Michael Keaveney: At Morningstar Investment Management, we're long-term investors, and base our decisions on valuation. By nature, we're also contrarian, willing to hold unpopular investment positions when supported by our fundamental analysis.
So, what are the market characteristics that can help identify contrarian opportunities? Here are a few:
Unbalanced Investor Flows is a majority of investors by type or number underweight an investment, and therefore a concentration in remaining investor types?
Negative cash flows or earnings expectations Are expectations low relative to reasonable base rates? Expectations and price declines often form a positive feedback loop, creating opportunities.
Negative sentiment in Investor Surveys Surveys can be different from flows, as responses are prone to expressing desired positions as opposed to actual holdings. The desired positions are often the high fliers.
Low trading volume or turnover the more popular an asset, the more likely it is to be traded. Contrarian opportunities arise where volume is lower.
High and rising volatilities more volatile investments or markets are accompanied by excessive risk aversion and avoided by those with a shorter-term and peer-aware mindset, which makes for a good hunting ground for the contrarian.
Low valuation ratios relative to history This is a complement to estimating intrinsic value using cash flows. When comparing an investment to its own history, it is important to account for differences in capital intensity and normal profitability levels.
Just because something is unpopular, doesn't automatically make it a good investment. In our view, a contrarian approach acts like a screen whose results must be tested with in-depth fundamental and valuation analysis. Unpopular areas of the markets aren't guarantees of success, but we believe they are good places to look for opportunities. We view contrarian thinking as a means to an end, not as an end in itself.
Also, since investing is about probabilities, the more extreme contrarian indicators are, the more likely an investment opportunity will be compelling. When the indicators are mixed or vague, it is unlikely to be a convincing opportunity from a contrarian standpoint.
For Morningstar Investment Management, I'm Michael Keaveney.
