Wealth: Guts & Glory

If you have a strong stomach, undervalued stocks could yield a feast

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When Netflix came on the scene, Blockbuster stock plummeted from nearly $30 a share to about $3. Then, after restructuring its operations, the traditional movie rental company’s share price more than doubled. “Investing in Blockbuster was clearly a contrarian investment at $3 a share, as many felt the company was doomed,” says Haddon Libby, a local investment banker and contrarian who worked with Bank of America Securities for 10 years.

Contrarian investors deliberately go against the prevailing wisdom of other investors. To do that successfully requires a strong personality, belief in your convictions, and patience. Contrarians take the opposite view often favored by Wall Street on market segments and individual stocks. Their mantra: Buy out-of-favor and undervalued stocks.

“Contrarian investing should be a component of any thoughtful, diversified portfolio,” Libby says. “Done with strong research and conviction, contrarian investing is core to consistently outperforming the market.”

This kind of investing takes guts. When technology and other high-growth stocks  were all the rage, slow-growth stocks fell out of favor and became relatively undervalued. If you diversified your portfolio with both value and growth stocks, then applied trailing limit orders, selling stocks if they fell 20 percent in price, you probably were well positioned to avoid a major hit like many investors took when the tech bubble burst.

The challenge: Find investments before the masses do. Look at other economies. Libby invested in South American stocks before the recovery of those economies was widely reported. How did he do this? Friends with family in Argentina, Chile, and Brazil saw an improvement in their economies that was below the radar of U.S. stock research firms. Investing ahead of the curve netted Libby above-market returns.

Joan Lappin, founder of New York-based Gramercy Capital Management Corp., has followed contrarian principles for decades. A Wall Street alumnus since the ’60s, Lappin contributes to Forbes.com and TheStreet.com. She writes about stocks she likes, as well as the reasons she won’t put some big stock names in her portfolio.

“As a contrarian, you always have to be ahead of the crowd — that’s the only way to make money,” she says.

Lappin often buys stakes in companies where senior management falls short of delivering picture-perfect results. “I look past that to the fundamentals and ask, ‘Did the company not perform because of inept management or was it simply overtaken by marketplace forces it couldn’t control?’”

The hardest part comes after you buy. “You need tremendous belief in your own convictions that the company is doing interesting things in the right way, and [to] have the patience as a long-term investor to wait for the reward to come,” Lappin says.

If you decide contrarian investing fits your investment strategy, carefully read the footnotes when studying annual reports and other corporate financials. Ask yourself, “Is something terminally wrong with this company, or is it just what’s going on right now?”

If you’re considering a contrarian money manager, interview them and ask about their philosophy and exactly how they select stocks. However, Libby cautions, “Many investment advisers are just trying to sell inventory.”

One Wall Street veteran who has seen his share of red and black ink sums it up this way: “You have to be willing to make an investment, make no money for two years, and have the personality to possibly watch it fall and not bail out."
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