This Is Why Being a Contrarian Works

Callum is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Avant-garde

Avant-garde is a French term that refers to people who are innovative and experimental in their field. While there are investors who follow the leader, like buying up the same stocks as Warren Buffett or Carl Icahn, those returns are never truly realized as Warren and Carl bought the stock at a lower price and the market pushed it higher as all the sheep file in. In order to get truly market beating returns you have to buy stocks that everyone is down on and be an avant-garde investor. The idea is to buy up stocks that are really out of favor, and then profit as the market corrects based on fundamentals. Just look at these 3 examples of how you could have earned a triple digit return if you had been an avant-garde investor. 

 Is online streaming dying? 

During the fall of 2012 everyone was bearish on Netflix (NASDAQ: NFLX), saying how Amazon Prime and Hulu were going to ruin the company. Reed Hastings was making blunder after blunder. First with splitting the DVD rental and streaming business apart, which scared a lot of their customers away, and then by selling off $200 million worth of shares at $80 just after Netflix had bought $200 million worth of shares at over $200.

People were saying that Netflix would go bankrupt and would have to be bought up by one of the tech behemoths. All of this seemed certain, until their latest earnings report came out, which sent their shares up from $103 to $176. They beat their own guidance and surprised everyone by posting a profit. This company's stock has more than tripled off its low. That is an enormous return over the last 8 months, and why you should always look at stocks while they are beaten down. Sentiment and emotions can push stocks down lower than what "fair value" would dictate. Had you seen through that with Netflix you would have made a lot of money.

Going forward Netflix's future looks promising as their original content starts rolling out. The House of Cards is their first big original content roll-out, and so far it looks pretty successful. It has gotten a lot of fanfare and good reviews. If this roll-out was successful, just imagine what will happen when the new season of Arrested Development comes out. During its latest quarter, Netflix stated they added 2 million domestic subscribers and are projected to add another 1.7 million in the next quarter. Their original content can help them keep rolling in new subs. The future is looking bright right now for Netflix. Original content allows Netflix to get an edge over its competitors as they can offer content no one else can (they don't need Epix exclusivity anymore).

Will Nokia ever be a giant again 

This company, which used to be the giant in the mobile space, is just a shell of what it once was. Times see to be changing though, as Nokia Corp (NYSE: NOK) has rallied big off its $1.63 low to hit $4.70. If you had sold at the peak you would have made a 288% return. Now Nokia has fallen down to $3.81, but that still is a 234% return (it is now back up to almost $4). Nokia fell as they continued to hemorrhage large sums of money, their balance sheet was rapidly shrinking, they had a huge dividend they couldn't pay out, and they were losing market share left and right. Their Symbian system was a joke, and it looked like it was all over for Nokia. But not quite, as Microsoft Corp (NASDAQ: MSFT) had a bone to pick with both Google and Apple.

Microsoft stepped in, offered Nokia $250 million a quarter in "platform support" payments in return for Nokia using Microsoft's OS. This turned out to be very beneficial for both parties, as Nokia was able to turn itself around in the latest quarter, selling 4.4 million Lumia phones. It also looks like Microsoft will be able to get a good return on investment, as Nokia recently stated that Microsoft will be getting a $1 billion royalty payment very soon. They also benefit by closing the gap for their ecosystem, and increasing Bing traffic due to close integration in the Lumia phones. Everyone thought that Nokia's Lumia 920 wouldn't sell and it would be a bummer like Windows 7, but that wasn't the case. Going forward Nokia's deal with China Mobile (which will allow them to sell the Lumia 920 for virtually free in China) will boost smartphone sales even more, pushing Nokia above $5 a share. Microsoft will also benefit, because they currently make very little money in China due to piracy, but they will be able to make a substantial amount from royalty payments from their OS licensing.

Natural gas producers can't get a break

This energy company was recently in the news because their CEO finally stepped down from his post at Chesapeake Energy Corp (NYSE: CHK). Aubrey McClendon was covered in scandals, from selling historic maps to his own company to cover investment losses to taking a 2.5% stake in each new Chesapeake drilled, no one could trust him. His actions led to Chesapeake seeing its stock plummet and every analyst turned bearish as Chesapeake was very cash flow negative. But there were investors (including myself) who saw the true value of Chesapeake's assets and were able to make a very nice return in a short period of time. Asset sales bumped up Chesapeake's stock price over 50% as they sold off $3.3 billion worth of assets in the Permian Basin, $3 billion from selling of its pipeline assets (which include the $2.7 billion sale of Chesapeake Midstream Development), and $600 million from the Utica Shale.

The reason why shares flew up is because Chesapeake has been losing money (they are expected to post a negative cash flow of $4 billion in 2013) as natural gas prices dropped to as low as $1.63 mmBtu, but with natural gas prices almost doubling and the asset sales bridging the funding gap, investors gave Chesapeake another chance. The departure of Aubrey also saw Chesapeake rise another 11% as investors saw a new beginning in the life of the 2nd largest natural gas producer in the US.

Final thoughts  

The purpose of this piece is to show that just because everyone in the financial media is bearish on a stock doesn't mean it won't be a good buy. "Follow the leader sentiment" can push stocks much lower than what they should be trading at, and if you can see through the negativity you can net large returns. Just as you would have with Netflix, Nokia, and Chesapeake Energy. Jim Rogers, who made a 4,200% return with his Quantum Fund in just 10 years, was a huge contrarian investor. He made his large returns by buying up stocks that were deeply out of favor and were undervalued. Looking at stocks that are deeply sold off with huge amounts of negativity around them can make you huge returns and a stock that falls 50% should merit a second look.


callumturcan has no position in any stocks mentioned. The Motley Fool recommends Netflix. The Motley Fool owns shares of Microsoft and Netflix and has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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