Are you a contrarian investor?

The value of your investments and the income you receive from them can go up and down, and you may get back less than you invest. Any examples are for illustration purposes only.

If your portfolio is full of US tech, big names and bigger market caps, you aren’t alone.

Investing in high-growth companies and those with high quality, sticky revenue streams served investors particularly well in the decade after the financial crisis, when interest rates were nailed to the floor.

It didn’t seem to matter how much investors were paying for stocks in high-flying sectors like US technology or seemingly stable growers in consumer goods, they wanted a piece of them. But, while it’s far from a bad thing to want to back the biggest, most dominant firms out there, it’s not the only way to invest.

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With the US market seeing record levels of concentration in the Magnificent Seven, high valuations in tech stocks and an uncertain future for growth, parts of the market have started to explore opportunities elsewhere, with less of a focus on high-growth characteristics.

It means interest in value investing (i.e. focusing particularly on lowly valued stocks) is slowly creeping back after an age in the wilderness. It’s not a sign to completely change your investment strategy but it might be an opportunity to find out if there’s a hidden value contrarian investor in you.

Instead of looking to market leaders and reasonably priced growth stories, value investors look for the biggest bargains out there. They spend their days lifting up rocks for elusive gems and figuring out if a beaten up, unloved stock is cheap because it’s… well… rubbish, or if it’s been unfairly cast aside. A well-run company, with a near-term catalyst for growth flying under the market radar is the stuff of dreams for a value investor.

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It’s been described as looking in other investors’ dustbins for valuable stocks they got rid of because the value wasn’t clear at the time. It’s not a bad analogy because, fundamentally, you have to disagree with the market on a company’s position and prospects, which means you’ll have to research what they throw away.

It’s not always comfortable being the odd one out, especially if you’re going down niche rabbit holes while the rest of the crowd piles into the most popular trades of the time. At least if they’re wrong, they can comfort themselves by looking around and seeing most people doing the same thing.

Even if you are right, you’ll likely spend a lot of time until you are proven correct looking pretty different to the herd. That’s a lonely existence that not many investors have the stomach for. So, why do people do it?

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Well, taking a step back, the majority of investors out there are looking to buy stocks for less than they’re worth. The theory is that those stocks will be worth more when the market finally recognises their value. While some investors are willing to pay up for stocks already on a growth path, as they think earnings will lift the share price, others prefer to really focus on those cheap opportunities, hoping to find something no-one has seen yet.

It’s the latter strategy that attracts contrarians, happy to break off from the crowd, and it’s been a useful approach over the long term. Research, including that of Fama and French at the Stern School of Business, found so-called value stocks largely outperformed growth stocks over the past 100 years. There have been droughts, mostly in the past 25 years, but the basic model of buying at low valuations, where a company has a stimulus for recovery, has helped.

Benjamin Graham, Warren Buffett and UK star fund manager Anthony Bolton all carved out careers as proponents of value investing, concentrating on buying stocks below their intrinsic value instead of buying into stocks already valued highly.

It might sound like value investing is all about scouring the index for the lowest-valued share. It’s not. Cheap is one thing, but quite often companies are cheap for a reason. Value investing isn’t about buying the cheapest junk in the junk yard, it’s about finding where that cheapness doesn’t reflect the future quality of the business. There might have been a recent scandal that has tarred a firm’s reputation, management may be due a change or the sector might have become unfashionable - in all cases you need to see a route out of the negativity for it to be a viable opportunity.

Focusing on low prices without a catalyst for change risks the dreaded value trap - where investors get drawn in but the price just keeps going down.

There are a few key ratios to keep in mind when you’re trying to decide if a company is trading below its intrinsic value. Make sure you’re using these to get a sense of how a company stacks up against its peers, its own history and the broader market. That way, you’ll see if anything abnormal appears, like a sudden drop due to a big fine or failed product launch. Comparing across industries makes less sense as you won’t get the same insights. Putting a tech firm up against a supermarket will probably not really tell you anything about either one.

Price-to-book (P/B) ratio

This measure tells you how much investors are currently willing to pay for a pound/dollar of a company’s net assets. You can work out a firm’s P/B by dividing its share price by its book value (total assets minus total liabilities, divided by the number of shares in issue). A low P/B, typically below one, could mean you can buy the shares for less than they are worth.

Price-to-sales (P/S) ratio

To get an idea of what investors are willing to pay for each dollar of a firm’s revenue, you can divide a company’s market cap by its total revenue over the past year. If the P/S comes in under one, it could well be undervalued.

Debt-to-equity (D/E) ratio

Debt can really weigh on a business, especially if interest rates rise and repayments get more expensive. If a firm has a lot of debt it might explain why it has been so lowly valued, alternatively if the D/E is less than one it might be a sign the company is more stable - attractive to a value investor.

Return on equity (ROE)

This measures how efficient a company is at using shareholders’ equity to generate profits. 15-20% ROE is typically deemed a good gauge of this, meaning every pound or dollar of shareholder equity generates 20¢ or 20p of profit. Keep an eye out for consistent or growing ROE but make sure the company isn’t just using borrowed money to fuel it.

The alphabet soup of ratios above isn’t the be-all-and-end-all of value investing. If it was, everyone would be doing it and those big valuation discounts would close instantly.

There are intangible qualities some firms have that matter just as much to the turnaround story as the balance sheet. Case in point is Burberry. The British mac maker’s shares fell off a cliff in 2023-24 when the Chinese market, which it was massively counting on, pulled in the purse strings as the economy slowed. Brand revamp after revamp failed to lift the firm into the ultra-luxe leagues and suddenly the once aspirational name found itself battling an identity crisis and tepid demand.

The ratios all looked attractive and the share price eventually fell to a level not seen since 2010. Still, a value investor might have asked, “What’s the catalyst to break the fall?” and in this case there were two possibilities. Either China gets buying again or yet another brand refresh actually convinces the market this time. While the former started to show promise, it was a new CEO and back-to-basics campaign that breathed new life into the shares. Investors buying at the bottom could have made around 100% return before the feel-good story started to peter out.

Discrete calendar year performance

As at 1 April 2025. Source: FE Fundinfo. Total return basis, in local currency. Past performance is not a reliable guide to future results.

As tidy a trade as this all sounds, it’s not always as clearcut as our Burberry example makes out. Keep in mind that these turnaround stories can be frustrating and might take longer than you have patience for, if they ever materialise. Here are a few other things value investors need to remember:

• Get used to your stocks performing differently to the market. Finding value can mean you own a range of stocks that looks very different from the index so performance will likely be just as distinct.
• You will have periods when you’re out of style - the contrarians watching tech stocks fly over the years can attest to that. Just remember it’s rarely a bad idea to identify quality companies at knock-down prices.
• There’s an element of market timing in value investing, which is tricky at the best of times. Even when you decide the time is right to pounce on a cheap stock, it’s unlikely you’ll catch the bottom so you might need to contend with the stock getting worse before it gets better, if it eventually does.
• You’ll be looking a lot. Whereas growth managers are happy to keep their stocks as long as they’re growing healthily, once a value investor’s stock has turned a corner and the share price has risen, it’s often time to sell and recycle that cash back into other value opportunities.
• You’ll likely hold a lot more stocks. Given turnarounds can take time, if they ever arrive, value investors often hold a large portfolio of stocks so the risk of an idea failing doesn’t take the whole portfolio with it.

In the end, you might try to spot a couple of value opportunities or you might follow the process religiously. A great part of investing is you don’t need to be tied down to one approach. Even if all you want to take with you is the importance of avoiding overpaying for a share, sometimes that can be enough. The main takeaway is that we should give ourselves the confidence to break away from the herd when we feel valuations are stretched or we have better opportunities elsewhere.

Sources:

• Stern School of Business

Important information

When investing, your capital is at risk. The value of your investments, and the income you receive from them, can go down as well as up and you may get back less than you invest. Forecasts aren’t a reliable guide to future results or returns.

Make sure to do your own research on what investments are right for you before investing or consider seeking expert financial advice. Please note that this article is meant for information and does not constitute any financial advice. This is not an offer, recommendation, inducement or invitation to buy, sell, or hold any securities, or to engage in any investment activity or strategy.