2 Incredible Scavenger Stocks for this Market

On first glance, self-storage units seem like unlikely sources of investing wisdom. But cobwebbed concrete bunkers full of yesterday's junk can actually teach us a lot about finding great investments.

Just bear with me
A recent segment of public radio's This American Life documented an unusual cottage industry: the auction of foreclosed storage units. Each eight-by-ten space up for grabs most often houses junk. But sometimes, bidders can score untold treasure for a fraction of its value.

If bidders were allowed the opportunity to comb the unit's contents, bidding might be a fairly rational, efficient process. But they can't. They stand behind a line, crane their necks at what they can see, hypothesize over what valuable contents the spaces contain, and bid. It's an exercise in the unknown, as the segment's author, New York Times Magazine columnist John Mooallem, put it.

Sound familiar?
This bidding game, an elaborate probability ring with largely unknown odds, is no different from investing. Quarterly earnings reports, news blips, and flashes of economic data whir about the markets on a daily basis. They may give us cues to a company's true worth, but they don't tell the full story.

As investors, we're forced to make educated guesses on what we can see -- putting odds on the unknown. Our success, or lack thereof, depends upon developing a rational, calibrated process for filtering these nuggets.

The fallacy of logic
Most of the storage-unit scavengers start with a coherent strategy. They comb over the space with Maglites, punching the keys of a mental calculator -- the rational part of the equation. But racing minds and the fantasy of a big score interfere, and the right brain takes hold. What starts as a mostly rational process soon gets hijacked by the brain's penchant for dreaming.

Investors, you've seen this before: It's what famed economist John Maynard Keynes called "castles in the air" -- the very genesis of bubbles.

In search of the next big score, investors apply rules of thumb, seek confirming evidence, extrapolate wildly optimistic projections, and dramatically overvalue stocks in the process. How about a few more jogs down memory lane?

Company

% decline from highs

Tale of the tape

Pacific Ethanol (Nasdaq: PEIX  )

98%

Turns out, corn-based ethanol might not be the solution to our nation's—or the world's—energy woes. Even if it is, Pacific Ethanol was not the way to play. Enthusiasm bid the shares up, and when margins collapsed, the debt burden associated with new capacity builds crushed them.
Sirius XM (Nasdaq: SIRI  )

97%

Cool product, innovative idea, and a monopoly position on the satellite radio market. Alas, a monopoly in satellite radio is worth as much a monopoly in landline phones -- at the dawn of cellular era.

Avoiding the tempestuous lure of castles requires us to shun sexier, more speculative fare.

Here, it pays to remember that investing is a probability game. In a portfolio where a single hugely winning investment accompanies 10 stomach-churning losers, the odds suggest that you're not coming out ahead. Unfortunately, for every Amazon-esque success story, there are a thousand failed impostors.

So if we can't give rein to our wildest dreams, what strategies will help us find good investments?

Don't lose money
For investors, the solution is clear: Stack the odds in your favor, and buy what you can see. That doesn't mean sacrificing your upside. As hedge fund manager extraordinaire John Paulson's mentor said: "Watch the downside; the upside will take of itself." At Motley Fool Special Ops, where I'm senior analyst, we're obsessed with making good bets.

Here's one example. On first glance, there's no reason to invest in Hilltop Holdings (NYSE: HTH  ) . It's basically a holding company with a heap of cash, and its shares trade at roughly the value of those cash holdings.

So why did we invest? Hilltop's chairman is Gerald Ford, a legendary bank investor. Ford made a fortune buying distressed banks during the S&L crisis, alongside famed investor Ron Perelman. So as Hilltop trades at roughly the value of its cash, our downside is virtually nil: Hilltop consistently operates at breakeven. But our upside is mammoth: Bank failures are happening at an historic rate, and if the right opportunity comes his way, Ford could mint profits.

Simply put, we bought what we could see: The cash. The odds of us losing a lot of money are infinitesimally small, and the upside potential tremendous. At Special Ops, we seek precisely those types of bets. Here are two similar opportunities:

TheStreet.com (Nasdaq: TST  )
Shares trade just north of the value of its cash and investments. Near-term results haven't been pretty, but even at the credit crisis's nadir, TheStreet never burned cash. In better times, TheStreet has made good money, and the economics of its subscription newsletter biz are pretty compelling, if well-run. And newly installed management seems intent on just such steady operations.

TomoTherapy (Nasdaq: TOMO  )
Tomo's a small fry in a big market: Radiation therapy. It has no history of profitability, and competitor Varian (NYSE: VAR  ) dominates the market. But it's sitting on a pretty substantial cash heap, cash burn is minimal, and the shares trade at cash value. If its customer list is indicative, which include the venerable Mayo Clinic, its technology is special. That could presage growth, and at some point, big profits.

The bottom line
Investing -- in stock or storage units—presents two challenges: Making money, and preventing losses. At Motley Fool Special Ops, we focus on both. If that sounds appealing, just enter your email address in the box below for a peak at three premium stock ideas and a personal invite to join Special Ops when we reopen for an extremely limited time later this month. I hope to see you there.

Michael Olsen once kept a storage unit. If foreclosed, it may have given buyers the erroneous impression that a meth addict presided over its organization. He does own shares of TheStreet.com. The Fool owns shares of Hilltop Holdings. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insightsmakes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (13)

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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 February 23, 2011, at 4:02 PM, ThongLover854 wrote:

    Sirius...97% off its' high? Wow...really drawing for straws here aren't you? Gotta get those page hits...

    Sirius is now only up over 3000% off its' lows...ALAS, a monopoly in satellite radio is worth well more than a land line. In fact, coming this year, SiriusXM will reinvent what audio and mobile entertainment is again with the first ever DVR type service for your auto and phone...imagine a "favorites" channel for your favorite music, news, talk radio, sports...and also imagine a hard-drive filled with pre-recorded favorites...you can always start a favorite program at the beginning.

    Sirius is pulling in $3 billion a year...that will be at $4-5 billion sooner than you think. That's a far cry from a "dying service" as your description suggests.

    This is truly a sad use of the SiriusXM customer draw...adding SiriusXM in as comparison is just plain silly...

  • Report this Comment On February 23, 2011, at 4:15 PM, bottomfisherman wrote:

    Bash SIRI get hits, congrats you just got another one.

  • Report this Comment On February 23, 2011, at 5:55 PM, siriuslyrick wrote:

    Interesting contrast to Rick's "3 Stocks That Blew the Market Away" article at MF today. Perhaps we should just ignore the sort of junk we see in this "article," and it might go away. That's the last hit from me on this nonsense.

  • Report this Comment On February 23, 2011, at 5:56 PM, DNAstock wrote:

    Michael, Michael, Michael. You need to do your homework on SIRI before you start making foolish (in the literal sense) comments about it's prospects.

    You've blown any credibility you might have had.

  • Report this Comment On February 23, 2011, at 11:41 PM, sob1313 wrote:

    As for peix, ethanol is already in the pipeline. Demand for gas is only going to increase going forward, which makes ethanol of any kind a more valuable commodity. Peix is a totally different business structure than it was when they started. Now they are an ethanol marketing company that provides management services and personnel to man the plants. They are basically free agents who have a foot-hold in an industry that is in it's infancy. If they can hang on, and that is the million dollar question, they could see a big swing the other way. Time will tell, it always does...

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