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Contrarian Investing
“The time to buy is when there is blood in the streets.”

Baron Nathan Rothschild


Trend Following
“You want to enter into incipient trends, exit with discipline when those trends fail, and remain with winning trends for long periods.”

Michael W. Covel

– Enjoy more of our favorite quotes –


AUGUST 29, 2016



Revisions to our Value Portfolios

Combining Contrarian and Trend-Following Approaches



- The Contrarian Approach to Investing
- Value and Contrarian Investors: Joined at the Hip?
- The Trend-Following Approach to Investing
- Our Stock Selection Strategy
- 2008-2009: A Great Time to Buy!
- What About Value-Investing Opportunities Today?
- Revision to Our Value-Based Portfolios
- Our Plan for This Week



Do you follow the flow or invest opposite the crowd? Are you a trend-follower or a contrarian?
Is it possible to combine both approaches?



In this issue of the Value Alert newsletter, we will explain the contrarian and trend-following approaches to investing and identify the benefits of each. We will also delve into the approach of our two value-based portfolios and explain how we were able to achieve such high returns in the last seven years. You'll also learn why they have left us empty-handed in today's very expensive market environment.

We'll conclude by introducing a new, potentially very profitable portfolio revision we will implement soon!


Contrarian investing is a style distinguished by buying and selling against the grain of sentiment. Contrarian investors are known for going against prevailing market or individual stock trends by entering positions when others are excessively bearish or bullish.

Contrarians turn the tables on the principles of behavioral finance. Behavioral finance researchers study investors as a collective and their interaction with different investment situations. For example, behavioral finance tells us that most investors believe that if a company has been performing badly, it is going to continue to decline, and most investors believe stable, healthy companies will continue prospering.

The truth is that neither positive nor negative conditions can persist for long. Capitalism works, and business advantages accompanied by excess profits are quickly eroded by new entrants into a market niche. Likewise, struggling and money-losing companies are either turned around by new management that redeployment assets in innovative ways or liquidated with cash distributed to shareholders.

Contrarians turn these natural human assumptions about pattern continuation to their advantage by betting against those trends when sentiment reaches extremes. In the 18th century, Baron Rothschild aptly stated the contrarian philosophy when he quipped, “The time to buy is when there is blood in the streets.”


Value-oriented investors and contrarian investors have much in common because when sentiment is at its worst, value is often at its best. In periods of deep investor pessimism, stock prices frequently reach levels that are below a company's intrinsic value, i.e., ongoing-firm acquisition value, leveraged buy-out (LBO) value, discounted cash flow (DCF) value, net current asset value (NCAV), liquidation value, or other objective assessments of a company's fundamentals. With time, significant profits are assured for those who buy below a company's intrinsic value.

Likewise, when investor optimism is at a zenith, stock prices often move parabolically higher to extremes of over-valuation. At these times, contrarian and value investors have usually exited the market and watch the lively fireworks with disinterested curiosity from the sidelines.

The difference between value and contrarian investors lies in how each group determines the optimum point for purchase and sale. Value investors typically utilize fundamental analysis (using Price/Earnings, Price/Sales, Price/Book Value, and other fundamental ratios) to select stocks selling at a discount to a company's intrinsic value and later sell them when those ratios reach full value.

On the other hand, contrarian investors put more weight on the collective sentiment – either too high or too low – of a particular stock or the market as a whole. When the vast majority of investors are deeply pessimistic about a stock, contrarians are anxious to buy – and when sentiment is excessively bullish, contrarians are looking to sell.

The two disciplines frequently coincide because when sentiment is excessively bearish, the fundamental ratios used by value investors are often signaling a great buying opportunity is at hand– and when overly bullish, there is usually an assortment of fundamental ratios signaling that stock prices are far too precious.

Benjamin Graham’s seminal 1934 book Security Analysis laid the foundational for the school of thought now known as value investing. Graham taught a simple, incontrovertible lesson: stocks appear most attractive on a fundamental basis at the peak of their business cycle when they have the worst risk-reward ratio, and least attractive at the bottom of the cycle when the opportunity is optimum.

Graham's fundamental lesson was that a substantial market price discount to intrinsic value (margin of safety) is more consequential to investing success than company's earnings growth rate or its return on equity (ROE; a measure of business quality). A small legion of investors who have become wealthy from this insight can attest to its accuracy. That list of the rich from Graham's principles includes Seth Klarman, Whitney Tilson, Joel Greenblatt, Walter Schloss, James O'Shaughnessy, Warren Buffett, and many more.


Trend-following or 'swing trading' is usually based on price-related signals, and for investors typically operates in periods of weeks or months instead of the days, hours or minute timeframes that traders use. Therefore, trend-following is more appropriate for investors rather than short-term traders.

Trend-following is responsive by nature. It does not forecast or predict markets or price levels. Trend following typically utilizes technical analysis techniques to determine entry and exit points, and rarely takes interest in the fundamentals of a particular stock or ETF.

Trend followers are the group of technical traders who use reactive technical analysis. Instead of trying to predict a market direction, their strategy is to react to the market’s movements whenever they occur. This enables them to focus on the market’s actual moves and not get emotionally involved with trying to predict direction or duration. —Michael W. Covel, Trend Following

Like value and contrarian investors, trend-following requires the essential discipline to follow the precise rules of the game without second-guessing or emotional decisions.


ince our launch in September 2004, IntelligentValue has utilized a unique approach to value investing that merges contrarian, value-based stock identification with a trend-following/market-timing aspect. Our system is unusual because most investors and investment advisors are either fundamental factor/value (number) oriented or charting/technical (visually) oriented.

The reason our approach is unusual is that these are two very different investment disciplines. Most mathematical/fundamental-oriented value investors eschew visually oriented technical analysis, and vice-versa.

This might be because most individual's aptitudes lean toward either their logical/math skills or their visual/creative skills; rarely both (unless you are a polymath with the last name of da Vinci). Scientist tell us that the brain is divided down the middle into two hemispheres, and many theorize that each half performs a distinct set of operations.

Some brain specialists postulate that the left hemisphere controls math skills, and the right hemisphere controls a person's visual skills. Most individuals find one or the other skill set is dominant. (Take a test to learn which skill set is more dominant for you.)

IntelligentValue's team combines both skill sets into a single, comprehensive investment system. The technical/trend-following aspect of our model portfolios signal to exit a position when either 1) an individual stock's trend loses momentum and begins to head downward, or 2) the overall market's momentum is reaching exhaustion and risk is increasing.

Then when our trend-timing system tells us that the time is ripe to enter the market, we'll engage our new TurboValue stock-selection (logical/math) system, which uses Wall Street-caliber software and a state-of-the-art, point-in-time database to identify stocks that are priced below a company's intrinsic value.

2008-2009: A GREAT TIME TO BUY!

While our Aggressive Portfolio and Conservative Portfolio have cumulative returns of 31,771% and 6,221% (S&P 500 gained 223%), respectively, a sizable portion of that performance was generated in the first years following the financial crisis. These were classic, contrarian timing signals and we took full advantage of them!

Because of our IMRA system, we were able to successfully side-step the crash of 2008 and early 2009 and our long-time subscribers actually logged a small gain during that period (we produced alpha of about 50% through the crash).

Then in early March 2009, our system told us to get fully invested in the deeply undervalued equity of publicly traded corporations that were priced for the end of the world. Our portfolio performance for the following 9.7 months – through the end of 2009 – left many subscribers (and even us) with jaws agape. While the Russell 2000 turned in a great performance of 82% that year, our Aggressive Portfolio logged an incredible 1,649% return! The larger-capitalization stocks in our Conservative Portfolio also performed amazingly well that year. While the Russell 1000 index surged 66%, our Conservative Portfolio gained 693% for 2009!

While those were perhaps once-in-a-lifetime annual returns, it is not uncommon for seasoned value investors to have stories of beating the market by big multiples. Disciplined contrarian and value investors purchase near the bottom of a selloff when many stocks are priced disaster. While the average investor eschews the concept of buying stocks when the news is horrific, value investors know the optimum time to buy is at the point of maximum pessimism.

In the words of Tobias Carlile (author of Deep Value and co-author of Quantitative Value),

Though they appear intensely unappealing—perhaps because they appear so intensely unappealing—deeply undervalued companies offer very attractive returns. Often found in calamity, they have tanking market prices, receding earnings, and the equity looks like poison.

Those were the exact conditions under which we launched our two current portfolios in March 2009. The US and world economies were collapsing, and stocks had tanked by -56%. However, our IMRA system identified the optimum time to purchase stocks, and we profited handsomely with new stock-picking systems that heavily valued cash and cash flow.


Value investing today? Well, not so much. In an environment where the market has been climbing for an almost unprecedented 89 months, stocks are extremely pricey relative to their earnings and many other valuation measures. For example, the S&P 500 is trading at a price that is 25 times earnings – the highest ever without a recession, outside of the late '90s. Even worse, the Russell 2000 small-capitalization stock index has a P/E ratio of 'nil' because its composite earnings are negative.

In this extremely expensive market environment, our value-based systems have Buy Rules that limit us from making purchases. For example, in the case of our Aggressive Portfolio, after our custom ranking system places stocks from the Russell 2000 universe in order according to specific value and quality criteria, the system also screens the stocks to meet the following fundamental requirements:

1) A Price-to-Book Value ratio less than 1, and 2) a Free Cash Flow per Share/Price yield greater than 0.14, and 3) a Price-to-Sales ratio less than 1, and 4) one other criterion.

For our Conservative Portfolio, the custom ranking system orders the stocks from the Russell 1000 universe, and then applies the following criteria:

1) A Price-to-Sales ratio less than 1.3, and 2) an Operating Income Before Depreciation/Enterprise Value ratio greater than 0.125, and 3) one other criterion.

As you can see from the ratios, these portfolios are fairly strict because they have tight requirements for a stock to qualify for inclusion. As a result, in the last 18 months, these proven portfolio systems have come up empty-handed in finding stocks that are selling at a discount to the company's intrinsic value. Therefore, we have been holding a large amount of cash for some time.

Is it possible that the market will continue higher for longer? Absolutely! After all, in the late 1990s the market continued higher – above a PE of 25 – for an amazing three full years until it started declining.

While cash is an acceptable portfolio recommendation for many seasoned value investors, for other subscribers it is not, and many are canceling their subscription. Therefore, this week we are announcing an update that will soon allow us to purchase some undervalued stocks!

We are still going to add some ETF-based portfolios as we have discussed recently, but we will also add value-based stocks to our existing portfolios.



When market conditions are appropriate (and we expect that signal soon), we will purchase new stocks based on a revision to our existing portfolio system. Keep in mind that this is not a complete overhaul of our stock-selection methodology, but a refinement and a slight relaxing of the requirements for a company to 'make the cut.'

We first began developing this revision in early 2015 to address the increasingly expensive nature of the market. This revision to the system identifies stocks trading at an attractive valuation compared to other companies in their industry, sector, and the universe of stocks. It relies more on relative value than on absolute value, but our positions and portfolio are still protected from loss through the use of our Intelligent Market Risk Analysis (IMRA) and quantitative, trend-following sell rules for each individual stock.

The portfolio is not dependent on small-cap stocks to achieve high performance. In fact, the minimum requirements are $8 million in average daily liquidity (share volume x price) and $500 million in market capitalization. As you can see, we are limiting the number of small-cap stocks traded and have completely eliminated micro-cap stocks from consideration. These liquidity requirements should accommodate all of our subscribers without IntelligentValue selections affecting the entry/exit price of our subscriber's stock purchases and sales.

We have tested both the ranking system and portfolio Buy/Sell rules for robustness with dozens of different quantitative workouts to minimize the risk of curve fitting, data snooping, and other biases. These robustness tests include:

1) offsetting the start date by one week for 52 consecutive weeks,
2) offsetting the starting month for 12 months,
3) offsetting the starting year multiple times
4) even/odd stock ID tests (which breaks the stock universe into two distinct halves),
5) eliminating the top 1, 2, 5, 10, and 15 stocks selected,
6) changing primary selection criteria slightly to screen for performance deterioration,
7) variations in the number of stocks in the portfolio, and
8) adding a random selection component to test both the ranking system and portfolio Buy Rules

If any one of these tests degraded the performance by 10%, the cause was determined and eliminated.

The following chart and statistics display the backtest result of this revision using the same period (March 2009-present) used in our existing portfolios, as well as the same trend-following entry/exit dates provided by our IMRA system. For those familiar with quantitative portfolio creation, we took the same important steps to avoid data mining, curve-fitting and other potential out-of-sample (OOS) landmines we discussed above. Here are the results:


IntelligentValue's 'TurboValue' Portfolio Revision Backtest
March 9, 2009-to-Present
Total return: 7,106.22% (S&P 500 = 222.80%)
Annualized return: 77.57%
Max Drawdown: -14.64% (S&P 500 = -19.39%)
Risk Adjusted Return (Sharpe Ratio): 2.13

The TurboValue portfolio revision showed excellent results in this chart of the 2009–2016 backtest.

Notice the very high Sharpe Ratio (2.13) in the bottom line of the stats above. The Sharpe ratio characterizes how well the return of an asset compensates an investor for the risk taken. The higher the number, the better the compensation-to-risk ratio. To put our TubroValue Sharpe ratio of 2.13 in perspective, the Sharpe Ratio of the S&P 500 is 1.0 and the the Sharpe Ratio of the Russell 2000 ETF (IWM) is about 0.68 (because small-cap stocks are generally more volatile). Our current, small-cap Aggressive Portfoio has a Sharpe ratio of 1.50 and our Conservative Portfolio has a Sharpe ratio of 1.45 because each of these portfolios use our IMRA risk-avoidance system. Generally speaking, any Sharpe ratio above 1.0 is considered excellent.

One of the ways we achieve such a high Sharpe ratio is by exiting the market when our Intelligent Market Risk Analysis (IMRA) signals that a bullish trend has concluded. Then, we re-enter the market with a new set of stocks when our IMRA trend-following system signals that risk has subsided. This is not a quick trading system that will make your head spin with endless signals. In the seven years of this backtest, the IMRA system exited and later re-entered the market only four times.

That flatline in the chart from July 2015 to February 2016 is from the signals that the IMRA trend-following system gave us in real time. To see the market call the IMRA gave to exit all stocks on June 28, 2015, you can read our public Value Alert newsletter published on that date. We wrote up our analysis of the market and the IMRA sell signal in that newsletter.


We began using this revision with our own money (i.e., out of sample) when our IMRA market timing system gave a buy signal in January 1, 2016. The results are impressive, as shown by the statistics and chart below:

LIVE STATS since January 1, 2016
Total return: 67.61% (S&P 500 = 17.11%)
Annualized return: 125.62%
Max Drawdown: -7.64% (S&P 500 = -10.64%)
Risk Adjusted Return (Sharpe Ratio): 4.10


IntelligentValue's 'TurboValue' Portfolio Revision
LIVE Chart: January 1, 2016–present

Our TurboValue portfolio revision is performing as expected in this out-of-sample run with live money.

While the return for 2009-present is not as high as our Aggressive (small-cap) Portfolio, remember that this revision only chooses stocks with a market cap above $500 million. There are very few small-cap and no microcap companies included, as a result there is also very little volatility (resulting in that high Sharpe ratio).


While the ' TurboValue' revision to our portfolio trading system would have us fully invested in stocks at this time, our reading of the market is that this is not an appropriate time to enter with new stocks. While not giving an exit signal yet, our IMRA system is saying that the market is overbought and similar to late-June 2015, momentum is waning, and volatility has vanished. You can read the June 28, 2015 newsletter to see what we said about waning momentum and low volatility at that time.

Those are three potentially dangerous characteristics (overbought, waning momentum, and low volatility) that are occurring the same time. Therefore, we will remain on the sidelines at this time and see how conditions develop. This is a judgment call based on 30 years of experience, but if stocks break out of the current trading range, we will reassess the situation will add positions.

We believe there is a high degree of risk right now. There is a great deal of complacency among market participants, particularly about central bank policy. Most investors believe that the Fed has their back, and while still threatening two rate hikes this year, most believe the Fed will support the market with additional easing if there is any significant downturn.

We are now entering the historically dangerous months of September and October. The US presidential election in early November also holds a great deal of risk for market participants, particularly if something surprising occurs. In this very unusual presidential cycle, don't discount the possibility of bizarre, market-shaking events.

Details on this week's portfolio updates are posted in the Member's Area.

We hope that we have competently discussed the issues addressed in this Value Alert, and you can implement these ideas to your benefit.  Our objective is to give you the best value-oriented investment information possible, with ease of use, timely identification of the issues that affect our portfolio positions, and a full understanding of our approach. If you have any questions or comments, please contact us with a support ticket.

Best Wishes for Another Week of Intelligent Value Investing,


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Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the subjects discussed, market environment, company or ETF SEC filings. Investors may wish to consult a qualified investment advisor. The information in this material was obtained from sources believed to be reliable, but were not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. Shareholders, employees, and writers associated with IntelligentValue, Inc. may hold positions in the securities that are discussed. Neither, nor any of its employees or affiliates are responsible for losses you may incur.