Can you buy when the stock price drops by half? – The appeal and pitfalls of contrarian investing –
Hello.
Welcome to the Investor’s Thought Organization Room.
Today, I would like to talk about one of the investment methods that I personally value: “contrarian investing.”
I have a question for everyone, if I may.
If the price of a stock you’ve wanted for a long time drops by half, can you buy it?
For example, suppose a stock that was 2,000 yen per share drops to 1,000 yen.
A stock that was too expensive to touch before can now be bought for half price.
If it were a normal purchase, that would be good news, right?
However, when it comes to stock investing, the story changes.
“Won’t it drop even further?”
“Is there some bad news I don’t know about?”
“Is it really okay to buy a stock that is being sold off this much?”
Don’t such anxieties cross your mind?
Strangely enough, when stock prices are high, we want to buy them, and when they become cheap, we become afraid.
This is the psychology of an investor.
However, it is precisely within that fear that great investment opportunities are sometimes hidden.
This time, I will share my own thoughts on the appeal of contrarian investing and the pitfalls that lurk behind it.
Chapter 1: What is contrarian investing?
Simply put, contrarian investing is an investment method where you buy when many other investors are selling.
It is the opposite approach to “trend following,” which involves buying stocks that are rising in price.
For example, suppose a company’s stock price falls from 2,000 yen to 1,200 yen.
Pessimistic news is spreading in the market, and many investors are letting go of that stock.
However, when you look into the company’s performance and financial situation, you may find surprising facts.
Sales are growing.
Profits are also stable.
Debt is low, and the financial foundation is sound.
Yet, only the stock price has fallen significantly.
When they find such a situation, contrarian investors think.
“Does this company really need to be sold off this much?”
Of course, there is some reason why the stock price is falling.
However, is that reason temporary, or is it something serious that will affect the company’s future?
Discerning that is the starting point of contrarian investing.
Chapter 2: The greatest appeal of contrarian investing
The reason I find contrarian investing attractive.
It is that I can take advantage of the gap created between a company’s value and its stock price.
Stock prices are not necessarily determined solely by a company’s actual strength.
They fluctuate due to various factors, such as investor expectations and anxieties, economic outlooks, and interest rate trends.
And sometimes, they are sold off more than necessary.
For example, suppose a company’s stock price was 2,000 yen.
However, due to a temporary decline in performance, the stock price fell to 1,000 yen.
The important thing here is not the fact that the stock price has been halved.
It is about how much profit that company can generate in the future.
If the decline in performance is temporary and it is thought that profits will recover in a few years, a stock price of 1,000 yen might be attractive.
And if the market re-evaluates the company’s value, the stock price may recover.
If a stock bought at 1,000 yen rises to 1,500 yen, the profit is 50%.
If it returns to 2,000 yen, the profit becomes 100%.
Of course, there is no guarantee that it will definitely return.
Even so, if you can judge that the stock price is undervalued relative to the company’s future potential, there is a possibility of aiming for a large return.
I find the fun of investing in searching for such companies.
Instead of buying stocks that everyone wants, searching for value among stocks that everyone has stopped looking at.
I believe this is the real thrill of contrarian investing.
Chapter 3: Even if the stock price is halved, it is not necessarily undervalued
From here, I will talk about the pitfalls of contrarian investing.
The thing you must be most careful about in contrarian investing.
That is the point that a drop in stock price and becoming undervalued are not the same thing.
For example, suppose there is a company whose stock price has fallen from 2,000 yen to 1,000 yen.
At first glance, it looks like a bargain stock that can be bought at half price.
However, what if the company’s profits have also been halved?
Let’s think about it with some numbers.
If the stock price is 2,000 yen and the earnings per share is 200 yen, the PER (Price Earnings Ratio) is 10 times.
However, suppose that while the stock price has become 1,000 yen, the earnings per share have also decreased to 50 yen.
In this case, the P/E ratio becomes 20 times.
In other words, even though the stock price has been halved, the stock’s valuation relative to its earnings has actually increased.
Before decline After decline
Stock price 2,000 yen 1,000 yen
Earnings per share 200 yen 50 yen
P/E ratio 10 times 20 times
This is the scary part of contrarian investing.
If you only look at the stock price, it feels like it has become cheaper.
However, when you check the company’s fundamentals, you may find it is not cheap at all.
You should be especially careful with companies whose performance is deteriorating over the long term.
The competitiveness of their main products is declining.
The market itself is shrinking.
Their debt continues to increase.
For such companies, even if the stock price is halved, there is a possibility it will be halved again.
Do not buy because it has become cheaper, but buy because it is cheap relative to its value.
It is important to understand this difference.
Chapter 4: Contrarian investing is difficult after you buy
What is difficult about contrarian investing is not just the timing of the purchase.
Rather, I feel it is more difficult after you have bought.
For example, suppose you bought a stock that fell from 2,000 yen to 1,000 yen.
“Surely, if it has fallen this far, it will rebound soon.”
Even though you bought it thinking that, the stock price falls further.
900 yen.
800 yen.
700 yen.
Before you know it, it has dropped 30% from your purchase price.
What would you do if you found yourself in this situation?
“I could have bought it cheaper.”
“I shouldn’t have bought it after all.”
Such regrets might arise.
However, in contrarian investing, the stock price does not necessarily rise immediately after you buy.
In the first place, since you are buying when many investors are pessimistic, it is not rare for it to continue to be sold off for a while.
What is important here is not to judge based solely on stock price movements.
Has the future potential of the company you envisioned at the time of purchase changed?
Has the outlook for earnings recovery collapsed?
Has the financial situation deteriorated?
It is necessary to confirm these points.
If your thinking regarding the company’s value has not changed, a drop in stock price is not necessarily a reason to sell.
Conversely, if the very reason you bought it has collapsed, cutting your losses is also necessary.
What is needed for contrarian investing is not the guts to endure a decline, but the calmness to continue verifying your own judgment.
Chapter 5: What I am conscious of in contrarian investing
When I think about contrarian investing, there are things I value particularly highly.
It is understanding the reason why the stock price is falling.
For example, suppose an accident occurs at a company’s factory.
Production stops temporarily due to the accident, and business performance worsens.
The market may dislike that news and sell the stock.
However, if that company possesses high technical capabilities and has not lost its competitiveness, there is a possibility that its performance will recover over time.
On the other hand, what if accounting fraud, such as window-dressing, is discovered?
This has a different meaning than a mere temporary decline in performance.
The past financial figures can no longer be trusted.
Trust in the management team is lost.
In some cases, the very survival of the company may be in question.
I value these differences.
Of course, even an accident can have a serious impact on a company’s future, and a company that has caused a scandal can also recover.
The important thing is not to judge based solely on the impression of the news.
How much will the profits that the company will generate in the future change due to that event?
You need to think that far.
And one more thing.
What I am conscious of is not investing all of my funds at once.
No matter how attractive the stock price looks, it is not necessarily the bottom price.
A stock bought at 1,000 yen might become 800 yen.
There is even a possibility that it could go down to 600 yen.
That is precisely why you should set aside your purchase funds.
For example, if your planned investment amount is 1 million yen, you should only purchase 300,000 yen worth at first.
After that, consider additional investments while checking for changes in stock prices and business performance.
Of course, making split purchases does not guarantee a profit.
However, you can avoid a situation where everything is decided by a single decision.
In contrarian investing, I believe it is important not only to buy low, but also to leave yourself enough room to make calm decisions even after you have bought.
Chapter 6: The courage to buy stocks that no one else wants to buy
Contrarian investing has a unique difficulty.
That is that you must take actions that are the opposite of most people.
When stock prices are rising, cheerful topics increase around you.
“This company has potential”
“The stock price will still go up”
“You should buy even now”
When you hear such voices, you naturally want to buy as well.
Conversely, what about when stock prices are falling significantly?
“It’s all over”
“You shouldn’t buy such stocks”
“It will still go down”
Only pessimistic opinions stand out.
In such a situation, you are the only one heading in to buy.
This requires more courage than you might imagine.
However, there is something you must not misunderstand here.
Acting differently from others does not guarantee profit is what I mean.
It is, of course, possible that the majority of the market is correct.
There may be a valid reason why many investors are selling.
That is precisely why what is important in contrarian investing is not simply the courage to do the opposite of others.
It is about not being swayed by the opinions of those around you, but rather researching, thinking, and judging for yourself.
And when you realize that your judgment was wrong, you must be willing to change your mind.
If you cannot do that, contrarian investing becomes nothing more than stubbornness.
Chapter 7: The scariest thing about contrarian investing is not the decline in stock prices
When you are engaged in contrarian investing, you may feel the urge to buy more every time the stock price drops.
“It’s cheaper than before”
“I can lower my average acquisition cost”
“If I buy here, I’ll make a big profit when it rebounds”
I understand that feeling well.
However, there is a major pitfall here.
That is, the more the stock price falls, the more you want to prove that your judgment was correct.
For example, suppose a stock you bought for 1,000 yen drops to 800 yen.
Normally, you should investigate why the stock price fell.
However, when it is a stock you already own, you may find yourself looking only for information that is convenient for you.
This company has technical expertise.
The market will eventually recognize its value.
It has fallen so far that it is bound to rebound.
That is how we justify our reasons for buying after the fact.
This makes it impossible to make calm investment decisions.
Before you increase your position, I want you to consider one thing.
If you didn’t own a single share of this stock right now, would you still want to buy it?
This question can serve as a trigger to re-evaluate your judgment.
How much did you pay for it in the past?
How much of an unrealized loss do you currently have?
Set those circumstances aside for a moment and judge based solely on the current corporate value and stock price.
If you still find it attractive, it might be worth considering an additional investment.
Conversely, if you only want to buy more simply because you already own it, you need to be careful.
The scariest thing about contrarian investing is not the stock price falling itself.
It is becoming unable to admit your own mistakes.
Chapter 8: In Contrarian Investing, Waiting Is Also Part of the Job
Finally, there is something you must not forget in contrarian investing.
That is the importance of time spent doing nothing.
Just because you have found an attractive company does not mean you need to buy it immediately.
If the stock price has not fallen enough, you should just wait.
Even if it looks cheap, if the future of the business performance is uncertain, it is fine to wait and see a little longer.
And if you cannot find an investment opportunity you are satisfied with, it is fine to keep holding cash.
When investing, you may feel like you will miss out on profits if you do not take some kind of action.
However, investment opportunities are not one-time events.
In the stock market, there will continue to be times when stock prices fall significantly for various reasons.
If you do not have funds left at that time, you will not be able to buy no matter how attractive the investment opportunity is.
That is precisely why I believe that holding cash also has meaning.
Cash is not just money that is lying dormant.
It is also an option to prepare for future investment opportunities.
Contrarian investing requires both the judgment to buy low and the patience to wait for the right opportunity.
That is what I think.
Conclusion: What do you see when the stock price is halved?
So far, I have talked about the appeal and pitfalls of contrarian investing.
Contrarian investing has great potential.
Calmly assessing a company’s value when the market is pessimistic.
Investing while believing in a future recovery while many other investors are selling.
If that judgment is correct, it can lead to significant returns.
However, there is always some reason why a stock price is falling.
And if you buy without fully understanding that reason, you may end up with unexpected losses.
I do not think it is necessary to be right every time you invest.
As I have mentioned before, my philosophy on investing is that “a score of 70 is good enough.”
What is important is to invest for reasons you are convinced of, and to revise your thinking when you are wrong.
And, to remain in the market for a long time.
When a stock price is halved, what we should look at is not just the rate of decline.
It is the value that the company holds and its future potential.
Finally,
If a stock you have always wanted were to drop to half price tomorrow, would you be happy to buy it?
Or would you get scared and stop yourself from buying?
And, is there a proper reason for that judgment?
I would be happy if today’s talk serves as an opportunity for you to re-examine your investment decisions.
Thank you for staying with me until the end.
Let’s meet again next time in the Investor’s Thought Organization Room.