Invest in the Underdogs: The Contrarian Plays Bag the Biggest Gains

by: Andrew Gordon

The market punishes slow pokes and sheep, and that’s why the last thing you should do is invest like the pros. The difference between going with or against the pros is the difference between trailing in their path and picking up the crumbs, or forging your own trail and picking off the ripe fruit that nobody else has gotten to.

If you want to make good money, you need to invest “unprofessionally.”

You see, the pro game is predicated on speed. And there’s no way you can match it. It’s like wishing you could hit as well as Alex Rodriguez does every April. Well, if you had his bat speed, you could. But you don’t, do you? You don’t have the speedy software the pros have to pull the trigger. You’re never going to catch up to their fastball and you’ll only strike out trying.

And human nature does us no favors. It encourages us to participate in a good thing and when it turns ugly, we’re out of there. So we tend to climb on board just before the market peaks and get out well into its fall. Recent studies have shown that both fund managers and fund purchasers are guilty of this kind of terrible timing when it comes to getting in and out of the market. This is the other big reason to invest “unprofessionally.”

If you want to escape this vicious cycle, you could deliberately choose fundamentally sound companies that most investors dismiss because their profitability has either slowed or not kept up with faster-growing companies. But because investors are ignoring these companies, their shares come cheap … sometimes dirt cheap.

This contrarian play is so popular that there’s a word for it – value investing. You’ve probably heard of it. Value investing has a long and respected pedigree stemming from the publication in 1949 of The Intelligent Investor by Benjamin Graham, the father of value investing. Dozens of studies have shown that value investing really works. It’s a great way – but not the only way – to escape from doing what the herd is doing.

There are other ways to mix it up. I like looking at other metrics besides growth or value when choosing stocks. For example, my eyes light up when I see certain metric pairs, such as:

  • A recent fall in share price of at least 15 percent together with strong analyst recommendations. Shares of these companies usually bounce back strongly.
  • A PEG (price/earnings to growth) of less than 0.8 and weak analyst recommendations. You can get this combination in weak or cyclical sectors or sectors on the verge of rebounding. Why 0.8? Most investors use 1.0 as their cutoff. I like to tweak conventional thinking. It keeps me that much further away from the crowd.
  • Strong cash flow growth and low institutional ownership. As far as I’m concerned, cash is king. Cash is real. A company that can grow its cash faster than its competitors gets my attention. The institutional investors catch on to these companies eventually, and when they do the shares go up in a hurry.
  • Insider buying and weak stock growth. Top-level executives who put up their own money are privy to all kinds of sensitive information that never sees the light of day. If they’re buying, it’s usually for a good reason. Insider buying gives you advanced notice of better days, and weak capital appreciation has kept the share prices low. Nice combination.

    Search engines on the major financial web sites allow you to search for companies using these metrics. Remember, it’s the first step – not the last – in evaluating a company. But these pairings can point to companies that have escaped the adulation of the investing crowd. And that, my friend, makes you a contrarian with the chops to find ripe low-hanging fruit on your own.