Contrarian Thinking

How a little bit of contrarianism helps to obtain above average results in investing and general activities of life

Look for what you notice that no one else sees.

Contrarian thinking does not mean doing the exact opposite of what someone else is doing. Rather, it means thinking differently. As Benjamin Franklin stated, "If everyone is thinking alike, no one is thinking."

The greatest businesses and investments have been fraught with uncertainty over their lifetimes. However, those investors and entrepreneurs who have been able to stick with their convictions during these times have reaped the rewards that lie at the end of the tunnel. Here, I attempt to document my learnings on contrarianism through all that I have read, observed and lived through.

The best opportunities are usually found among things that most others don't do, a phenomenon that takes place in all areas of life.

Source: Howard Marks 2006 Newsletter

While this post will strictly focus on contrarian investing, the principles of this form of thinking apply to all areas of life. The greatest innovations, creative ideas, and social changes have been brought about when individuals have been able to navigate through a sea of uncertainty and ambiguity, hence it involves going against what other people think.

I also discussed how this process can go terribly wrong if the risk is not appropriately managed.

In Microeconomics 101, we learn that the demand curve slopes downwards: when the price of something goes up, the quantity demanded goes down. In other words, people want less of something at higher prices and more of it at lower prices. This makes sense; that's why stores do more business when goods go on sale.

Source: Investopedia

It often works this way in many places, but not always in the world of investing. As the price of an investment rises, many people tend to fall even more in love with it, feeling validated, but like it less as the price falls, doubting their decision to buy.

Unfortunately, most people lose faith in their investment when its price drops.

This is where the arbitrage of contrarian investing comes into play.

There are two styles of fundamental investing, and each has a form of contrarianism:

Value Investing involves buying a stock whose price is depressed because it does not reflect the true value of the underlying business or its future potential.

Growth Investing involves buying a stock whose price may already reflect the current growth prospects of the business, even though it may be trading at a relatively higher price multiple. However, the business in the underlying stock is expected to continue its pace of growth and probably grow even faster.

Both schools of thought work, and both have a contrarian angle to them.

The contrarian angle of value investing is that a stock is looked down upon for various reasons, making it attractive to value investors.

The contrarian angle of growth investing is that a stock may not be expected to continue its hyper-growth story and could revert to mean- for the layman- it means reverting to its historical average; causing investors to sell the stock earlier in anticipation of a decline in the price of the stock.

I'd like to share an interesting example of a contrarian investment story about The Washington Post.

In 1933, Eugene Meyer, a financial genius who made a fortune in the stock market, purchased the struggling yet significant newspaper and began to turn it around. His daughter, Katharine Graham, inherited the only interest in acquiring the paper, and when she grew older, she took over the management with her equally impressive husband, Phillip Graham, who primarily took the reins.

Katharine Graham was not just another wealthy child who took an easy path in life because she could; she wanted a challenge that would stimulate her. However, life took a drastic turn when Phillip Graham fell into a rut of heavy drinking due to the mental trauma of managing the company and eventually died of alcoholism, leaving the management of the corporation to Katherine, a 46-year-old mother of three with no work experience and in charge of a company with thousands of employees.

Taking over the paper, which she and her husband had thought would be an easy journey, turned into a battle of trying and wrenching events that lasted for nearly two decades.

As she settled into her leadership position, Graham found that the paper's board was too conservative, which was an obstacle she faced. To succeed, she would have to develop her compass and think differently to turn things around.

Her first move against the board's whims was to replace the executive editor, an old boy, with an unknown young upstart.

The next move she made was more complicated than ever, as the Post was on its way to do an IPO, a move she proceeded with despite vehement opposition from her advisors as the markets were performing poorly. During the listing, she uncovered a burglary against the Democrats when Nixon was in power, which would eventually lead to the Pentagon Papers, an investigation that the White House was furious about.

Put yourself in the shoes of an investor. Would you put money into a stock that is up against the most powerful office in the world, which is out to show that the investigation is false?

Many large investors began to sell their stock, having lost faith in the Post, but Graham continued to buy back shares of the Post by spending large amounts of money that she had in the bank.

However, her investigation of the Pentagon Papers would go on to become a raging success, one that changed the course of American history. It also won the paper a Pulitzer Prize.

A contrarian investor in her stock was a young man at the time named Warren Buffet, who became an enormous advocate and steward of the company. The Post's main competitor in the market, Star, who had refused to come to the Post's aid during the turmoil, folded and was acquired by the Post.

Graham's stock buybacks turned out to be a brilliant contrarian success, against the judgment of the markets.

A $1 investment in the Post in 1971 would be $89 in 1993, the day Katharine Graham stepped down, compared to $14 for her industry and $5 for the S&P 500, making her one of the best CEOs of all time against all odds.

These numbers are easy to quote but extremely difficult to apply in real-time as an investor who would have placed a bet on this stock during its time of peril would have gone through multiple periods of uncertainty, but the reward is only achieved by going through these periods of uncertainty.

What sets the contrarian apart from the herd is their ability to understand both first level and second level thinking.

First-level thinking involves simple analysis, such as evaluating whether a company is of high quality and has good prospects.

Second-level thinking, on the other hand, delves deeper and considers a range of potential outcomes, the likelihood of each outcome occurring, and how one's own expectations differ from the consensus.

In investing, success is the antithesis of simplicity many a time, and those who can think beyond simple ideas and formulas are more likely to find rare insights that can lead to above-average returns. However, such insights require time and effort to develop conviction, and active bets can lead to below-average returns if one's analysis is incorrect. To minimize risk, it is important to have a margin of safety - the minimum threshold that makes taking a certain level of risk sensible.

Entrepreneur and venture capitalist Paul Graham on the importance of being at least a little bit contrarian:

"Let's start with a test: Do you have any opinions that you would be reluctant to express in front of a group of your peers?

If the answer is no, you might want to stop and think about that. If everything you believe is something you're supposed to believe, could that possibly be a coincidence?

Odds are it isn't. Odds are you just think whatever you're told."

Remember that just because other people agree or disagree with you doesn’t make you right or wrong- the only thing that matters is the correctness of your own analysis and judgment.

Mimicking the herd only invites regression to the mean.

It is important to avoid biased and incorrect decisions by not overestimating one's own intelligence. Ultimately, the correctness of one's analysis and judgment is what matters, regardless of whether others agree or disagree.

In fact the more intelligent you think you are, the more adept you could become at creating a narrative that reinforces your beliefs. You can rationalize and frame data to support your argument or perspective, which can be risky.

In a 2012 study by Richard West, Ressell Meserve, and Keith Stanovich, they examined the blind-spot bias, an irrationality where people can identify biased reasoning in others, but are oblivious to it in themselves. The blind-spot bias is more pronounced in individuals with higher intelligence.

Study Link.

Annie Duke, in her book "Thinking in Bets," categorizes consensus thinking and independent thinking into two definitions: confirmatory thoughts and exploratory thoughts.

A group can exacerbate our tendency to confirm what we already believe. In other words, confirmatory thought amplifies bias.

Confirmatory thought promotes love and celebration of one's own beliefs, distorting how the group processes information and works through decisions, the result of which can be thinking as a group and not independently.

Exploratory thought, on the other hand, encourages an open-minded and objective consideration of alternative hypotheses and a tolerance of dissent to combat bias. Exploratory thought helps the members of a group reason toward a more accurate representation of the world.

However, groups can improve the thinking of individual decision-makers when the individuals are accountable to a group whose interest is in accuracy. Contrarianism follows the path of exploratory thought.

We all tend to gravitate toward people who are near clones of us and love to follow ideas. After all, it feels good to hear our ideas echoed back to us.

Valuation in a stock price also partially reflects that sentiment.

There is a strategy called the Blue Ocean Strategy, where instead of battling numerous competitors in a contested "red ocean," it could be far more profitable to seek out uncontested "blue" water. The companies that utilize this strategy are often wildly different from anything else in their industry, and as a result, they grow rapidly.

This does not necessarily mean that the company utilizing this strategy has to be a small company; it can be a very large company doing this at scale and hence become so large.

If you have watched The Romantics on Netflix, then you would have come across an interesting thought process from a contrarian, Aditya Chopra.

Aditya Chopra's brilliant plan to own 100% of DDLJ is an excellent case of risk and reward. His ability to tune out the noise when pitching the DDLJ script to the jury is a great example of contrarian thinking. When you assess risk well, contrarian thinking can pay off big time.

However, when you do not assess risk well, contrarian thinking can cause massive pain.

Contrarianism can be extremely painful when the trend is going against you. It can appear at that time that "everyone" has reached the conclusion that the herd is wrong, and thus contrarianism can appear to have become too popular, and it can be mistaken for herd behavior.

This happens a lot when the stock price of a quality company, which has historically given excellent returns, drops, and investors feel that the depressed stock price in this company provides an opportunity without having too much insight into what the future holds. Even the greatest companies go through cycles where the stock can be depressed for years, even though the fundamentals of the underlying business are improving.

Investment philosophies are generally developed after having been exposed to a lot of life's lessons. They can be the sum of many ideas accumulated over very long periods of time. So, while I am writing this article, I am a mere mortal learning from my observations and the great individuals around me.

Contrarian investing can also work on occasions with simple first-level thinking and the ability to think over the long term. Case in point, these three events: COVID scare, the global financial crisis, and the 2001 internet boom.

It is impossible to predict these kinds of market crashes, but it is possible to be ready with some sort of research and conviction firsthand to take advantage of these instances when possible. The increase in potential return comes with an increase in potential risk; it is rare to find instances where these two factors are not moving the same way.

There are occasions in the market when there are forced sellers and forced buyers. Identifying these opportunities can be beneficial in the game of investing, as one may be able to buy the asset at a valued price or sell the asset at an overvalued price.

A bargain or value buy generally arises when the perception of the stock is worse than the underlying reality. That means the best opportunities are usually found among things that others won't do. After all, if everyone joins in and feels that it is a bargain buy, it won't be a bargain buy.

"To buy when others are despondently selling and to sell when others are euphorically buying takes the greatest courage but provides the greatest profit." - Sir John Templeton

In fact, the principles of contrarianism extend well beyond investing, where these principles can be applied. Unique individuals are unique because of a dash of contrarianism in their nature.

"Your patience may be tested, but your conviction will be rewarded." - Rakesh Jhunjhunwala