The Contrarian Plays That Bag the Biggest Gains

“He that makes himself a sheep shall be eaten by a wolf.” – Italian Proverb

The market punishes slowpokes and sheep, and that’s why the last thing you should do is invest like the pros. The difference between going with or against the pros is the difference between trailing in their path and picking up the crumbs, or forging your own trail and picking off the ripe fruit that nobody else has gotten to yet.

If you want to make good money, you need to invest “unprofessionally.”

You see, the pro game is predicated on speed. And there’s no way you can match it. It’s like wishing you could hit as well as Alex Rodriguez. Well, if you had his bat speed, you could. But you don’t, do you? And you don’t have the speedy software the pros have to pull the trigger. You’re never going to catch up to their fastball, and you’ll only strike out trying.

And human nature does us no favors. It encourages us to participate in a good thing – and when it turns ugly, we’re out of there. So we tend to climb on board just before the market peaks and get out only after it falls. Recent studies have shown that both fund managers and fund purchasers are guilty of this kind of terrible timing when it comes to getting in and out of the market. That’s the other big reason to invest “unprofessionally.”

If you want to escape this vicious cycle, one thing you could do is deliberately choose fundamentally sound companies that most investors dismiss because their profitability has either slowed or not kept up with faster-growing companies. Because investors are ignoring these companies, their shares come cheap… sometimes dirt cheap.

This contrarian play is so popular that there’s a name for it: value investing. If you’re a regular reader of ETR, you’ve probably heard of it. Value investing has a long and respected pedigree stemming from the publication in 1949 of The Intelligent Investor by Benjamin Graham, the father of value investing. Dozens of studies have shown that value investing really works. It’s a great way – but not the only way – to escape from doing what the herd is doing.

There are other ways to mix it up. I like looking at metrics besides growth and value when choosing stocks. For example, my eyes light up when I see certain metric pairs, such as these:

• A PEG (price/earnings to growth) ratio of less than 0.8 and weak analyst recommendations.

You can get this combination in weak or cyclical sectors or in sectors before they rebound. Why 0.8? Most investors use 1.0 as their cutoff. I like to tweak conventional thinking. It keeps me that much further away from the crowd.

• Strong cash flow growth and low institutional ownership.

As far as I’m concerned, cash is king. Cash is real. A company that can grow its cash faster than its competitors gets my attention. The institutional investors catch on to these companies eventually, and when they do the share prices go up in a hurry.

• Insider buying and weak stock growth.

Top-level executives who put up their own money are privy to all kinds of sensitive information that never sees the light of day. If they’re buying, it’s usually for a good reason. Insider buying gives you advanced notice of better days, and weak stock growth has been keeping share prices low.

Nice combinations.

Search engines allow you to search for companies using just half of these paired metrics. The other half is very easy to find once you’ve looked up a company on a major financial website. Remember, doing this is the first step – not the last – in evaluating a company. But looking for these pairings can point you to companies that have escaped the adulation of the investing crowd. And that, my friend, makes you a contrarian with the chops to find ripe low-hanging fruit on your own.

[Ed. Note: Andrew Gordon, ETR’s Investment Director, author of nearly a dozen books on energy markets, global countertrade practices, and the hot growth sectors of China and Russia, is the editor of INCOME, a monthly financial advisory service that uncovers income-generating stocks that promise safety (first and foremost), along with much-higher-than-average profit potential.]