Contrarian Investing

by Anthony Gallea.

Contrarian Investing is a state of mind. Contrarians seek to invest against the opinion of the crowd when that opinion reaches an extreme. When a stock or a market plunges on bad news, most investors sell, or avoid the investment altogether. But that is just when the contrarian becomes interested and takes notice of a potential opportunity.

The Buy Signals
1. A stock must be down at least 50 percent from its highest closing price during the past 12 months.
2. Any two of the following four criteria
- A Price/Earnings (P/E)of less than 12
- A Price/Free Cash Flow (P/FCF) of less tthan 10
- A Price/Sales (P/S) of less than 1.0
- A Price/Book Value (P/BV) of less than 11.0
3. A change in top management or stock buyback in concert with the other indicators may be viewed as additional bullish indicators.

The Minor Rules
1. Look for high priced stocks. Many institutions won't buy low-priced stocks.
2. Look for companies with market capitalisations of more than $150 million.
3. Consider a change in top management as positive in a company with problems.
4. Consider brand name, proprietary product positioning, company's size, one time event eg war, accident .

The Sell Signals
1. Sell once the stock rises 50 percent from its purchase price, or after 3 years whichever comes first. The exception is when a once-troubled company's prospects are clearly improving, or when the stock price seems to be climbing a "wall of worry".
2. With a stock that's a winner, but isn't yet set to be sold, established a stop loss that guarantees you a profit of 30 percent or more.

Risk Management
1. Place a good-until-canceled, stop-loss order to sell the shares automatically should they fall 25 percent from purchase price. If the stop loss is triggered, you can buy the stock again later, but only at a price higher than you paid when you bought it the first time.
2. Diversify by holding a portfolio of 20 to 35 different stocks with no one stock comprising more than 5 percent of your portfolio (3 percent is recommended).
3. Don't concentrate any more than 15 percent of your portfolio in any one idea or theme (such as gold or utility stocks). Less than 10 percent is preferred.
4. Consider having dividends paid in cash, and not reinvested, to build a stake for other contrarian plays.