Customer Reviews

Contrarian Investing: Buy and Sell When Others Won't and Make Money Doing It (New York Institute of Finance)

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The research support for the authors strategy is weak but the book is worth buying for the wisdom it contains on risk, insiders, and investor psychology. Inexperienced investors could find themselves stranded when implementing the books' often subjective sell criteria.

One of the authors admit to having to give up part of their occupations to write the book, it shows. Is this book really a value investing book in disguise? Take out one rule about stocks being down 50% and you are left with a book on insiders and low P/E investing.

There is an absense of any testing of the final recommended set of rules. A clue as to why is when the authors admit that in September 1996 only a handful of stocks met their recommended strategy criteria.

Where is the authors own performance following thier criteria?

The research cited in the book is only on each core components of their purchase criteria but not on the combination, or risk management rules or acombination thereof, and therfore claiming the whole is suported by the research is a giant leap.

This lack of research leaves many questions unanswered. How did their strategy do with gold stocks, or steel stocks, which have been contrarian plays for years? What would have happened to their strategy in this raging growth stock bull market?

The authors too often fir example of their strategy by making exceptions to their rules by using subjective analysis and hindsight: such as "when the company's prospects are clearly improving, when the stock price seems to be climbing a 'wall of worry.'"

Too often the authors use the words "often", "can". which are useless as rules or criteria. Too often the authors contradict themselves.

However the good sections on risk, investor psychology make it worthwhile reading.

This book is an excellent work on exercising rational techniques for investing in the stock market with a long view of returns. Not intended to be a "speculators" guide, the authors describe specifically what indicators prompt an investor to buy and sell, actions that will be contrary to prevailing market sentiment, but validated by the results of several long-term studies on the success of these indicators in the market. The book doesn't pretend to be fool-proof in its methodology, offering sound advice on how to protect against losses, save profits, and distribute risk in one's portfolio. All this adds to the credibility of the authors and raises the reader's confidence in the thoroughness of their approach to stock market investing.

Nowadays many people so easily refer themselves as contrarians as if the title will easily make them winners in the investment game. Of course, common sense, though not really common, tells us something otherwise.

In this book, many historical examples had been quoted about how those genuine contrarians bought on panic and sold on eurphoria, and it's only when the market consensus was at its extreme that the contrarian play would pay. It makes no sense just to think that you are playing opposite to the crowd whilst you simply belong to one of them.

In this respect, the authors had put forth a contrarian system for investors to follow, rules based on value/fundamental investing but with solid technical elements of when to enter a market and when to stop profit/loss. So called real life stories and testimonials to support the authors' theories and propositions are abundant everywhere. Psychology behind a trend is vividly elaborated.

I think that the book is a good leisure reading for veterans and a good starter for beginners. Definitely you wont get bored. The lovely pigs on the front cover do tell something about how the authors would like it to be.

p.s. The foreword by Jim Rogers, reprinted from an article In Rogers' own book Investment Biker, and also many of those adages in the beginning of every chapter, are excellent.

"Dont fight forces; use them."
"The easiest job I have ever tackled in this world is that of making money. It is, in fact, almost as easy as losing it. Almost, but not quite."

In 1998, Anthony Gallea, a Portfolio Manager at Smith Barney, with help from William Patalon, a professional writer, wrote the classic "Contrarian Investing." Jim Rogers wrote the forward to the book. Many successful investors have cited this book as a book that greatly influenced them. This volume, like Ben Graham's "The Intelligent Investor" is at times dated, yet full of classic investing principles that stand the test of time. Every serious stock market investor must read this book. I summarize its key points below, but do not let that stop you from reading the book yourself!

General contrarian ideas:
' Watch out for "this time it's different from all other times" in the press.
' Don't "buy when blood is in the streets." See the blood, wait a while, then buy.
' "Study and think, think and study."
' "Buy on the cannons, sell on the trumpets"
' Success as a contrarian demands a long-term view (2-3 years).
' Contrarian: buying when others won't. Once we've bought, we want other investors to come around to our point of view.
' Contrarian path is not always an easy one to travel.

1. What is a contrarian?
A natural skeptic. If everyone believes something strongly enough to have already acted on it, there is profit to be made in taking the opposite position. This requires a real consensus, an extreme of opinion, not just a 10% stock drop. Contrarian investors succeed by not only disagreeing with the crowd, but knowing when to act on that disagreement. They are looking for extremes in opinion.
Contrarian indicator buy signals: insider buys, P/E below 12, p/fcf <10, p/s<1.0, p/bv<1.0
It is hard to be a contrarian investor- often times you will be a detached thinker, a loner.

2. The contrarian advantage.
Independent analysis is the key ingredient to successful contrarian investing. Many investors are too scared, too lazy to think for themselves. They watch the superficial news instead of doing analysis. The media helps extend popular opinion, driving it to extremes in both directions. Contrarians do their own analysis and thinking, and take action on their unique beliefs.

3. The psychology of investing against the grain.
Society rewards conformity, just like a herd of animals requires conformity for their survival from predators. Contrarians think differently - they are independent, they ask questions others do not and approach problems in a fresh way- they reject the herd mentality. Analysts have to herd along because being wrong is OK, but being grossly wrong by being out of consensus is unacceptable. Then, when analysts are wrong, they engage in ego-defensive behavior and defend their incorrect stance. As investors struggle with new information, they tend to reject it in favor of beliefs they already hold. This is inherently irrational. Many investors believe that they are acting rationally, when instead they are acting emotionally, defending their own egos. It is not a good practice for contrarians to share their opinions with others, because it saddles them with the additional burden of "being shown wrong."

4. Market Manias.
"In nature there are no rewards or punishments, there are consequences." As investments gather momentum, it gathers followers. Fraud is a great contrarian indicator that a market is getting overheated. (although I think it's more of a lagging indicator, because the frauds are usually masked by a bull market - this time Madoff, GS, CDOs, mortgages, AIG, all came out after the market had crashed already) Head for cover when someone says, "it's different this time" The market will always run out of "greater fools". Manias are often fueled by easy credit/leverage. In 1929, it was 10-1 leverage on buying stocks. In 2008, it was 99-1 leverage in buying real estate.

Signs of manias:
(These are classic signs. Although the authors wrote this book 10 years before the 2008 meltdown, the latest real estate/mortgage/banking meltdown followed exactly the same script.)
1. Manias come during periods of prosperity.
2. Most manias are fueled by easy money and easy credit.
3. All manias are characterized by ever-widening acceptance.
4. Manias are always supported by authoritative opinion that reassures speculators
5. Participants ignore the voices of doom, which are really the voices of reason, and later blame them for bringing the "good times" to an end
6. Mania's tops are impossible to forecast
7. It is impossible to invest successfully in a speculative mania - it's all driven by momentum (normal fundamental rules no longer seem to apply)
8. Manias all end with a crash so destructive that the pain is felt for years, even decades that follow.
9. as a mania progresses, demands for the investment burgeons, but so does the supply, and the newer offerings are always of increasingly questionable quality
10. All manias end abruptly and with little warning.

5. Technical analysis is a key contrarian strategy.
One buy signal is price down 50% from peak stock price. Very powerful, statistically significant indicator. Winston Churchill: "Nothing in life is so exhilarating as to be shot at without result." Management shake-up is often a good reason to buy a stock. (IBM example)

6. Riding the Price trend.
"Only a fool holds out for top dollar" - Joseph Kennedy. A trend is the visible expression of current and past opinion. Very hard to predict when a trend will reverse. "The trend is your friend" is true- the profits only come while we're riding a trend. Once you find a trend, ride it as long as you can. There must be a clear reason to force you out. Most of your money is made by sticking with a winning position, and not through frenetic trading. At major tops or bottoms, volatility tends to increase (True in 2008 bottom!) No one can accurately predict the length of a trend. Sometimes a stock is listless/trendless for months before a trend can develop.

7. Insider buying and selling gives insight.
A stock that is off 50% from high, and has strong insider or knowledgeable outsider buying is one of the best contrarian plays. (Insider selling is not a clear-cut signal, buying generally is). "Knowledgeable Outsider": investors like Buffett, Kerkorian.

8. Fundamental stock analysis.
The authors favor the traditional low-priced screens for stocks, similar to the Ben Graham value investing principles. (I think true contrarians are even more flexible in their thinking - some of the lowest P/E stocks in the recent crash went bankrupt, especially banks) P/E below 12, P/BV<1.0, P/FCF<10, P/S<1.0

9. Low P/E ratio.
Book advocates buying low P/E stocks. I agree, but this is only one indicator, and not enough. In addition, earnings can be distorted by GAAP accounting and P/E can be distorted by large amounts of cash per share. EV/EBITDA or CF is maybe better.

10. Low P/Book.
Price below book can be a cheap entry point for a stock. Be careful that the book value is accurate, however. (Banks recently had inflated book values)

11. Cash flow, price/sales.
FCF = Pre-tax income minus Maint. CAPEX.

12. Sell signals.
(This chapter is mis-named. Instead of telling when to sell, the authors actually give some risk management guidelines.)

Things to watch out for:
1. Get Rich Quick - looking for the proverbial 10-bagger - you may be taking too much risk.
2. Confusing brains with a bull market.
3. Market tips from others should be ignored!
4. Hooked on the idea
5. Lack of knowledge- you must do your own research!

Risk management rules:
1. Less than 5% of portfolio per stock (I'd say up to 10% is fine)
2. limit exposure to a theme or industry to 20% (again, I'd go higher here since I concentrate my investments in the 3-5 industries that I know best, and accept the higher volatility that goes along with this approach.)
3. Use stop loss of 25% (or tighter)
Don't "average down!" resist the urge to buy more - if the stock drops 25%, sell it and move on. Owning a loser consumes a lot of energy. But owning a loser twice is far worse. If you buy back, do it only higher than the price you paid the first time. This is counter-intuitive, but it confirms that a rising price trend has begun.
4. Seek noncorrelated investments
5. Don't overlook the diversification benefits of international stocks
6. Always compare an investment's risk and return to cash.

13. When to sell stocks.
Use stop-losses to staunch the bleeding. Accept that being wrong sometimes is just part of the business. Contrarians do not try to predict prices. No one knows where a stock's price is going to go. Once a price trend is under way, no investor knows how long it will last, or how far it will run. Don't waste time second-guessing yourself for poor or untimely selling decisions.

14. Planning to win: Creating your Contrarian Strategy.
Successful investors share two characteristics: 1. They have a plan, 2. they follow that plan with unwavering discipline. Successful investors build their styles over a period of years. They persevere. Eventually, their discipline, and their willingness to stay with what they know, pays off. Be patient. Be consistent. Ignore popular opinion.

15. Summary: The Rules of the Contrarian System.
The Buy Rules. Initial trigger: "down by half rule" Confirming indicators: Major buys by insiders or knowledgeable outsiders. Low P/E, P/CF, P/BV, P/S. Minor rules: stock must be at least $5 per share. Better off buying fewer shares of a high-price stock than many shares of a lower-priced one. Look for market caps over $150M. Consider a change in top management as a positive in a company with problems. Look for one-time events that hammer the stock.
The Selling Rules: put in place 25% stop-loss. Sell after 50% gain or 3 years (I disagree- I think you have to let your winners run) Exception to 50% gain rule - after 100% gain, set a stop that locks in a 70% profit.
Risk diversification rules: 5% purchase rule. 20% industry rule. High-tech stocks not suitable for contrarian investing (dated- this book was written in 1998 during the heat of the tech/internet stock mania)

Contrarian investing is not simply investing against the crowd. It is investing against the crowd when the crowd is wrong and overreacting. At the start of this book the author says, "Investing is a strange business. It's the only one we know of where the more expensive the products get, the more customers want to buy them. That doesn't happen with a car, a house, or a VCR. Usually, people shop for bargains." This one quote says it all.

This book is simply about value investing with the title Contrarian Investing. Being a value investor is not simple because one has to be willing to pull the trigger when the majority of other investors have the opposite view of the market. I really liked this book because in my opinion, the investment philosophy described in this book is the best way to invest.

- Mariusz Skonieczny, author of Why Are We So Clueless about the Stock Market? Learn how to invest your money, how to pick stocks, and how to make money in the stock market

To be a contrarian means betting against crowd, and against the prognosticators and pundits who, as highly visible experts, are makers of mass opinion. A contrarian is interested in the extremes in market sentiment, not just disagreeing with the majority. In order for a contrarian to profit, the whole must be convinced they are right in their investment sentiment and the contrarian position juxtapose in the reverse sentiment. A contrarian investor measures opinion of the investing public, and the when the opinion reaches an "unreasonable extreme", he invests against it; a contrarian should avoid mass media speculation that accompanies market tops. Investors are attracted by action, by the potential for profit. When a stock has risen for a long time, and then really accelerates to the upside, it can suddenly attract a whole new group of investors who will strong bid for the stock. People have a way of projecting into the future, a straight line from the past, unfortunately for them, the run rarely continues. Reversal occurs.

Buy rule: 1. A stock must be down 50%, in the last 12 months and experiencing significant insider purchases. 2. Any two of the following: PE < 12, Price/Cash Flow < 10, Price/Sales < 1, Price/Book Value < 1

Sell rule: 1. A stock must rises 50% from its purchase price or after 3 years which ever comes first 2. Sell on 25% loss 3. The investor should seek stocks that pay dividends can keep in cash for investment purposes.

The research support for the authors strategy is weak but the book is worth buying for the wisdom it contains on risk, insiders, and investor psychology. Inexperienced investors could find themselves stranded when implementing the books' often subjective sell criteria.

One of the authors admit to having to give up part of his occupation to write the book, and it shows. Is this book really a value investing book in disguise? Take out one rule about stocks being down 50% and you are left with a book on insiders and low P/E investing.

There is an absense of any testing of the final recommended set of rules. A clue as to why is when the authors admit that in September 1996 only a handful of stocks met their recommended strategy criteria.

Where is the authors own performance following thier criteria?

The research cited in the book is only on each core component of their strategy criteria but not on the combination. Little research is provided on their risk management rules or a combination thereof. Therefore claiming the whole is supported by the research is a giant leap.

This lack of research leaves many questions unanswered. How did their strategy do with gold stocks, or steel stocks, which have been contrarian plays for years? What would have happened to their strategy in this raging growth stock bull market?

The authors too often fit example of their strategy by making exceptions to their rules by using subjective analysis and hindsight: such as "when the company's prospects are clearly improving, when the stock price seems to be climbing a 'wall of worry.'"

Too often the authors use the words "often", "can". which are useless as rules or criteria. And too often the authors contradict themselves.

However the good sections on risk, investor psychology make it worthwhile reading.

I recommend that all people who wish to invest in common stocks read this book first. I suggest this book to all my clients.

This thoughtful, logical book progresses smoothly through the fundamentals and into the more advanced concepts. Completely practical, and very timely given the current market conditions.

I bought this book as a counterpoint to my interest in momentum investing in high technology stocks. The criteria they set for picking "loser" stocks that can be "saved" restrict contrary picks to a few investments, but the investments are worthwhile additions to a portfolio of momentum stocks. Their criteria for stop-loss trades is also worthwhile to either contrarian or momentum investment picks.