Contrarian investment philosophies share a whole host of similarities with the Value investment philosophy we practice hear at NaviCom International Investment.

. The most striking similarity between both philosophies is the pursuit of assets that are undervalued to their real market price. This article will give you 5 rules of contrarian investing and provide insight into how these rules can also be utilized as part of your value investment strategy.

The contrarian view on mass market sentiment

What we like about the contrarian approach is the ability to see the financial markets so much differently from the masses. The skills required to gauge the direction of market sentiment are not overly technical from an analytical perspective, yet are more reliant on the principles of mass or crowd psychology.

In short, mass psychology presents the case that individuals, investors in our case, take a great deal of comfort from being part of a crowd, which in turn serves to unlock the unconscious mind.

What has this got to do with investing I hear you ask?

Well, as soon as you begin reaching your investment decisions from the comfort of your subconscious mind, you are essentially investing on sentiment and more importantly the same sentiment of the masses.

To help you put this into perspective, think about the business section on CNN, and ask yourself if you are taken in by the smiles of pretty ladies and handsome boys as they script read to feed the masses with mainstream views….over and over and over again?

How can so many people be so right and profit so highly from the very same opportunity? Call it brainwashing, even go so far as to call it financial propaganda if you will. Either way the mass market hysteria projected from the mainstream media will not serve your hard earned capital well should you be taken in.

5 Rules of Contrarian Investing

These rules are aimed at providing both the novice and seasoned investor with some practical ideas on how to improve your trading as an investor searching for value. As with the value investment philosophy, discipline and patience as characteristics you should master, after all, the best things come to those who wait don't they?

  • Rule #1 - Price is your friend, technical analysis is your enemy and timing just sits on the sidelines.
    OK, so maybe we can't just completely rubbish the value that some technical analysis brings to our decision making process. However knowing that markets and corporations are not strictly regulated in a black or white manner as we are led to believe, adds suspicion to some of the financials available to the public domain.
    Market manipulation and innovative accounting techniques used by a large number of Fortune 500 companies, contain the serious potential to distort your interpretation of data. Combine this shady data with mass market sentiment and you are on a sure path to diluting the spending power of your investment capital.
    Timing is an often discussed component of the investment decision making process. Again, as a contrarian investor in search of value, you need to remove timing from your criteria checklist.
    Recognizing a great company that adheres to the principles of the value investment philosophy is a company that rewards investors irrespective of market conditions. Whether I acquired shares in that company 3 years ago, or whether I execute the trade after I finish writing this article should have zero impact on my decision making process.
    The only factor I may consider is why on earth I hadn't recognized the value potential of that company three years ago? Nevertheless, I shall not dwell on past performance but shall rejoice that I am now able to add a value driven investment to my portfolio.
    So what makes a great company a great investment irrespective of timing? In short, a great company will capitalize when the general market is on the up, and will preserve these gains during times of market decline.
  • Rule #2 - Understand and decipher the basic components of financial statements
    If I sound like I am contradicting myself from Rule #1 above, please bare with me. There is a huge difference between technical analysis (your enemy as of Rule #1) and your understanding of financial statements.
    In around about way, technical analysis will generate the performance data of a number of companies, run it through the data processing mill, and end up with a series of predictions that are based on a number of economic driven variables. These predictions are more often than not the result of handy guess work. When a prediction pays off, the law of averages kicks in.
    Understanding data from financial statements of a company and the company's competitive advantage, will usually tell you whether the company's price presents value or is at its fair price.
    Learning how to identify value from the Income Statement, Balance Sheet and Statement of Cashflows is the surest way to simplistic value investing.
  • Rule #3 - Buy solid companies that are out of Wall Street favor
    If we look at how mass psychology leads investors to react on sentiment, we should know by now that investment 'opportunities' that are trending in the media and on Wall Street present the contrarian investor with no value whatsoever.
    Using your new found understanding of financial statements, looking for value driven companies through your interpretation of fundamentals will help you to develop patterns as you become a more accomplished value investor.
    • Low price-to-earnings
    • Price-to-cash-flow
    • Price-to-book-value
    • Increasing dividend yield

    This data is where you should focus your analysis to determine the value potential of a company. There is little to no guess work involved making your prediction analysis so much more accurate than that of the data processing mill.
  • Rule #4 - Small-cap investing has more long-term value than Blue chip positions But what about the increased levels of risk involve in small cap-investing? If you select wisely and follow the philosophy we teach here at the Value Investment Report then you are able to mitigate risks to their minimum. This is the true value of value investing.
    Sticking to the value investment principles and ensuring that a company meets ALL points of the criteria, small-cap investments have proven their worth to value driven investment portfolio time and again.
    Make sure that your focus is limited to companies whose capital structure contains no more than 60% debt, especially if the sector is manufacturing related. Maintaining a standpoint of asset liquidity protects a small-cap companies as they evolve through the business cycle.
    Finding small-cap companies that demonstrate the consistent distribution of dividends is a sure sign of management capabilities and an underlying culture that cares for its shareholders. These two factors alone are big plus signals for sustainability - an essential component of the value investment philosophy.
    One final slice of food for thought as you look to incorporate small-caps as part of your value driven portfolio, is diversification. Yes, it may seem obvious and yes this isn't news as such. However becoming familiar with small-cap companies throughout a number of sectors can pay off as you begin to get a feeling of how companies perform under different market conditions. Generally speaking, you should be looking to pad out your value driven investment portfolio with twice as many small-cap companies in compression to one larger, dare I say it, Blue chip company.
  • Rule #5 Be patient in your selection, we are not day traders Imagine living a life where you are constantly checking your iPhone for stock price fluctuations during trading hours. Waking up in the morning and jumping on your computer to see if the morning is green or red. Frantically selling a stock on the whim that it's going to be a cold summer or purchasing more because fracking just became legal.
    This is the life of an investor who sees no value in his or her decision making. Always shifting capital from one press report to the next. Stressful? Yes. Waste of time? Yes. A good way to profit from investments? No!
    Removing stress from your decision making so you see things as a rational human being is often the difference between profit and loss. Utilize your time to much greater effect knowing that when you have identified the value opportunity your work is done for the foreseeable future.
    Of course even the price of value driven stocks will fluctuate, but by following the value investment philosophy you can be certain that over the long-term the company in which you have placed your trust in will prosper, along with its shareholders.
    Being patient with your identification process is a key component to this. Great companies, bursting with value do not come along every day. They are most certainly there at all times, however finding the right company to fit in with your particular needs so that it complements the performance of other assets within your portfolio can take time.

Principles of value investing

These 5 rules of contrarian investing are definitely relevant to succeeding as a value investor. Understanding some basics concepts can help you to sift through the bad to reveal the good.