Contrarian Investing: Should You Use this Investment Strategy in 2022?

You can't say you've never heard of a contrarian viewpoint if you've never heard or read Warren Buffett's famous quote, "Be fearful when others are greedy and greedy when others are fearful."

Contrarian investing is just that — it means investing against the crowd. But it's a hard way to go. As humans, we tend to want to move with the crowd. So, if you're like Buffett and picking up a bunch of ho-hum companies in the 1990s instead of buying up companies related to the tech bubble, it might seem, gosh, too boring for words. But as Buffett proved, being a contrarian can have a huge payoff. 

If you see yourself as the type who goes your own way (you've always worn pants in the summer and shorts in the winter), you might have the makeup to be a great contrarian investor.

Let's get into the definition a little more and a few contrarian investing tips so you know whether it might be the way to go as you ring in the new year. 

What is Contrarian Investing?

Contrarian investors use lots of market research to their advantage and the biggest goal is to move your capital from overvalued positions to those that are undervalued. When you buy stocks at discount, you make money once the larger crowd catches on and everyone else says, "We should have invested in that company ten years ago!" 

(Contrarian investors would have already recognized the company as excellent and have been way ahead of the game.) However, you've still got to do your research, because if you invest in bad companies to begin with, of course you won't make money.

Here's an example of how it works: Let's say that the majority of investors, seeing the Omnicron variant taking over, sell all of their hospitality-related stocks. A contrarian investor buys these stocks instead, believing that consumer demand will ratchet back up as soon as advanced COVID vaccines and boosters hit the market. A contrarian investor might also choose to short overvalued stocks.

Contrarian investors go against the grain in just about every way possible. So how do you do it? Let's walk through a few tips to use contrarian investing as a strategy.

Tip 1: Start with great analysis.

Skip watching the news. If something great has happened with a particular company and you hear it on the news, you're already too late. The news media is always a day late and a dollar (or in many cases, thousands of dollars) short. You must apply your own analysis to learn about companies, independent of what's happening in the wider world.

Ultimately, It doesn't matter how promising a sector looks — if you can't pick a good company, you won't make money. You need to know about the fundamentals of great companies, and this is where value investing comes in. (You can't become a good contrarian investor without knowing about value investing — just ask Buffett.)

Learn how to calculate debt-to-equity (D/E) ratio, earnings per share (EPS), price to book value (P/BV), price to earnings (P/E) ratio, P/E growth (PEG) ratio, to name a few. 

Tip 2: Understand an industry inside and out.

Going against the grain in an entire industry or whole markets may be worth it if you have the inside scoop.

To become a contrarian investor, consider becoming a full-on industry expert. You can act on what other investors don't know. For example, let's say you've worked in grocery stores your whole life. You know some specific technology will start coming toward grocery stores — a new type of device that scans produce more efficiently and it hasn't hit the mainstream. You can be a contrarian investor by investing from the get-go. When others don't know what you know, it can create great opportunities.

Tip 3: Have patience.

You've got to take a long-term view as a contrarian investor because you're waiting for the rest of the world to "catch up" to what you already know is a great company. The rest of the world tends to react to  company news. For example, when a company shows poor earnings reports, stock prices drop, even though the company might be a healthy business with brand loyalty and great management. You'll recognize the inherent strength in the company and ignore these tiny blips. As long as you implement your excellent analysis, you'll know that over time, the company will pull through.

To tide you over, take a look at the companies you're interested in and look at dividends. Do they pay dividends? A dividend is a sum of money paid, usually quarterly, by a company to shareholders out of its profits or reserve money. If you invest in a company that does pay dividends, you'll reap the benefits while you're waiting for everyone else to notice that the stock is a worthy purchase and subsequently becomes overvalued.

If you are right, your predicted outcome will take forever to reveal itself — maybe even longer than you think. Your waiting game can last a long time. 

Be Greedy When Others Are Fearful

It's perhaps the most famous cornerstone of contrarian investing: Be greedy when others are fearful. When did following the herd benefit you at all — in life and in investing? Best to go your own way.

Developing a thorough understanding of contrarian investing can do wonders for your portfolio in the long run. Unfortunately, contrarian investing can be a lonely road, because others may neither understand nor appreciate the methods you've adopted. Friends, family and co-workers simply may not share your investment strategy or see the risks and returns how you see them. At the worst, they may make fun of you — "Why would you invest in that company?"

If you can stomach all the variables and have a huge hunch that you're right, why not take it? A healthy dose of skepticism is the contrarian's bread and butter.

Ready to adopt this investment strategy in 2022? Good for you, but do your research.