Stock Investors Benefit from a Contrarian Investment Strategy
Contrarian investing is based on the belief that stock prices oscillate around a company’s determinable intrinsic value, or what Ben Graham referred to as a company’s “central value”. By taking advantage of these price swings, investors can achieve profitable long-term results with less risk. A company’s intrinsic value is rooted in measurable financial characteristics. One can assess this value by carefully analyzing a company’s assets, core earning power and trends in its return on capital.
Stock prices oscillate around this intrinsic value as investors’ opinions change regarding the company’s future. When confidence abounds, investors are attracted to the stock, and their buying drives the price above its central value. When optimism abates and pessimism deepens, investors sell the stock, driving the price below its
central value. The cycle is
often completed when uncertainty passes and the stock appreciates back towards
its intrinsic value.
There is more at work here than just investor sentiment. Rational business fundamentals that relate to underlying economic principles drive price changes as well. A company’s stock rises during good times when demand is strong, sales growth is robust, competition is limited, and profits are expanding. Then, the stock falls as robust profits attract new capital, add competition or increase supply, eventually eroding profits and growth. The stock will appreciate again when demand returns, costs fall, profits and growth resume, thus completing the cycle once more.
Intensive financial analysis provides contrarian investors with the courage to sell what other investors, in an emotional frenzy, are greedily buying at high prices. Similarly, they have the conviction to buy what other investors are despondently selling at low prices. By avoiding loss of capital at one extreme and not overpaying at the other, risk is reduced and returns are enhanced.
Throughout history, this contrarian approach has delivered profitable results with less risk for conservative investors focused on the long term.
--Insight Investment Counsel--
“Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.”
--Benjamin Graham--
“Greater risk brings greater returns.” This standard investment mantra is not always true for bond market investors when rising interest rates can wreak havoc on bond portfolios.
To illustrate this important relationship, Insight conducted an analysis of two Morningstar bond fund categories and two Vanguard index funds. We compared the annualized returns following the bond bull market years when interest rates declined from 2008 to 2012. As the table shows, the returns for the intermediate-term strategies provided over two-thirds of the returns of the long-term strategies.
Bond investors with a long-term time horizon will face periods of rising interest rates, and must prepare for the resulting challenges. Insight’s Strategic Fixed-Income Management recognizes this and structures client bond portfolios with the objective of reducing volatility while providing returns consistent with moderate-risk bond management.
--Insight Investment Counsel--