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The Next Black Monday

Three of the five best days the Dow Jones Industrial Average has ever experienced occurred in one 10-day stretch in 1987: Oct. 20 (up 5.88%), Oct. 21 (up 10.15%), and Oct. 29 (up 4.96%).

But that was not a great week for investors. It came in the wake of Black Monday -- Oct. 19, 1987, the single worst day in the Dow's history -- when, by 4 p.m. ET, the market became $500 billion less valuable. The Dow dropped 22.61% that day and followed it up a week later with an 8% drop -- the second-largest single-day drop in history.

When the dust settled, the biggest of big names had taken a bath. PepsiCo (NYSE: PEP  ) , Wells Fargo (NYSE: WFC  ) , and Abbott Labs (NYSE: ABT  ) each lost 15% or more of their value that month.

We bring this up because the investing landscape today is strikingly reminiscent of those days. The term bubble was omnipresent. Corrections have been predicted, followed by opposing bullish predictions driven by fundamentals. In fact, last week actually looked a lot like 1987's Black Monday week, but with some government bailouts, a ban on short-sellers, and the end of investment banking as we know it all mixed in. Depending on your source, it's either the greatest time to buy or the greatest time to sell that anyone can remember.

Bring on Black Monday?
So, what's it all mean? Full disclosure: We're not sure it's possible to make much sense out of conflicting short-term signals.

But whether next Monday will be another "black" trading day or one of the best in history, there are only three things that matter when it comes to investing successfully:

  1. The quality of the companies you buy.
  2. The price you pay for them.
  3. The length of time you own them.

For those reasons, patient long-term investors should be hoping the market gets even worse from here more so than for hitting on the next Google or whatever.

Say what?
Let's face facts: There will be but a handful of the next great growth stocks, and the odds of picking one are ... not good. But when events like last week's hit, hundreds of quality companies become available at prices that virtually ensure success for long-term-minded investors.

That's what history has taught us. As Wharton professor Jeremy Siegel wrote, there is one reason Standard Oil was a better investment than IBM, despite IBM's superior growth: "valuation, the price you pay for the earnings and dividends you receive."

The most expensive book ever written
The Internet bubble was another painful reminder of that lesson. Our research showed that if you took a stake in every stock highlighted in Greg Kyle's 100 Best Internet Stocks to Own when it was published in the spring of 2000, and you held those stakes through October 2007, you'd have lost 62% of your capital.

For a book that cost about $15, that hurts., F5 Networks (Nasdaq: FFIV  ) , and 11 other companies simply earned a positive return, but 18 companies on that list went entirely bankrupt.

The culprits? Quality and valuation. Many were poorly run and profitless companies that were nonetheless selling at stratospheric levels. Consider that even well-run tech companies such as Dell (Nasdaq: DELL  ) , Intel (Nasdaq: INTC  ) , and Infosys Technologies (Nasdaq: INFY  ) disappointed shareholders because they were simply priced too aggressively. (We should note that Dell, Intel, and Infosys were not included in Kyle's book.)

And that's the irony of the chase: You're far more likely to find the next big bust than the next big thing.

But that was eight years ago, at the height of the "tech bubble." It's got nothing to do with today. Right?

Look at a 50-year chart, and you'll see that the Dow and S&P 500 are near all-time highs, despite the recent market sell-off. Regardless of the market environment, remember, three things matter for a successful investment plan:

  1. The quality of the companies you buy.
  2. The price you pay for them.
  3. The length of time you own them.

If you insist on buying quality companies at good prices for the long term, you're setting yourself up for success.

We're not trying to make successful investing sound easy. It's not. But it is possible for anyone willing to devote some time, effort, and resources to building a brighter financial future.

At Motley Fool Stock Advisor, Fool co-founders David and Tom Gardner have a stellar track record of recommending quality businesses at good prices. Their stock recommendations are beating the market by more than 46 percentage points on average since 2002.

You can see their five favorite stocks for new money now, as well as all past stock ideas and research, free with a 30-day guest pass. There is no obligation to subscribe, but we're confident that the service can help make you a better investor.

This article was first published Oct. 19, 2007. It has been updated.

Neither Tim Hanson nor Brian Richards owns shares of any companies mentioned. Both Tim and Brian wear plaid on the outside, 'cause plaid is how they feel on the inside. Amazon is a Stock Advisor recommendation. Intel and Dell are Inside Value picks. Google is a Rule Breakers selection. The Fool's disclosure policy is writing checks its body can't cash.

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