Is now a perfect opportunity for contrarian investing?

Different investors take their own approach to picking stocks, from believing that “trends are your friends“, to go against the prevailing wisdom. The latter approach is known as contrarian investing – acting in a way that goes against what investors are doing.

In recent days some stocks have plummeted. This is most obvious in the US banking sector, but there are many examples elsewhere. Contrarian investing suggests buying stocks cheap when sellers dump them and then holding them until they recover. As billionaire investor Warren Buffett says, “be greedy when others are afraid“.

Could now be the time for investors like me to try and profit by using this contrarian approach?

Buffett and contrarian investing

It could be. The basic idea behind contrarian investing is the same as many investment strategies. That the market as a whole sometimes fails to assess the intrinsic value of a business. Buffett has occasionally made large profits from contrarian investments.

The Salad Oil scandal of the 1960s (in which loans were made based on non-existent salad oil as security) dramatically reduced the market valuations of financial services companies, including American Express. But Buffett rightly assumed that Amex would have little business leverage, so the stock was cheap. He built up his company’s stock Berkshire Hathaway still have days.

Buffett invested $5 billion in Goldman Sachs in the midst of the financial crisis of 2008. That resulted in multi-billion dollar profits for the ‘Sage of Omaha’.

Focus on business valuation

However, contrarian investing can sometimes be a dangerous mistake. Crowds may be smarter than individual investors realize.

Sometimes, the thing that drives a stock price down to a bargain level can be a big deal that the company falls apart. This is the case with construction giant Carillion, for example.

At other times, self-destructive investor confidence can change the underlying economics of a business. A reasonably healthy business may suddenly find that a supplier is withdrawing its credit terms and demanding cash on delivery, changing its outlook overnight.

Successful investing involves assessing the value of a business and buying below that price. When events move quickly, it can be impossible to accurately assess the value.

Yesterday, several medium-sized US banks saw their share prices fall and rise within hours. But with the outcome of the current banking crisis unclear, it is simply impossible for me to make an assessment of some of the future values ​​of these banks with a degree of confidence.

Avoid speculation

That’s why I see buying these shares now not as contrarian investment, but as speculation.

As a long-term investor, I want to buy and hold shares in great businesses that I think are good value. Sometimes it goes with a lot of people, like when I bought it Apple a few years ago. Other times, it can be contrarian, like my decision last year to buy Super dry.

That contrarian investment still needs to fit in with the overall investment strategy of buying what I think is a good business at a low price.

If I can’t assess the value of a business, I can’t make investment decisions about it either. For many stocks, that’s why I think now is not the right time to take a contrarian approach.