At its heart, contrarian investing means buying what’s out of favor and selling what’s in vogue. It rests on the belief that markets are not always rational in the short term.
This strategy is supported by certain research. A seminal study by Lakonishok, Shleifer, and Vishny (1994)1 found that buying out-of-favor “value” stocks and avoiding popular “glamour” stocks led to superior long-term performance. Their findings showed that investors often over extrapolate recent trends, pushing prices beyond reasonable valuations. In contrast, contrarian strategies exploit this irrationality, earning higher returns by identifying and acting on mispricing created by market sentiment.
As Warren Buffett famously advised: “be fearful when others are greedy, and greedy when others are fearful.”2
Other emotional decisions such as fear, greed, or herd behavior may push prices far from their underlying value. Panic selling during downturns may drag quality stocks below their true worth, while bullish frenzies may inflate speculative assets beyond reason. Contrarian investors aim to take advantage of these mispricings.
This approach can be particularly effective in volatile or overheated markets, where crowd psychology may overwhelm fundamentals. For example, during periods of market euphoria, like tech booms or speculative rallies, investors may rush into growth stocks with inflated expectations, bidding up prices beyond what the underlying fundamentals justify. A contrarian might take the opposite approach: trimming growth exposure and shifting into value stocks that have been overlooked or punished, even if their fundamentals remain sound.
What Investors Should Know
This strategy typically requires strong research habits, a clear investment thesis, and the emotional discipline to hold positions that may be unpopular in the short term. Investors may also need to be especially wary of value traps3 (cheap stocks with weak fundamentals) and have a longer time horizon, as contrarian positions can take time to pay off.
It’s also crucial to distinguish genuine market overreaction from justified price movements. Just because a stock is down doesn’t mean it’s undervalued—fundamental analysis is key.
Contrarian investing, when done well, is more than a mindset. It is a methodical, evidence-based strategy that aims to reward long-term discipline and independent thinking. In volatile Canadian markets, where sentiment can shift quickly, it can serve as a powerful counterbalance to emotionally driven decisions.
For experienced Canadian investors who are comfortable evaluating fundamentals and maintaining a long-term perspective, contrarian investing can offer a compelling framework for finding value where others aren’t looking.
1] Josef Lakonishok, Andrei Shleifer, and Robert W. Vishny, Contrarian Investment, Extrapolation, and Risk, The Journal of Finance 49, no. 5, April 1994: 1541–78, https://onlinelibrary.wiley.com/doi/full/10.1111/j.1540-6261.1994.tb04772.x
2] Jing Pan, Warren Buffett Cautioned: Be Ready for a Stock Market Crash — Here Are 3 Safe-Haven Assets He Likes Instead, Yahoo Finance, July 25, 2024, https://finance.yahoo.com/news/warren-buffett-cautioned-ready-stock-104500651.html?guccounter=1&guce_referrer=aHR0cHM6Ly93d3cuZ29vZ2xlLmNvbS8&guce_referrer_sig=AQAAAJ4798jr5wtkcl_1ZGMAWf9Ou6dZiilmD2-rYJyRP-Zzp7PJ2ZWL11_F1O7DknqvlujzF10mHoYaZ3ayqZ1DtQV_fGzMN3CgaFwCjEwp2xvmAFpfpB-nQrfubjqpexZNGXniJeGu8YP2QbWOIjRMaFkk2yZQwCmYgAh_Hs4CtxDf
3] James Chen, Value Trap: What It Is and How to Avoid It, December 27, 2023, https://www.investopedia.com/terms/v/valuetrap.asp#:~:text=Value%20traps%20are%20misleading%20investments,extended%20periods%20of%20low%20multiples.