Guidelines for Contrarian Investors Going Bargain Hunting
by Charles Rotblut | May 19, 2022
Featured Tickers:
PTON
TGT
WMT
Wednesday’s drop was no fun. Both the Dow Jones industrial average and the S&P 500 index incurred their largest one-day drops since June 2020. The market reacted not only to lowered guidance from Walmart Inc. 
(WMT) and Target Corp. (TGT), but also to concerns about a slowdown in consumer spending.
Market downturns are painful, but they also create opportunities to buy stocks while they are on sale. The key—as is the case with any other market environment—is to have and follow a defined strategy for selecting stocks.
Here are some guidelines for taking a contrarian stance and bargain hunting for stocks.
Seek Out Discounted Valuations: A decline in a stock’s price is not enough to make it a bargain. The actual valuation must be lower too. A useful benchmark is to check the stock’s current valuation ratios against its range over the past five years and/or against its peers. Considering absolute valuation ratios also helps. A price-earnings (P/E) ratio below 18 will identify stocks with below-median valuations, for instance. A+ Investor, VMQ Stocks and AAII Platinum subscribers can also seek out stocks with Value Grades of A or B.
Ensure the Company Is Fundamentally Strong: The stock market tends to be a voting machine over the short term, reflecting shifts in investor sentiment. Over the long term, it is a weighing machine and considers a company’s fundamentals. This paraphrase of Benjamin Graham’s famous quote applies now. Contrarian-minded investors should seek out stocks suffering from lousy sentiment but not deteriorating fundamentals.
Determine If the Issues Are Temporary or Longer Lasting: Short-term business headwinds can create opportunities to buy into a good company at a reduced price. For instance, Target—which is held in the VMQ Stocks model portfolio—is incurring higher storage costs for excess inventory of bulky products like kitchen appliances and patio furniture due to a sudden shift in consumer demand. Still, Target’s CFO plans to recommend that the board approve a “mid-teens to low 20%” increase in the dividend later this year. Peloton Interactive Inc. (PTON), conversely, has been forced to slash the price of its exercise bikes. It has also reported negative cash flow from operating activities for several consecutive quarters. Connected fitness products account for more than half of Peloton’s revenues.
Have Preset Buy Prices: One strategy Sir John Templeton used was to place buy orders at prices well below what stocks were trading at. This “Ulysses contract” ensured that the value investor would purchase shares in attractive companies should their stocks fall in value low enough. The same type of strategy can be used with price alerts instead. (Our My Portfolio tool can alert you when a particular stock falls to a new 52-week low.) Preset buy lists make it easier to act when stocks go on sale.
Be Comfortable With Not Knowing Where the Bottom Is: The saying of perfection being the enemy of good applies here. If you wait for the bottom to be set, you’re going to miss it. Getting a good stock at 20%, 30% or a greater discount is very often good enough to build your long-term wealth. And if you buy too early, realize that by taking a contrarian stance, you’re probably buying at prices that are closer to the bottom than they are to the top.
- In an environment like we’re in now, it can be beneficial to mimic the approaches of the world’s greatest investors.
- The market sell-off likely has some people worried about their savings being off track. A retirement calculator should tell you whether this is the case, but we found big differences when we looked at 10 of them.
- We share more takeaways from our research into retirement calculators in our latest Individual Investor Show, which premieres today. You can watch it on YouTube or listen to it on your preferred podcast app (including Spotify).
- The May Shadow Stock Portfolio Update has been posted.
- In Lesson 4 of Step M in the PRISM Academy, we discuss how to effectively monitor your progress regarding withdrawals. You can use the Monitoring Your Progress Worksheet to monitor your withdrawals. Complete Lesson 4 today.
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AAII Sentiment Survey
The percentage of individual investors describing their outlook for stocks as “bullish” rose, as did the percentage of those describing their outlooks as “bearish” in the latest AAII Sentiment Survey.
Bullish sentiment, expectations that stock prices will rise over the next six months, increased by 1.6 percentage points to 26.0%. Even with this week’s rise, optimism is below its historical average of 38.0% for the 26th consecutive week and is unusually low for the 16th time out of the last 18 weeks.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, decreased by 3.0 percentage points to 23.6%. Neutral sentiment levels are below the historical average of 31.5% for the fourth consecutive week.
Bearish sentiment, expectations that stock prices will fall over the next six months, increased by 1.4 percentage points to 50.4%. This is the 25th time out of the past 26 weeks that pessimism is above its historical average of 30.5% and the 15th time out of the last 18 weeks that bearish sentiment is unusually high.
Most of this week’s results were recorded prior to yesterday’s large market drop.
As noted above, bullish sentiment remains unusually low while bearish sentiment continues to be unusually high. The bull-bear spread (bullish minus bearish sentiment) is also unusually low.
Historically, the S&P 500 index has gone on to realize above-average and above-median returns during the six- and 12-month periods following unusually low readings for bullish sentiment and for the bull-bear spread. Unusually high bearish sentiment readings historically have also been followed by above-average and above-median six-month returns in the S&P 500.
Besides the downward volatility in the stock market, the ongoing invasion of Ukraine by Russia, stock market volatility, inflation, interest rates, the coronavirus pandemic and politics are all influencing individual investors’ outlook for stocks. Other factors include the economy and corporate earnings.
Bullish: 26.0%, up 1.6 points
Neutral: 23.6%, down 3.0 points
Bearish: 50.4%, up 1.4 points
Bullish: 38.0%
Neutral: 31.5%
Bearish: 30.5%
See more Sentiment Survey results.
May 12, 2022 A Playbook for When the Stock and Bond Markets Are Down
May 5, 2022 Don't Abandon Diversification Because of This Year's Rough Patch
April 28, 2022 Remembering Geraldine Weiss and Her Winning Dividend Strategy
April 21, 2022 A Costly Example of Why Asset Location Matters
Discussion
Robert from Missouri posted over 4 years ago:
Also time to consider harvesting any tax losses in taxable account avoiding the Wash Sale but not buying within 31 days before or after selling for loss. But if in mutual fund can move to equivalent mutual fund or ETF immediately to avoid market risk during Wash Sale period. Can offset any capital gains and $3K of ordinary income with excess. And can build up to take profits might be hesitant to take for tax reasons if harvested losses can offset. Typical bear markets last 1.5 to 3 years but we have had decade long periods where "real" returns after inflation have been subpar so thinking this will be quick fix may be mistake. My guess is we may be half way to bottom unless of course that bottom proves a trap door!
Barry from TX posted over 4 years ago:
Trying to time the bottom of a market is the BIG Brother (as in “sinister” and “large than you”) of a “buying on the dip” timing strategy for buying specific stocks. The BIG differences between timing markets versus timing stocks are that (1) the “fundamentals” you need to know are more technical and indirect than direct internal accounting metrics and ratios and (2) there is a much larger role of the “sentiment [wisdom] of the masses” on determining the outcomes of YOUR individual decision. Stocks and markets go up for only one reason – there are more buyers than sellers – there is "momentum.” What are the forces that produce momentum? Taking the advice in this article “to mimic the approaches of the world’s greatest investors,” I am reminded of what John Keynes compared markets to “beauty contests” in his General Theory (1936). At the time, a popular item in the Sunday London Times was a contest asking readers voted on (there’s that voting machine analogy) who they thought was “the most beautiful” woman among several dozen photos published each week. The winner of the contest was the reader whose “guess” came closest to the winning photo’s total votes. Keynes cleverly compared this “guessing” process of the beauty contest to the “guessing” process an individual investor faces when trying to “guess” the “most beautiful” stock (the most attractive investment). The key is NOT what YOU think. The KEY is that you must “guess” what the highest percentage of OTHER INVESTORS think. It is their buying of the stock you think is “the most beautiful,” i.e., “the best buy” -- that determine what “beauty”— a rising stock price -- is. The mechanics and math of Keynes “beauty contests” theory led to research into what is now called Theory of Mind and Cognitive Hierarchy Theory whose basic findings are that a VERY, VERY SMALL percentage of people have the cognitive capacity to think through up to 3 levels of “out-guessing” what other peoples’ strategies are for picking the winner of “beauty contest” guessing games, like buying stocks on the dip or timing market bottoms. Caveat Emptor.
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