The Tycoon Report

Can You Make Money Being A Contrarian?

Friday, July 11, 2008 | Ethan Roberts

Tycoon readers, you might be surprised to know that in my younger days, I was a bit of a rebel.  Like many teens and 20 somethings, I thought I knew all the answers.  In my black and white mode of thought, the world was divided into good guys and bad guys.  For example, the corporate world seemed like one of the bad guys.  They were only interested in making huge profits, even if they had to pollute the world or commit mayhem in foreign countries to do so.  On the other hand, the good guys were the ones who wanted to save the planet, strive for world peace, and eat yogurt with granola.  If you could play a little guitar and sing like Dave Mason, that was good too.  Maybe I should have taken his advice:

"So let's leave it alone
Cause we can't see eye to eye
There aint no good guy
There aint no bad guy
There's only you and me and we just disagree"
-------Dave Mason, "We Just Disagree", 1977

Then despite myself, I grew up and had an attack of common sense.  I finished graduate school, went to work, and pretty much left the fantasy world of academia for the real one.  I saw that most of the time nothing in life is entirely black and white, but rather all things tend to gravitate toward eloquent shades of gray. 

But I couldn't seem to shake off the rebel stuff completely.  So when I became interested in the investment world, I was naturally drawn to the Contrarian approach, whether it was related to stocks or to real estate. 

What exactly is the Contrarian approach?  Wikipedia defines it as follows:

"A contrarian is one who attempts to profit by investing in a manner that differs from the conventional wisdom, when the consensus opinion appears to be wrong.  A contrarian believes that certain crowd behavior among investors can lead to exploitable mispricings in securities markets."

We see examples of mispricing all the time in the stock market.  When people are too pessimistic, they often drive down the price of good stocks far lower than they should, and conversely when people are too optimistic, they drive up the price of stocks to a level that becomes unsustainable.  Eventually the beaten down stocks begin to attract new money and the overbought stocks sell off.

Contrarians are often value players.  But they look for absolute value, not just relative value.  Absolute value is when a stock trades at a big discount to its own historical levels of value, not just relative to the market average or other stocks within the same sector.  Warren Buffett is one of the best known contrarians.  The Nebraskan legend, worth $62 billion dollars, frequently buys stocks for his Berkshire Hathaway company that have been trounced for years.  He does this when he feels that the selling is overdone and the fundamentals of the company warrant a purchase.  Buffett's style is to buy stocks with "intrinsic value", or the underlying fair value of a stock based on its future earnings power.



One well known contrarian strategy is to buy the "Dogs of the Dow".  The "Dogs" are the 10 Dow stocks that have the highest dividend yields at any given time.  The usual strategy is to buy them on the last day of the calendar year and then hold them just over a year before selling them.  Then you buy the newest 10 Dow stocks with the highest dividend yields.  In this way you are always buying some of the greatest companies in America when they are at weak levels. 

Between the dividend yield and the price appreciation, when they rebound, one can do quite well.  In fact, the Dogs of the Dow has an average annual return of 17.7% since 1973.  During that same period, the overall return for the Dow stocks was only 11.9%.  There were some years the Dogs lost money (including year to date 2008), but most years they've had positive returns.  The Dogs have even outperformed the major indexes during terrible bear market years, such as 2000-2002.

From the "Dogs of the Dow" list, we can further extract what are called the "Small Dogs of the Dow".  These are the five lowest priced stocks among the ten "Dogs".  Because they are lower priced, they are often more volatile, and have even outperformed the overall Dogs list throughout the years.

Presently, the biggest Dog of the Dow is Bank of America (BAC), which has an 11.89% dividend yield, as of 7/7/08.  General Motors is right behind it with a 9.77% yield.  You have to be pretty gutsy to buy these stocks right now with the market in its current turmoil.  Although it's a contrarian strategy, the contrarian doesn't buy BAC right now just because it's down or is the top "Dog".  One buys BAC because they believe in the company long term, and believe in its ability to withstand a crisis such as the Sub Prime Meltdown, so as to become profitable again in the future. 

Symbol	Price on 7/7/08	Yield %	Small Dog?
BAC	21.53	11.89	YES
GM	10.24	9.77	YES
C	16.40	7.80	YES
PFE	17.39	7.36	YES
T	32.68	4.90	NO
VZ	35.43	4.85	NO
GE	27.10	4.58	NO
JPM	34.04	4.47	NO
MRK	36.60	4.15	NO
HD	22.32	4.03	YES

Look, there's nothing glamorous about being a contrarian and there are certainly some disadvantages to being one.  First, you will be unpopular with your investment buddies.  They may laugh at you, or tell you how foolish you are.  You will probably be early with your contrarian calls at times, and people will question why you aren't investing along with the obvious trend.

But as the true contrarian, you don't care what others think.  Yes, you see the obvious trend, but you also see the change in the wind before it arrives.  The signs are always there.  Think back to Former Fed Chairman Alan Greenspan's warning of "irrational exuberance" in the stock market.  Greenspan was actually years too early, and received much criticism for his call in the middle of a roaring bull market.  Investors were especially peeved that the market fell over 2% the next morning after that call was made.  But by the end of the day, stocks had almost fully recovered their losses, as they shrugged off the chairman's warning.

Greenspan's view was a contrarian one, and he was right about the markets being frothy, but he was absolutely dead wrong in the timing of his prediction.  It would be more than three years later before the markets would collapse.


Critics of the contrarian approach will say that like a broken watch that is right twice a day, a contrarian is eventually correct -- but how long and how painful is the wait before he is proven right?  Well, maybe that is so, but Warren Buffett doesn't seem to mind waiting awhile to be proven right.  Anyone want to argue with the richest man in the world?

That brings me to the second disadvantage of being a contrarian.  Because you are like a salmon swimming against the current tide, you may have to endure some risk of being wrong before you are proven right.  Believe me, it is easier to be a momentum investor.

I remember selling most of my stocks and mutual funds and going into cash in late December, 1999.  I missed the last three months of the big rally and that was difficult to watch.  But it was a lot better than losing most or all of my gains, as many investors did after stocks crashed in March, 2000. 

So this morning, I was in a contrarian frame of mind and decided to buy some beaten down stocks for my IRA account.  I bought a few hundred shares of Ford (F) at 4.50 and the same amount of Bank of America (BAC) at 21.56.  I want to make it clear that I am not suggesting, advocating, or urging anyone else to buy these particular stocks.  I am simply relating to you what I myself did as a contrarian investor.  As I write this, these stocks are showing a profit, but by the time you read this who knows if they will be up, down, or sideways. 

You may recall that I discussed Ford in last week's article, and so today I felt it was time to put my money where my mouth was.  I bought it because it was trading at levels not seen since 1991 and because in my IRA account I have a long time to be right, even if I am too soon in my purchase.  I bought BAC with the same thought in mind, along with the juicy dividend.  Now here is where somebody will write in and tell me I'm a dope because BAC may have to cut the dividend.  Now that wouldn't make me happy, but if they only want to give me 5 or 6%, I can live with that too. 

In the meantime, I own BAC, one of the biggest stocks in the country, which sold for $52 a year ago, at a bargain bin price.  Is it unloved and unwanted?  Heck yes!  Even Jim Cramer was talking about possible bank failures unless the government does something, on "Mad Money" tonight.  I know that some people would say if Cramer says banks could fail, that's the best contrarian reason to "buy, buy, buy"!  But I have far more respect for the man than to say that.


There are many other contrarian strategies which have been well documented over the years, such as:

1)    Buying stocks with high levels of short interest ratio
2)    Buying stocks with analyst consensus sell ratings
3)    Buying stocks when the percentage of  bearish newsletter sentiment is extremely high
4)    Buying stocks after a major international crisis causes a market sell off

Perhaps I will address the first three in a future article.  As for the fourth strategy, take a look at this chart below.  This is a chart from 1948-1990, showing the market lows after each major international crisis, and where the market was one and two years later:

Crisis Event	Market Low After Crisis	Following Year percentage	Following 2 years
Berlin Blockade	7/19/1948	-3.3	13.2
Korean War	7/13/1950	28.8	39.3
1962 stock market break	6/26/1962	32.3	55.1
Cuban Missile Crisis	10/23/1962	33.8	57.3
Kennedy Assassination	11/22/1963	25.0	33.0
Gulf of Tonkin	8/6/1964	7.2	3.1
1969/1970 stock market break	5/26/1970	43.6	53.9
1973/1974 stock market break	12/6/1974	42.2	66.5
1979/1980 oil crisis	3/27/1980	27.9	5.9
1987 crash	10/19/1987	22.9	54.3
1990 Persian Gulf War	8/23/1990	23.6	31.3
Average Appreciation		25.8%	37.5%

So as you can see, buying after a major crisis makes for one sweet contrarian play!

To learn more about contrarian investing, there are several good books on the subject you can get from your library, bookstore, or from Amazon.  Two of the best known ones are:

1)   "Contrarian Investing:  Buy and Sell When Others Won't and Make Money Doing It", by Anthony Gallea and William Patalon.

2)    "Contrarian Investment Strategies in the Next Generation", by David Dreman


So can you make money by being a contrarian investor?  Absolutely, YES!  We must resist the easy temptation to join the madness of crowds!  You can become the James Dean of investing, but do it as the "Rebel WITH a Cause", and remember that this cause is about making money!




Until next time, have a great weekend!




Ethan Roberts
Contributing Editor
The Tycoon Report