Fear Can Be Your Friend

These are frightening times.

The Dow Jones Industrial Average recently made official what has seemed inevitable for a while -- we're in "bear market" territory now that the Dow is off more than 20% from its most recent highs.

Inflation is hurting. Gas has climbed ever higher. Credit is harder to come by. Uncertainty abounds, for both consumers and investors.

But here's why I'm allowing fear to be my friend: Some of the greatest investors in history have proven that scary times set the stage for the best price opportunities for long-term investors. A sampling:

  • "Buy when the blood is running in the streets." (Baron Rothschild)
  • "Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it." (Warren Buffett)
  • "Mr. Market needs some serious mood-stabilizing medications most of the time." (Benjamin Graham -- but OK, I took some serious artistic license with that one)

They're running
The fear factor has hit stocks far and wide. From high-end consumer goods to technology, from financial services firms to toy makers, there's a lot of pain out there -- and investors have responded by taking their money out of equity funds, which are down more than $15 billion since the beginning of the year.

But now is no time to stuff your mattresses with cash instead of stuffing that cash into stocks.

Here are just a few examples of stocks that have gotten stomped recently:

Company

Percent Drop From 52-Week High

P/E

PEG Ratio

Bare Escentuals (Nasdaq: BARE  )

(53.1)

16

0.55

Coach (NYSE: COH  )

(47.4)

13

0.72

Jakks Pacific (Nasdaq: JAKK  )

(32.8)

8

0.71

Rick's Cabaret (Nasdaq: RICK  )

(44.7)

19

N/A

Skechers USA (NYSE: SKX  )

(35.1)

11

0.63

 *Data from Motley Fool CAPS and Yahoo! Finance as of July 10, 2008.

You're shopping
When it comes to those stocks, clearly, blood is running in the streets these days.

Of course, no great long-term investor would buy beaten-down stocks indiscriminately. When it comes to stocks, discriminating is always a smart thing to do. Although many stocks look incredibly cheap, there are many I'm just not interested in.

By way of an example, General Motors (NYSE: GM  ) recently hit a low unseen since the mid-1950s. Still, given its reliance on trucks and SUVs and rumored liquidity concerns, not to mention my own lack of confidence that it can innovate, there aren't enough airbags to make that a safe vehicle for my money.

And financials, where blood has been in the streets since last year? Thanks, but no thanks. Given the current credit crisis and my suspicion that there's a lot left to shake out for the financial firms, right now I wouldn't touch a stock like Citigroup (NYSE: C  ) with a 10-foot pole.

Instead, I'm looking around for innovative companies that have been beaten down and have little or no debt. From the table above, Coach looks like an incredible bargain to me. It's not often that you'll find a high-quality brand like Coach trading at just 15 times earnings with a PEG ratio under 1.0, but that's the nature of the current economic beast.

As investing guru Mason Hawkins of Longleaf Partners recently wrote to shareholders:

Successful investors must endure the short-term vagaries of market declines to be positioned well for the long term and to minimize transactional costs and taxes where relevant. Really good investors also arm themselves with conservative appraisals and use periods of weakness to buy more of their qualifiers when discounts to appraisal increase, i.e., when the margin of safety of value over price widens.

Do you want to be a "really good investor"? Then take a page from the pros and let fear present you with a good opportunity to buy shares of great companies -- for a bargain.

Their fear = your BFF
OK, so maybe fear in general isn't your "BFF" (best friend forever!), but when fear drops the stock prices on great companies, you've got a golden opportunity to buy. Just take it from Buffett, Rothschild, Hawkins, et al.

If you're not sure which on-sale stocks are the strongest for the long haul, Motley Fool Stock Advisor has some great long-term investment strategies to help you pick. Its recommendations have beaten the S&P 500 by an average of nearly 37 percentage points since the newsletter's inception in 2002. A 30-day free trial will give you all of our past and present recommendations, as well as our best bets for new money now. Click here to get started -- there's no obligation to buy.

Alyce Lomax does not own shares of any of the companies mentioned. Coach is a Stock Advisor recommendation. The Fool's disclosure policy doesn't fear the reaper.  


Read/Post Comments (3) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 10, 2008, at 11:00 PM, geojak wrote:

    Alyce: your advice in your artical about fear seems sound and time tested, and very akin to the adage, "buy low, sell high". And how do you know when you're buying low? Because it's lower than it used to be right? And price averaging helps.

    However I'm left a little curious by a little economic circuitus thought on the topic. Per my understanding, much of today's market is driven by large investment houses that often reap huge profits and employ people to beat the averages. Of course they're all people too and they secomb to group psycology too. SO, is there a reason the Institutional investment firms not buying in mass when the prices go down? Perhaps that's why it seems like the bear market in recent years never stays down too long. The investment houses can't resist the opportunity to buy on sale and ride the wave? So is it just a matter that us little investors have to be a little more agile and get in on the little corrections like the one at present, and then hope that it's not the beginning of the great depression or some other fundemental paradigm change? I guess that's price averaging by spreading out your purchases comes in again right.

    Do you have some further thoughts on this if you follow?

    Cheers, GeoJak

  • Report this Comment On July 12, 2008, at 10:23 PM, IBleedConcrete wrote:

    Geojak: Many money managers would love to plow money into the market right now but they are forced to deleverage and sell instead. If a person buys a house and then their wages are cut, they may need to sell the house at a loss. Similarly, investment banks borrowed so much money when the market was strong that they aren't able to pay interest on their current debt.

  • Report this Comment On July 13, 2008, at 8:41 PM, vandeelen wrote:

    Just because there is fear in the market doesn't mean we've made a low. There hasn't been enough fear for a selling climax.

    And even so, there are a lot of factors weighing in making this a very bad economy. Not only is oil acting like a wrecking ball on economic activity, but it is pushing up inflation, which will push up interest rates, which will lead to even fewer mortgages, etc.

    Considering that 2/3 of the US economy is consumer driven, and the biggest losers in this scenario are the consumers, I would say worse is yet to come. Wait until makers of consumer products have been hit, before starting to look for a bottom in the market.

    Until then, I'm overall short the market. See ya at Dow 6,000. :) If there's an attack on Iran, all bets are off.

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