The goal of the contrarian investing strategy is to purchase undervalued assets to realize a profit when the asset's market value increases. For instance, a contrarian investor would buy a company in an industry that is currently unpopular, such as energy, provided that the stock has a low price-earnings ratio.

Price-earnings ratios of businesses operating in the industry are expected to increase due to the improved growth prospects due to sector rotation and the recovery of energy prices. As a result of an increasing multiple and rising profits, the value of the investor's energy stock will increase at a rate larger than that of the entire market.

The idea that crowd psychology would ultimately lead to the mispricing of assets in a particular market is the fundamental principle upon which contrarian investing is based. Following earnings releases, corporations often suffer high volatility early in the trading day, which typically settles down by the end of the trading day. There is abundant evidence that this behavior occurs after earnings announcements. For instance, a stock's price could take a significant hit just as the market starts, but it might rapidly recoup some of those losses.

Value Investing vs. Contrarian

Both are similar in that their primary objective is to find discounted stocks in the market and capitalize on their undervaluation before most of the market does so. For instance, screening for opportunities can be done with any strategy by searching for positive financial measures that indicate a stock's price is significantly low compared to the market as a whole. Some industry professionals, such as the well-known value investor John Neff, think that the two concepts may even be interchangeable.

The primary distinction lies in the fact that value investing places an exclusive emphasis on a company's basic advantages, such as its financial ratios or the current value of future cash flows. Contrariwise, investors that take a contrarian position will consider not just objective and objective criteria, such as negative media coverage, but also subjective considerations, such as oversold signs. Instead of looking for assets that are just undervalued, contrarian investors look for assets that have been oversold and are now trading at a discount.

Finding Contrarian Investments

Finding investment possibilities suitable for a contrarian strategy may be accomplished via various methods, including fundamental and technical analysis.

Fundamental Strategies

Popular early contrarian strategies included looking for firms with low multiples of several metrics, such as price to earnings, price to book value, price to cash flow, and price to dividends. Since the market places a smaller multiple on these firms' valuations, the prevailing consensus is that investors do not place as much value in them as they do in companies with high financial ratios. When the market has an excessively negative outlook, investors can consider looking at volatility indices like the VIX and buying assets at that time.

Purchasing the companies in the Dow Jones Industrial Average with the highest yields is the basis of the "Dogs of the Dow" contrarian approach, which is considered one of the most popular of its kind. This indicates that the investor is purchasing the firms experiencing the greatest financial hardship since lower prices result in greater returns.

Technical Strategies

Because the approach is driven by behavioral finance elements that can be quantitatively examined, many contrarian investors also add technological analysis into their decision-making process. For instance, one example of a contrarian approach would be to purchase stocks with a Relative Strength Index that has fallen below the 30.0 threshold, which indicates that oversold conditions are present. The objective is to make the most of the potential return to the norm that will almost certainly take place.

International Contrarians

The ideas of contrarian investing may be applied to foreign markets by investors looking to purchase assets in undervalued areas or nations throughout the globe. It is not uncommon for whole nations or areas to rise and fall in popularity throughout history. For instance, since many investors chose not to participate in European equities when the European sovereign debt crisis started in 2008, price-earnings ratios for European companies are now much lower than before.

At the height of the financial crisis, investors who acquired equities in Greece or Ireland would have been able to reap huge gains on their investments. The same thing happened with investments in Asia during the financial crisis that hit Asia in the 1990s.

Investors may evaluate if a country's economy is overvalued or undervalued by looking at it, in addition to particular events that cause discounted values. One of the most well-known metrics that Warren Buffett uses is the overall market capitalization of a nation divided by its gross domestic product.

Countries with a ratio that is over 90% are often considered to be overvalued, while countries having a ratio that is below 75% may be considered to be undervalued. Investors who are looking for chances in other countries may find this to be an excellent beginning point.