Back in 1939 an investor called John Templeton made an unusual series of investments. As America was emerging from 10 years of the Great Depression, the young Templeton (who was only in his late-twenties at the time) sensed an opportunity.
He bought $100 of every stock trading below $1 on the New York and American stock exchanges – paying around $10,400 for stakes in 104 companies. Four years later, 34 of those companies had gone bust, but Templeton had still made four times his money.
He went on to build a reputation as an investor who was prepared to look almost anywhere in the world to find value. Templeton’s strategy marked him out as a contrarian, which was summed up in one of his best known quotes:
“Bull markets are born in pessimism, grow on skepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.”The makings of a contrarian
Contrarian investors go against the herd. They take the psychologically-difficult route of buying stocks that most of the rest of us won’t touch. These are the investors who are prepared to buy in the market when sentiment is low. They target unloved and distressed companies, and they can be some of the earliest movers when markets hit rock bottom. It was contrarians who made serious money in the early months and years of recovery after the dotcom crash and the financial crisis.
Evidence shows that human nature is likely to have us run for cover in the face of danger. That’s why contrarianism is so counter-intuitive to many investors, even though it can work well over time.
In his book “Contrarian Investment Strategies”, David Dreman, a value-focused contrarian investor, wrote that “favored stocks underperform the market, while out-of-favor companies outperform the market, but the reappraisal often happens slowly, even glacially.”
Yet despite the challenges faced by contrarians, Dreman insists it’s worth the wait. He says that the re-evaluation process, which is heavily influenced by investor behaviour, is the key to large and consistent profits in the marketplace. “As long as investors believe they can pinpoint the future of favored and out-of-favor stocks, you should be able to make good returns on contrarian strategies.”
Name Mkt Cap £m Quality + Value Rank StockRank Style Piotroski F-Score Yield % Rolling Sector Barratt Developments 5,753 95 Contrarian 7 7 Cyclicals Tate & Lyle 2,781 92 Contrarian 7 4.8 Defensives Kingfisher 6,235 91 Contrarian 5 3.8 Cyclicals Travis Perkins 3,263 87 Contrarian 6 3.6 Cyclicals WPP 16,160 84 Contrarian 5 4.7 Cyclicals Centrica 8,325 82 Contrarian 7 8.1 Utilities Micro Focus International 5,536 79 Contrarian 6 5.6 Technology Imperial Brands 26,185 75 Contrarian 7 6.6 Defensives National Grid 28,091 75 Contrarian 7 5.5 Utilities Babcock International 3,765 75 Contrarian 6 4 Industrials
Source: Stockopedia Past performance is not a guide to future performance
Hunting for unloved shares
With this in mind, we’ve taken a contrarian approach to British large-caps this week. As the market continues to recover from falling prices earlier this year, there could be scope to pinpoint unloved stocks that might bounce back.
The screening rules use Stockopedia’s Quality & Value ranking measures to find large-caps with the strongest combinations of appealing valuation and high quality but weak momentum. We’ve added the 0-9 Piotroski F-Score as a representation of financial strength, as well as the yield available on these stocks. While these rules will highlight companies that have hit setbacks, the idea is that their quality could be enough to support a recovery over time.
Unsurprisingly, there have been a few profit warnings over the past year from some of the companies in this list. They include Tate & Lyle (TATE), Kingfisher (KGF) and Micro Focus (MCRO). Others have hit uncertainty for different reasons – such as WPP (WPP), Centrica (CNA) and Imperial Brands (IMB). Careful research is needed in these situations, but the value/ quality profile of the companies suggests that they are firmly in contrarian territory.
So whether it’s an embattled stock or sector or a broader market dip, contrarian investors love moving away from the herd. It’s a strategy that takes mental strength but relies on the time-tested rule of value investing that, over time, the market will price fundamentals correctly.
As Sir John Templeton said: “If you want to have a better performance than the crowd, you must do things differently from the crowd.”
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