In other cases a company is cheap because of the broad market's tendancy to over/under react to news, or lack of coverage and attention from big investors.

Market Participant

Jason said...

I'm not certain I understand where we disagree.

I'm trying to differentiate Value investors and contrarian investors. Value Investors value stocks and buy the stocks that are lower than their value estimate. These are typically unpopular stocks and therefore mispriced.

A contrarian investor buys a stock because it is unpopular. They skip the valuation part and buy the stocks that have been beaten up, simply because they've been beaten up.

I agree with what you said. I think I probably didn't make myself as clear as I had wanted. What do you think?

Market Participant said...

I think that the key difference is that pure value investor's basically ignore market sentiment towards an area whereas contrarian investors look to buck market sentiment.

For example right now, the stocks of many home builders are very cheap. A value investor might look at these companies say that they are very cheap relative their projected earnings and assets, and therefore a good investment.

A contrarian investor would say that these stocks are cheap because of all the predictions of disaster for the homebuilding segment. After checking for basic fundamentals, they would jump in figuring that prices will rise when investor favor homebuilders again.

My guess is that the two styles get lumped together, for a simple reason. If you assume the typical market participants have a bias for growth at any price, then investing for value is contrarian.

Market Participant