Does Contrarian Investing = Value Investing?

In another one of my conversations with a coworker on the topic of investing, an interesting discussion came about concerning contrarian investing and what it meant. To this individual in particular, it meant that an investor buys a company that is mispriced lower than an investor believes it should be. I suggested that his definition sounded more like value investing to me and that they way I understood contrarian investing was to buy stocks that are going against the general market trend. From a dividend based investing perspective, this means buying dividend stocks that everyone is avoiding like the plague (i.e. Merck a couple of years ago when all the issues around on of its cancer drugs came out). My colleague’s response was confusion and we discussed that this should be a post on my blog – what really is contrarian investing and how does it differ from value investing. This post will attempt to answer this question and briefly discuss how it applies to my own dividend based investment strategy.

I scoured the web for good quality definitions of both contrarian investing and value investing and found them at Wikipedia. I thought that each of these definitions provided good insight into each strategy:

Contrarian Investing:

From Wikipedia: A contrarian believes that certain crowd behavior among investors can lead to exploitable mispricings in securities markets. For example, widespread pessimism about a stock can drive a price so low that it overstates the company’s risks, and understates its prospects for returning to profitability. Identifying and purchasing such distressed stocks, and selling them after the company recovers, can lead to above-average gains. Similarly, widespread optimism can result in unjustifiably high valuations that will eventually lead to drops, when those high expectations don’t pan out. Avoiding investments in over-hyped investments reduces the risk of such drops. These general principles can apply whether the investment in question is an individual stock, an industry sector, or an entire market or asset class.

Value Investing:

From Wikipedia: Value investing is a style of investment strategy from the so-called “Graham & Dodd” School. Followers of this style, known as value investors, generally buy companies whose shares appear underpriced by some forms of fundamental analysis; these may include shares that are trading at, for example, high dividend yields or low price-to-earning or price-to-book ratios.

Looking closely at these two definitions, it is clear that both strategies are focused on identifying stocks that are low in price compared to other stocks (isn’t that the name of the game in investing anyway?). Further, if you read David Dreman’s book, Contrarian Investment Strategies: The Next Generation he discusses at great lengths the three metrics (high dividend yields, low price-to-earning, price-to-book ratios) mentioned in the value definition. The only real difference that I see is the fact that contrarian investing involves consideration of market sentiment whereas value investing looks only at fundamentals. However, how does one gauge market sentiment? It is through underpriced stocks identified through value screens such as high dividend yield stocks or low p/e ratios. I guess both my colleague and I were right in our definitions!

From a dividend based investment perspective, the definition of the terms contrarian and value is not the important thing. What is important is finding stocks that consistently increase their dividends and buying them at a price that is lower than what we believe they are worth. Whatever you call it, your purpose is the same.

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• Day 6: The Dividend Key – Dividends as Defensive Buffers
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• Weekly Dividend Investing Roundup – March 21, 2009
• Day 5: The Dividend Key – High Yields and Low Payout Ratios