It takes an iron stomach to invest with a contrarian view.
By definition, contrarian investors are going against the crowd and investing in places the rest of us fear to tread. Billionaire investor Howard Marks is well known for his contrarian style and his take on investor psychology which offers key lessons for average investors like you and me.
You can’t always profit from “popular”
The logic supporting contrarian investing is that the price of a company that ‘everybody knows will do well‘ often already reflects the expectations for strong earnings in the future, reducing potential share price gains while increasing the risk of share price falls if expectations are not achieved.
“Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity” – Howard Marks.
Sydney Airport Holdings Ltd (ASX: SYD) seems to me a good example at the moment. The company is benefiting from its formidable market position, a well-documented boom in tourism numbers and a beautifully consistent dividend.
Everyone knows this, and the company’s share price has marched up relentlessly over the last two years in recognition.
Each share in Sydney Airport Holdings currently sells for 52 times its trailing annual earnings. By comparison Auckland International Airport Ltd (ASX: AIA) sells for 33 times its annual earnings, while the wider S&P/ASX 200 (Index:^AXJO) (ASX:XJO) averages just 22 times earnings.
High stakes investing
According to Reuters consensus earnings for Sydney Airport Holdings in 2016 suggests growth of 9% which is certainly impressive. But lofty valuations reduce an investor’s margin of safety and buyers should be sure to weigh up the potential risks.
Share prices can move drastically, both up and down, when investors are surprised by unexpected events. How might the market react if the company fails to meet the earnings ‘consensus’ for some reason?
Sydney Airport has done incredibly well for investors in the last few years and for easily identifiable reasons. However looking at the company’s current price from a Howard Marks contrarian perspective, it’s likely that its popularity could also create greater investing risk.
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Motley Fool contributor Regan Pearson has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.