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How to Profit From the Pessimism

Superinvestor Sir John Templeton was famously known for saying, "The time of maximum pessimism is the best time to buy." Turns out the guy may have been onto something.

Consider what happened to three major companies -- institutions, really -- during what has arguably been the market's most pessimistic point in nearly 80 years.

  • First up, the health-care behemoth. In 1998, investors were willing to pay as much as 73 times earnings to invest in this company. Since then, earnings per share have grown from $0.73 to $1.56. On top of that, its investors are treated to a juicy dividend of approximately 8% per year. Today you can pick up beaten-down shares of this best-in-breed brand for a paltry 10.5 times earnings. (Don't worry, we'll tell you the company name in just a moment.)
  • Next, let's take a look at the 10-year trajectory of one of the fastest-growing large companies on the planet. Here we have a management team that during the last decade has increased its earnings per share by 223% and grown its revenue more than 700%. Its balance sheet is pristine by any measure. Its management is, quite literally, the best in the business. In 1998, investors ponied up almost 40 times earnings to own a piece. Today, it's trading at less than 15 times earnings.
  • Finally, we have a company that practically mints cash -- producing billions in cash flow with margins north of 80%. In 1998, investors picked up shares at 61 times earnings. Since then, this omnipotent technology entity has increased revenue 400% and earnings per share around 350%. And what thanks it gotten for such performance? Not a whole lot, lately, considering investors are only willing to shell out 11 times earnings for a cut of the action.

Opportunity drops
We won't keep you in suspense any longer. The first company is none other than Pfizer (NYSE: PFE  ) . The second is run by a couple of guys whose names may sound familiar: Warren Buffett and Charles Munger, the brains behind Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) . And you've probably used the third company's products at some point -- Microsoft (Nasdaq: MSFT  ) .

Here we have a classic case of the baby being thrown out with the bathwater. That's the thing about maximum pessimism: Often, it's indiscriminate. Most investors perceive investment risks to be highest when stock prices are lowest. The informed and prepared investor sees opportunity.

Have you been brave enough to buy?
Back to Sir John and his sage advice about picking up people's quality "losers" during sharp sell-offs. Of course, keeping a cool head when the heat is on is easier said than done -- a phenomenon that behavioral economists call an "empathy gap."

It turns out that people are horrible at predicting how we'll actually feel or act in real-time. You've probably experienced an "empathy gap" or two -- you say you'll act a certain way during a crisis, but when said crisis occurs, your actions bear little resemblance to your promises.

In the midst of momentous company failures, freezing up of liquidity, and vast de-leveraging by hedge funds have shaken the financial system to its core, most people's empathy gaps are more like empathy fault lines.

John Templeton came up with a brilliant system to stay out of his own way during heat-of-the-moment decision making -- a system that should sound familiar to most Fools: He kept a "wish list."

His great-niece, Lauren C. Templeton, described his process in her book, Investing the Templeton Way:

One way Uncle John used to handle this was to make his buy decisions well before a sell-off occurred. ... During his years managing the Templeton Funds, he always kept a "wish list" of securities representing companies that he believed were well run but priced too high. ... He often had standing orders with his brokers to purchase those wish list stocks if for some reason the market sold off enough to drag down their prices to levels at which he considered them a bargain.

Pre-commit to buying bargains
Of course the money shrinks have a name for this, too: It's called "pre-commitment," and it's a brilliant tactic to neutralize those pesky emotions in our caveman brains.

If you don't already have a watch list, start one. Put down the price you are willing to pay for great companies and review it on a regular basis. That way, the next time butterflies are doing a number on your stomach, you'll have a concrete plan of action that you can actually follow.

For more in our "What Investors Should Be Doing Right Now" Special Report:

Andrew Sullivan, Dan Dzombak, Dayana Yochim, and Wade Michels contributed to this report. Buck Hartzell owns shares of Berkshire. Berkshire, Microsoft, and Pfizer are Motley Fool Inside Value recommendations. Berkshire is also a Stock Advisor pick; Pfizer is also an Income Investor selection. The Fool owns shares of Berkshire and Pfizer. The Motley Fool is investors writing for investors.

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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 November 02, 2008, at 8:15 PM, aikenst wrote:

    Regarding Pfizer, I'm curious about with a new administration about to come to Washington, how will Pfizer be impacted? They have some pretty attractive government programs which may find new scrutiny under any new administration, Democrat, or Republican.

    There has to be some reason everyone seems to hate PFE.

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10/21/2016 4:00 PM
BRK-A $215600.00 Down -1375.00 -0.63%
Berkshire Hathaway… CAPS Rating: *****
BRK-B $143.60 Down -0.89 -0.62%
Berkshire Hathaway… CAPS Rating: *****
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Microsoft CAPS Rating: ****
PFE $32.18 Down -0.36 -1.11%
Pfizer CAPS Rating: ****