Investing Like A Contrarian

Posted: Jul 21, 2010 10:32 AM by Matthew McCall

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Filed Under: ETFs,Fundamental Analysis,Stocks

Tickers in this Article: AA, JCO, MSFT, PFE, VZ

When everyone is zigging, you should be zagging, so says the theory behind contrarian investing. Investopedia defines contrarian investing as an investment style that goes against prevailing market trends by buying assets that are performing poorly and then selling when they perform well. To me this sounds like the old adage of "buy low and sell high", which we all know is much easier said than done.

I will admit, I am a closet contrarian investor when the masses are all on one side of a trade, especially when negative sentiment is at extreme levels. A recent example is BP (NYSE:BP) after the oil disaster. The stock fell from $60 to $26 in two months and rallied over 50% in the three weeks following the drop. When the stock was in the $20s the consensus were anticipating continued troubles for BP and now many are talking about a recovery. When everyone was selling, it was the time to buy.

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Dow Contrarian Stocks
The worst performer in the Dow this year has been aluminum company Alcoa (NYSE:AA), falling 35%. The company is best known as the first company to report earnings each quarter and the most recent number showed earnings of 13 cents per share. The better than expected number was impressive because aluminum prices fell during the quarter, hurting the bottom line for the company. The stock initially rallied on the earnings report and more importantly the guidance for aluminum consumption to improve during the second half of 2010. The stock remains in an ugly downtrend, but near $10 it becomes a long-term value play on the global economy. 

Pfizer (NYSE:PFE) has fallen 20% in 2010 and has now been in a long-term downtrend for ten years. The stock peaked in 1999 near $49/share and has been making lower highs and lower lows, making PFE a true contrarian play. The large pharmaceutical company has several major drugs such as Lipitor used to control cholesterol, but the pipeline has not been impressive and investors have shunned the stock. With the forward P/E ratio at 6.5 and a dividend yield of 4.9%, PFE may be ripe for a bounce with sentiment on the extreme negative side.

Another high dividend Dow stock that has been in a downtrend for a decade is telecom company Verizon (NYSE:VZ). Similar to PFE, VZ peaked in 1999 and has since lost 62% of its value over an eleven-year span. The stock has two factors that make it a buy candidate this summer. Technically, the stock has support in the low $20s, not far from where it is currently trading. There are also the rumors on the street that Apple (Nasdaq:AAPL) will allow the iPhone to be carried on VZ's network in the near future. Add in the 7.1% dividend yield, and VZ could be an average-risk contrarian play.

Microsoft (Nasdaq:MSFT) is also off its 1999 high, but the stock has held up much better than the other stocks mentioned in the article. That being said, MSFT is down 18% in 2010 even after a recent bounce from the low $20s. With a forward P/E of 10.8 and a decent dividend of 2.1%, the stock is an attractive long-term buy after the 2010 sell-off. However, because the company is so large and it faces competition from smaller rivals there is a risk when buying the current market leader. (For more, see A Contrarian Bull In King Awful's Court.)

Contrarian ETF
Investors that do not want the risk of an individual stock, a new ETF began trading in April that tracks the Dow Jones Contrarian Index. The JETS Contrarian Opportunities Index ETF (NYSE:JCO) follows an index that is designed to find laggards in the market and then use a fundamentally based system to rank the top stocks in the list. The diversification is evident with 125 stocks in the allocation and top sectors ranging from consumer services to health care to industrials. As of June 30, 2010 the top holdings in the ETF were EV3 (Nasdaq:EVVV) and Akamai Technologies (Nasdaq:AKAM), both respectively making up less than 1.3% of the total fund. The ETF has yet to catch on with larger investors, but due to the current state of the market this ETF could be a great diversification tool for investors, and will eventually begin to garner more attention.

The Bottom Line
I will not sugarcoat taking a contrarian investment strategy with your portfolio. It is not fun to buy stocks that have been beaten down. However, if you have patience, it may be much more fun when you sell your position for a big gain. (For related reading, check out Buy When There's Blood In The Streets.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

By Matthew McCall

Matthew McCall is the president of Penn Financial Group, LLC, a registered investment advisor. He also publishes two newsletters, The ETF Bulletin and The PFG Letter as well as other educational material. As a registered investment advisor, he manages clients' investments based on their specific goals and objectives.

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