Three or four times each year, I come across an article that urges investors to be contrarian. I doubt whether the authors of these articles have ever made much money in the markets, because this is dangerous, facile nonsense that is likely to do more harm than good to your investment fortunes.
Of course, I can understand why being a contrarian has a superficial appeal. We have all heard of the madness of crowds, we all know that when the masses are rushing to buy houses or invest in dotcoms that we should be wary.
We are flattered to be considered contrarians. It is a sign of strength, proof of an independent mind and the courage to swim against the tide. When I worked for Schroders, I remember one particular time when the market was crashing and one ex-military senior director came around to urge us to “show resolve”.
The lesson I learned from Robert Maxwell
I never understood that at the time and I still don’t. This type of bulldog breed stoicism is totally out of place in financial markets. What is needed is not an attitude of mind, but a keen intelligence and a proper considered analysis of every situation and every investment position.
Although plenty of naive private investors think it so, there is no market rule that says that what goes up must come down and vice versa. In fact, the truth is quite the opposite.
I can remember my father buying shares in Stothert & Pitt back in the 1980s. If that name rings a bell, it might be because you have seen the name on quayside cranes. Based in Bath, Stothert & Pitt had been around since 1785, a good enough pedigree for my father – who, needless to say, had not done any financial analysis of the company whatsoever.
He assumed that it must be good for a few more decades yet, and with the shares trading at just a few pennies, he took the plunge. In fact, Stothert & Pitt was in serious trouble. It fell into the clutches of Robert Maxwell, and shareholders including my father lost most of their money.
Think logically about a share price
When share prices are low, they are normally low for a reason. For all of my strictures about the City, its financial analysts are seldom too far off the mark and a company’s share price is normally a pretty accurate reflection of the state of its business. A low share price is a reason for caution, while a rising share price normally means that the business is doing well. And there is another factor that is often overlooked…
In business, success tends to breed success. Good companies tend to stay good and bad companies struggle to turn around. A good business will have loyal customers, it will come up with innovative products, it will have staff happy to work there, it will have continuity of leadership and it will be respected by its peers.
All of these intangible factors will support the business, and they will do one other thing that is crucial in the stock market: they will help the company to strike good deals.
When it comes to buying another company or entering into some kind of partnership, it is the strong companies that hold the better cards and walk away from the negotiating table with the better deal.
So, think about this. Shares of successful companies rise over time. As they do so, they repeatedly hit new highs. One very successful fund manager with whom I worked long ago would pay very close attention to the list of shares hitting new highs. He reasoned that the business was probably doing well, that other investors knew it and that the crowd would take the share price up further.
This is only for the shrewd investors
What he did do as well, though, was to check the valuation, making sure that it was in the realms of reason. And this is really the heart of the matter. Momentum is generally a good thing, so long as it is founded upon reality. But sometimes momentum becomes self-feeding, and sometimes it is based on an exciting theme – such as natural resources – and not on any reasonable assessment of value.
A share can be expensive at 50p but cheap when it has doubled to 100p if the business has created three times as much value in the meantime. So next time you see one of those articles exhorting you to be contrarian, do what others won’t do – chuck it in the bin.
Rather than being a contrarian, I like to catch small companies when they are on the cusp of something extraordinary. Catching them before the mainstream media get wind of them and their share prices jump.
This is where the shrewdest investors get in. Of course this is a risky business, but an exhilarating one as well. I am always on the search for these companies, scouring annual reports, broker reports, corporate websites or attending AGMs.
Now, I believe I have found a tiny British company that could be about to make a very significant breakthrough and could see its share price rocket. It has just secured an exclusive deal that could see this meagre oil company blast most of the big guns out of the water.
In the next 12 months, I believe the value of this company could jump as much as 344%.
This company is still off the radar and has 3,000 acres of exclusive access to what could be the planet’s largest ever oil reserve.
• This article is taken from Tom Bulford’s free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.
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