Should You Buy Stocks That Everyone Hates?
Contrarian investors move when others falter. They look for neglected stocks that have fallen out of favor in recent months or years and use them as buying opportunities. However, these investors do not buy a stock just because its price is going down.
Investors who completely ignore the fundamentals can end up losing their portfolio.
Reverse investment rules to follow
Warren Buffett, the well-known investor and chairman of Berkshire Hathaway, is a well-known contrarian investor. But investing like Buffett – whatever the returns – is a big challenge. Here are three things to keep in mind.
1. Focus on the long term
If you’re going to buy a stock that other investors aren’t, you want it to grow in price over the long term. That means negative sentiment about a contrarian stock should be short-lived, such as due to short-term major economic problems, political backlash or an earnings report where the company missed guidance. These headwinds are not structural problems, and when they are resolved, the stock can extend its rally.
Contrarian investors question whether long-term catalysts are perfect. Some companies are strengthening their growth prospects while stock prices are falling. This type of mismatch fuels negative sentiment and presents a long-term opportunity for experienced investors.
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2. Look for solid foundations
If investors are selling a stock because the company has bad fundamentals, that’s probably not the stock you want to buy.
You can examine metrics to get a sense of a company’s financial health. For example, the current ratio compares a company’s current assets to its current liabilities. Contrarian investors, like value investors, often look for strong companies that are under-appreciated.
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3. Be patient
Inverse investing often requires patience, as you may be holding on to a stock and waiting for its value to change over a long period of time.
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Why contrarian investing isn’t for everyone
You don’t have to hunt for bargains and be a contrarian investor to reach your long-term financial goals – and in fact, the strategy won’t work for most average investors. The easiest way is to buy a diversified index fund. These funds offer exposure to multiple assets and come at low costs.
Diversified index funds also eliminate the need to learn the complexities of valuing stocks and determining which investments deliver compelling upside. Reverse investing is only profitable if you are right about the underlying business. Not everyone can do enough research to back up their beliefs, and picking unimportant stocks to take off is difficult even for Wall Street experts.
