Damodaran, Fisher & Steinhardt On Successful Contrarian Investing

While a lot has been written about the importance of going against the herd in order to be a successful investor, it’s important to remember what a couple of very successful investors and one finance professor had to say on the subject.

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A long time ago, famous value investor Philip Fisher wrote:

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“Much has been written in the literature of investments on the importance of contrary opinion. Contrary opinion, however, is not enough. I have seen investment people so imbued with the need to go contrary to the general trend of thought that they completely overlook the corollary of all this which is: when you do go contrary to the general trend of investment thinking, you must be very; very sure that you are right.”

Another famous investor, Michael Steinhardt also said:

“A contrarian is a plus but it’s not enough. To be contrarian is easy, but to be contrarian and to be right in your judgment, to be right when the consensus is wrong is where you get the golden ring.”

Lastly, Aswath Damodaran is a Professor of Finance at the Stern School of Business at New York University, and he wrote a great investing book called Investment Fables: Exposing the Myths of “Can’t Miss” Investment Strategies. The book looks at the pros and cons of a number of popular investing strategies. It also provides a ‘moral’ for each strategy along with his analysis. Included in his discussion regarding the contrarian investing strategy is the ‘moral’:

“The crowd is more often right than wrong.”

Additionally, Damodaran provides the following timeless scenario for all would-be contrarian investors. Here is a excerpt from the book:

The Last Rational Investor

[muunger]

Jack was a loner with little faith in human nature. He was convinced that the rest of the world was irrational and becoming increasingly so, and he felt that herd behavior was the rule rather than the exception.

As he read about a selloff on a blue chip company after an earnings report that fell short of expectations caused the stock to drop to $8 from its 52-week high of $45, he told himself that the stock could not go down much further. After all, the company had been around 50 years and had once been considered a market bellwether.

He called his broker and bought 1000 shares at $8, convinced that it was only a matter of time before it bounced back. A few weeks later he checked the price again and the stock was down to $5, and he bought 1000 shares more, believing even more strongly that a rebound was just around the corner. Two months later, the stock had hit $2, and without a hint of self-doubt, Jack bought 1000 shares more and waited for his payoff.

Four days later, the company announced that its CEO had resigned and that the stock had been delisted. The only consolation for Jack was that the stock price had finally hit zero and would not go down any further.

 

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