I Will Tell You How to Become Rich

"Be fearful when others are greedy, and greedy when others are fearful."

Warren Buffett gave that timeless advice in his 20s while getting his MBA at Columbia, and he's gone on to do very well with it. He avoided the tech-stock bubble of the late '90s, when everyone and their brother got greedy. And in this past downturn, he was able to snap up preferred shares of Goldman Sachs and GE on the cheap while other large investors ran for the hills.

What are investors greedy for now?
Three areas of the stock market have the majority of investors salivating at present:

  1. Tech stocks. This sector holds many examples of bloated valuations. Chinese search giant Baidu (Nasdaq: BIDU  ) trades for an extraordinary 93 times trailing earnings! While I think the company is unbeatable, I worry about its valuation as an investment.
  2. Dividend stocks. With interest rates low, people are clamoring for anything with high yields. Stocks such as Chimera (NYSE: CIM  ) and Annaly (NYSE: NLY  ) now have a fanatical following. While I've seen the case made for why they could be good investments, I still worry. When people are this greedy, disaster's usually not far off. My colleague Matt Koppenheffer believes dividend investing is a fad, but I'd say a more worrisome fad is...
  3. Bonds. Investors are greedy for safety. They're worried about volatility and the markets, and they just want something safe. They couldn't be more wrong. If interest rates rise, they'll be slaughtered as bond prices fall. In fact, fellow fool Amanda Kish is wondering whether the bond bubble just popped. Intelligent investors should be fearful of the herd's lust for safety.

What do investors fear most now?
The best investment opportunities arise when investors are scared. Europe, especially Ireland, seems to top investors' list of phobias today. That said, Fools should tread carefully here, since Ireland has some serious issues with its economy.

I recommend that interested investors look at Ryanair (Nasdaq: RYAAY  ) , Europe's leading discount airline. The firm paid its first dividend in October, and it has a great management team led by the outspoken Michael O'Leary.

After learning that competitor Aer Lingus had turned down a lowball bid from Ryanair for the company, O'Leary said, "It is doubtful that Ryanair will waste any further management time or resources making another offer for Aer Lingus, as its scale and losses will continue to render it increasingly irrelevant in Europe's airline landscape." That's a relatively mild comment, as far as statements from the outspoken CEO go, but it shows O'Leary's commitment to running his company with his own maverick style.

A world of uncertainty
A strange situation arises when investors are both greedy and fearful, as penny stocks can demonstrate. These equities are tiny for good reason -- feared because the companies behind them usually have a real chance of going out of business. Since they are priced so low, though, people's greed sometimes gets the best of them, and many investors decide to purchase "a lottery ticket."

Every now and then, this gamble pays off. Folks who bought Sirius XM (Nasdaq: SIRI  ) when it languished between $0.05 and $0.10 a share are sitting pretty now. But the verdict's less clear for YRC Worldwide (Nasdaq: YRCW  ) . While it's no longer a "penny stock" in the traditional sense ,after a 1-for-25 reverse split in October, the company still meets the SEC's definition of a penny stock, which "generally refers to low-priced (below $5), speculative securities."

Be wary! For every Sirius, there are 100 carcasses of dead penny stocks like Ambac, Motors Liquidation (bankrupt GM), and Enron.

"... And invest with a margin of safety"
While Buffett didn't say this last part, "margin of safety" is known as the three most important words in investing. It's a very simple concept. Give your assumptions some breathing room, so if they prove wrong, you don't lose much. If you think a stock is worth $20, for example, and it's trading at $18, that's not much of a margin.

This isn't a hard-and-fast rule. The quality of the business and the brand, the strength of the balance sheet, and the size of its future growth opportunity all affect a stock's margin of safety.

WD-40 (Nasdaq: WDFC  ) is one quality business that many investors often overlook. Everyone knows WD-40; you probably have it on a shelf in your garage or under your sink right now. Here are three reasons why I like it:

  1. Its products are basically the same as the competition's, but its strong brand allows it to charge more for comparable products, earning high returns on equity.
  2. It's a very dependable business. WD-40 has a place in Americans' minds as being dependable and cheap. This is reflected in WD-40's 80% share of the U.S. consumer oil & lubricants market.
  3.  The balance sheet is rock solid. WD-40 has been paying down debt since 2002, leaving nearly none left. Once the debt is gone, the business will be able to reinvest the extra cash or increase its dividend, which currently stands at a healthy 2.7% yield.

While I believe WD-40 has a real margin of safety in its brand, intelligent investors demand more options for their hard-earned investing dollars. Thousands have requested access to a special report created by Motley Fool analysts; you can download it today at no cost. In this report, Fool analysts cover several outstanding companies The Motley Fool owns, including the stock Fool analyst Morgan Housel calls "probably the world's greatest investment." To get instant access to the names, click here – it's free.

Dan Dzombak recommends you read The Best Investment Advice You Will Ever Get. He does not own shares in any of the companies mentioned. His musings and articles he finds interesting can be found on his Twitter account: @DanDzombak. Baidu is a Motley Fool Rule Breakers choice. The Fool owns shares of Annaly Capital Management.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (16) | Recommend This Article (101)

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 December 06, 2010, at 3:55 PM, brickcityman wrote:

    Good article,

    would you mind commenting on this blog post?

    http://caps.fool.com/Blogs/question-to-tmf-staff-writers/484...

  • Report this Comment On December 06, 2010, at 4:00 PM, marcjones281 wrote:

    Michael O'Leary is absurd

    Good profile here:

    http://www.flightglobal.com/articles/2009/12/22/336477/profi...

    Favorite quote of his:

    ‘If someone wanted to pay £5 to go to the toilet I would carry them myself. I would wipe their bums for a fiver’. (2009)

    And favorite quote on the business:

    ‘Our strategy is like Wal-Mart: We pile it high and sell it cheap’. (1994)

  • Report this Comment On December 06, 2010, at 5:34 PM, ThriveCounseling wrote:

    Whenever I read articles like this, my first thought is "How old and stale this advice is" --it's like the golden rule of investing. However, this advice needs to be heard over and over. As a therapist running a counseling practice in Cambridge MA, I see first hand how difficult it is to follow this advice (some of the spartest people in the country struggle with this concept!). Probably even more articles need to be written on "how to have courage when others are afraid" and "how to be a negative nancy when everyone else is happy." --I think the latter would be esp. funny. Thanks for reading my comment! http://thriveworks.com

  • Report this Comment On December 06, 2010, at 8:03 PM, MichaelHamilton wrote:

    WD40 has had zero sales growth over the last few years and is on a high P/E. It is already paying out 50% of earnings in dividend so there is not great scope for dividend increases. There are far better opportunities in the market at this time.

  • Report this Comment On December 06, 2010, at 8:29 PM, Mstinterestinman wrote:

    Great Advice and the man is one of my heroes.

    also WD-40 is a good company but if you take a look at my portfolio you'll get some ideas for much better ones ;)

  • Report this Comment On December 06, 2010, at 10:04 PM, TMFDanDzombak wrote:

    @Mstinterestinman thanks

  • Report this Comment On December 06, 2010, at 10:04 PM, TMFDanDzombak wrote:

    @MichaelHamilton such as?

  • Report this Comment On December 06, 2010, at 10:05 PM, TMFDanDzombak wrote:

    @ThriveCounseling This is definitely one that doesn't get driven home enough.

  • Report this Comment On December 06, 2010, at 10:05 PM, TMFDanDzombak wrote:

    @marcjones281 Thanks for the links

  • Report this Comment On December 06, 2010, at 10:05 PM, TMFDanDzombak wrote:

    @brickcityman sure

  • Report this Comment On December 06, 2010, at 10:46 PM, TMT33 wrote:

    I don't understand the point re NLY. If it was as popular as you suggest, the yield would be much lower. I think the reason the yield is so high is people are avoiding it.

  • Report this Comment On December 07, 2010, at 1:29 AM, 11x wrote:

    I agree on the concept of buying a stock like WD 40. It's simple, easy to understand, etc, all the things you mention. however, I don't think management excels at creating shareholder wealth. I would prefer Clorox over WD40.

  • Report this Comment On December 07, 2010, at 10:05 AM, TMFDanDzombak wrote:

    @11x Thanks

  • Report this Comment On December 07, 2010, at 10:05 AM, TMFDanDzombak wrote:

    @TMT33 I can assure you, as one of the editors, that the followers of the high-yield dividend stocks are fanatic.

  • Report this Comment On December 07, 2010, at 12:23 PM, chiefjoseph16 wrote:

    I disagree on this article. Sure the fed will eventually increase interest rates, There are key indicators that will show when that rise will likely happen. One of those being the U.S. debt being substantially high. Until the debt is under control, I wont expect that it will be crashing.

    I also disagree with the quote be greedy when others are fearful and be fearful when others are greedy.

  • Report this Comment On December 08, 2010, at 10:48 AM, TMFDanDzombak wrote:

    @chiefjoseph16 Why do you disagree with the quote?

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