2 Words That Will Crush Wall Street Over the Next 20 Years

Over the past two years, I've been developing a plan to beat Wall Street's unexceptional performance. Today, I unveil it.

As a Motley Fool employee, I have two pretty fantastic perks:

  1. I get 100% free access to The Motley Fool's annual subscription services, of which I get to pick and choose the best ideas from a plethora of outstanding sources.
  2. I have unparalleled access to future legends, such as Costco CEO Jim Sinegal and Liar's Poker author Michael Lewis, in addition to many others.

Two years ago, one of these future legends came to speak at Fool HQ. His name: Jack Fockler. His occupation: managing director and vice president at The Royce Funds, a highly Foolish small-cap value firm. In his talk, Fockler mentioned two simple words that I've been contemplating for the past 24 months, and I'm now ready to take action on them. We've all heard these words hundreds of times in our lifetime, but rarely in the same sentence.

In retrospect, it's so unquestionably logical to invest in this manner, but I've only recently put it together. I'm excited to share it with you. The bigwigs on Wall Street will never see us coming.

Those two words? Time arbitrage.

What it means
Arbitrage -- buying in one market and selling in another for a higher price -- is usually used in an investing context with regard to currency, interest rates, share class, or merger price discrepancy opportunities.

The concept of arbitrage in investing sounds great. With perfect execution, investors could literally generate risk-free profits by buying and immediately selling a security in a different market.

It's our time
If arbitrage is buying in one market and selling in another, then time arbitrage is the concept of buying a stock from those with a different time horizon, and selling on our own terms.

I am a strong believer in very long-term investing, which means my time horizon is enormous. I don't mind being wrong for two years as long as I'm right on the 20th year, which is how I now think about my investments.

In fact, I welcome it. Please, Wall Street! Sell off a great company because it missed your quarterly estimates or because some whiz kid analyst thinks the sector is out of favor. You need to window dress the next quarter, I need to fund my retirement in 20 years. I certainly like my odds, regardless of what you choose to do in the short term.

When it doesn't work
Simply buying a beaten-down stock and holding for a long time period is not enough. There are certainly some horrible companies out there that you should never buy, regardless of your time horizon. Typically, these are companies whose fundamental business has been disrupted or they've taken on insurmountable debt. Stay away from these value traps. Don't buy and hold them with even a glimmer of hope that they might appreciate.

Long-term stock picks
Now that you know how I think about the timeframe of my investments, let's dig into some beaten-down stocks to look for time arbitrage opportunities (and avoid the potential value traps).

Company

1-Year Price Change (%)

ATP Oil & Gas (Nasdaq: ATPG  ) -29.2
YRC Worldwide (Nasdaq: YRCWD  ) -95.5
Nucor (NYSE: NUE  ) -17.8
NVIDIA (Nasdaq: NVDA  ) -17.9

Trucker YRC Worldwide is significantly down from its 52-week high thanks to its massive debt load, which creates a very real chance of bankruptcy. There has been some bright news for the company, but if you apply the question "Has the outlook for the company changed?" the answer is most assuredly "No." For me, that indicates I should keep my long-term cash far away.

Deepwater driller ATP Oil & Gas has also been beaten down, but I think there's opportunity here. Fellow Fool Toby Shute agrees, making ATP his top stock pick of 2010. Of course, a lot has changed since Toby's original recommendation, including the infamous BP (NYSE: BP  ) and Transocean (NYSE: RIG  ) Deepwater Horizon disaster, and the resulting imposition, then lifting, of a moratorium on deepwater drilling. With the recent monetization of the massive (and expensive) ATP Titan floating production facility, I would feel comfortable taking a long-term position in ATP.

For my two favorite stock picks, let's return to Motley Fool perk No. 1 from above. As a Motley Fool employee, I get to freely browse around our paid services and special reports. I'm proud to share two of my favorite ideas from these services.

First up is NVIDIA, a pick made by Fool co-founder David Gardner in Motley Fool Stock Advisor. Given that his average pick is up more than 100% since 2002, I generally listen when he makes a recommendation, especially when the stock is down and his thesis still holds. David strongly believes in NVIDIA's long-term prospects in both high-performance graphics and mobile devices. Fears about NVIDIA's ceding the low-end market are a mere distraction over the long term, which makes it a perfect time arbitrage opportunity.

Since Fool.com readers have been increasingly interested in dividend stocks, I carefully examined our market-beating service Motley Fool Stock Advisor to find the best beaten-down dividend stock in our universe.

After much debate, I settled on Nucor. I believe Wall Street's shortsightedness is overlooking this leading U.S. steelmaker. Over the past 12 months, the stock is down 13% versus the S&P's 8% gains.

I am confident of a time arbitrage opportunity here. At the beginning of 2010, the U.S. steel industry was operating at a mere 60% of its capacity. Nucor's stock was beaten down as a result, while its competitor United States Steel (NYSE: X  ) has been relatively flat. It may make sense to sell Nucor if your time horizon is one year, but it makes no sense whatsoever if you believe steel will be an important part of U.S. construction in the long term. It also makes no sense to sell Nucor when you consider it has increased its dividend by an average 26.2% per year over the past 10 years, delivering compounded annual total returns of 21.3% to shareholders.

Add in the fact that Nucor has a rock-solid balance sheet, and you'll realize it has what it takes to survive the short term and prosper on the other side. If your timeline is more than five years you should not miss this opportunity by any means.

Want to share in my perk No. 1 to search for other time arbitrage opportunities? Click here to get immediate and free access to 13 High-Yielding Stocks to Buy Today. In it, we recommend the one dividend stock for the rest of your lifetime, as well as 12 other great companies. In addition to Nucor, I will be stalking all of these companies for time arbitrage opportunities for my personal portfolio.

Jeremy Phillips owns shares of NVIDIA, but none of the other companies mentioned in this article.

Costco Wholesale is a Motley Fool Inside Value recommendation. Costco Wholesale, Nucor, and NVIDIA are Motley Fool Stock Advisor selections. The Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


Read/Post Comments (22) | Recommend This Article (146)

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 October 21, 2010, at 4:36 PM, mm199691 wrote:

    Excellent article that I wish had been written and read yesterday. Nucor went below my 20% loss tolerance this morning and I promptly sold. At least it was in a tax deferred account. So for a $20 round trip in fees, I could just buy back. My eyes are on you ... Nucor. Mr. Phillips, I do believe that you are right.

  • Report this Comment On October 21, 2010, at 6:38 PM, PositiveMojo wrote:

    Jeremy, I respect your strategy but it's not my cup of tea. The reason I invest in the market is to make money. Nucor is a sleeper while Netflix soared almost 20 points in the past few days. Your assumption is that if you buy Nucor then in 20 years it is going to have a significantly higher value. That seems to be eerily similar to the thinking that houses don't go down in value - oops for that thinking!

    The economy of the world is rapidly changing and so are the rules of investing. The pressure on companies like Nucor from China, India, etc. are causing dramatic shifts. I believe that the only answer is to invest in well managed companies and watch your investment. A competent investor must become educated in many of the new sophisticated tools, like ThinkOrSwim from TDAmeritrade. Failure to do so is likely to get your head taken off.

    As far as Nucor being a buy or a sell. If you do a technical analysis - it has been oscillating between $37 and $40 since the beginning of July. During the past 6 trading days people have been dumping the stock and the price pressure for today is down. It is a struggling stock and I think there are dozens of better places to put your money. Especially when I have to take a risk for a 3 point shift - why do I want to subject myself to such pain?

    Like I said - I respect your strategy - but I respectfully disagree. But thanks for the article!

  • Report this Comment On October 21, 2010, at 7:19 PM, polenium wrote:

    I like this concept.

    However if you have a really long timeline, then I don't think deep water drilling stocks and BP are good picks.

    Carbon based energy is the future and unless you have unlimited shorelines to destroy neither is deep walter drilling.

    Betting against the best interests of the majority isn't foolish.

  • Report this Comment On October 21, 2010, at 8:32 PM, StockPicker500 wrote:

    Nice article!

  • Report this Comment On October 21, 2010, at 9:16 PM, prginww wrote:

    Just checked nucor at tdameritrade and there is a reason it isn't doing much--the numbers are not good. astronomical PE,no visible PEG, low returns on equity, assets and investment, decent EPS recently, but not in trailing quarter, decent mrq revenue growth, poor trailing. gross, operating and net profit margins poor, price to book not bad, and price to sales below 1. All in all, nucor needs work, and an upturn in the economy.

    But then so does the USA. Soon we will all be knockin on heaven's door. Why isn't the govt heavily invested in innovation, why is the debt near 60 trilliion bucks, where did all the jobs go when all the major industries deserted our shores, and who let that happen, not the workers I'd imagine.

    WTF???

  • Report this Comment On October 21, 2010, at 11:44 PM, Mstinterestinman wrote:

    Steel is a tough place but Nucor is easily the best of the steel companies. They give a very nice dividend and they do a good job of conserving cash for when a down turn could come. With almost 6 dollars a share in cash the dividend is quite safe. You get 3.5% per year guarateed to patiently wait for steel production to improve. I own a couple non dividend payers I believe could be lightning in a bottle but nothing wrong with having guaranteed cash flow in my pocket 20 years from now from my KO and NUE holdings.

  • Report this Comment On October 22, 2010, at 2:13 AM, AirForceFool wrote:

    polenium,

    Did you mean to say carbon based energy "isn't" the future? If you did, I'm going to have to disagree... don't get me wrong... I would love for look across the plains and see thousands of wind turbines, and across the desert and see solar panels for as far as the eyes could see... and we may get there... but does anyone think this is going to be in the next 10 years? 20 years? I daresay we're looking at a longer timeframe then that... unfortunately... we're going to keep deep water drilling because Americans will flip if they have to pay $5 a gallon for gas... let alone the $8 or $10 some countries are paying.... people will vote for change very easily... until if affects them... then it's a different story... I agree that BP isn't a good buy, but then the article doesn't pick BP as a place to put money... way to much risk... I do have to say that I have about 10% of my portfolio, so I am a bit jaded... Ethanol... total flop... took more money and energy to produce than you get out of it... sheesh... so unless we want to pay taxes to subsidize forever... I'm not against government (and by extension myself) helping to fund projects that can become self sustaining... heck, I think we should be ramped up to eleven by now on a scale from one to ten...

    Heck, throw out some tax credits to make it cost effective, and I'll build my retirement house on solar, and sell the extra power back to the power company... but the fact is that the U.S. produces 9% of the world's oil... a third of that off shore.

    Using numbers from a decade ago

    (http://www.corrosioncost.com/pdf/petro.pdf), we use twice the oil as nat gas or coal... don't even get me started on our coal reserves... and four times the nuclear energy... when was the last time a nuclear plant came online? 1996 if anyone was wondering... so if nuclear is part of the solution, we're sure moving slowly.

    Chris

    I'll vote for alternative energies that make sense, and make cents on oil in the meantime.

    Didn't mean for this to be an energy rant... just my humble opinion... which when combined with 50 cents will get you a Mt Dew....

    against the best interests of the majority isn't foolish

  • Report this Comment On October 22, 2010, at 2:15 AM, AirForceFool wrote:

    Forgot to mention great article... I was stoked to hear that the two words WEREN'T....

    cloud computing... that alone was enough for me to rec....

  • Report this Comment On October 22, 2010, at 10:41 AM, BioBat wrote:

    jimfromarabia,

    the PE on nucor is awful because the economy completely shutdown last year and its earnings were terrible like many other companies that have cyclical supply and demand. The ridiculous PE then throws off the PEG ratio. Looking at the quarterly revenue growth (year over year) of nearly 70% hammers that point home.

    Nucor is the best in the industry that's been heavily affected by the recession. I guess if you think this will drag on for years, it's a bad place to put your money but if you think that supply will pick up in the not too distant future, then Nucor is a promising investment.

    As for the other talk about moving away from a carbon fuel source. Sure, it's a nice pie in the sky dream but it's something that's been talked about exhaustively since the late 60s and here we are 50 years later still as addicted to oil as ever and I can pretty much guarantee that it's not going to stop until every last drop is sucked out of the earth - oil companies will make you oodles of money.

    That said, I like Nvidia of the companies listed above. It's been beat down relentlessly in the past year and essentially has a monopoly on high end graphics chips - chips that are going to be integrated into every TV, cell phone, and computer going forward.

  • Report this Comment On October 22, 2010, at 12:06 PM, akbarcaskey678 wrote:

    Great article, but I think YRCW is worth a second look. Its a massive risk, but as a 20 year old investor, Ill take it because I doubt the chance of a double dip recession. As long as the ecnomy continues to imporve YRCW will see an increase in revenue due to strong demand of shipments. Like Fedex and Cummins, YRCW will benefit from all types of demand

  • Report this Comment On October 22, 2010, at 2:49 PM, goalie37 wrote:

    Awesome article. I too have a decades long time horizon, but I don't think I've ever read anything where the writer held the same frame of mind. Fool on!

  • Report this Comment On October 23, 2010, at 10:29 PM, Piddlepuppy wrote:

    Nucor has rolling mills that are state of the art, last time I checked. They turn scrap metal into steel. Right now, scrap metal is piling up, I can buy square tubing for 25 cents a pound and my local scrap dealer! I should pay that per inch. They became number one because of the nice equipment, they will continue to grow. I may buy some calls.

  • Report this Comment On October 26, 2010, at 2:56 AM, easyavenue wrote:

    Exactly how is time arbitrage different from Mr. Graham's value investing? Buy temporarily undervalued stocks and hold them long term. I like your article, but I don't think you've got a new idea. Just a new name for an old idea that has already proven its worth.

  • Report this Comment On October 26, 2010, at 9:07 AM, TMFMoby wrote:

    easyavenue - I agree. The idea is very similar in execution. It's more of a mindset than anything. For me, it's a reminder that when a stock I still like is selling off, I'm simply buying from folks with shorter timeframes. That helps me get over the "they must be selling for a reason" mental wall.

    Foolishly,

    Jeremy

  • Report this Comment On October 28, 2010, at 3:24 PM, ikkyu2 wrote:

    I love the guy who said he enjoyed your article and then started talking about technical analysis of Nucor. Talk about missing the point!

    If you are a true long-term buy and hold investor - horizon 5+ years, maybe 20 years - all you really need is a good investable thesis, combined with something - an idea, a rule, a benchmark - to talk you out of hysterical sell-low behavior when you get cold feet. "Time arbitrage" is a very compelling ingredient for the latter category.

  • Report this Comment On October 29, 2010, at 1:17 PM, tedski2000 wrote:

    What irony. Mojo means to (respectfully) undermine the author's strategy, when, in fact, he precisely underscores it.

  • Report this Comment On October 29, 2010, at 3:03 PM, anuragupta wrote:

    NUE is cash flow negative. Its dividend stands halved over the last 1-2 years. Current payout ratio as 225%.

    I guess the only case to be made is what happens to it after the recovery which I am not sure if it would keep happening in the near future.

  • Report this Comment On October 29, 2010, at 3:17 PM, NoOracleHere wrote:

    Let me see if I've got this right. Time arbitrage means to buy now with one time horizon, oh, wait, that's meaningless because buy now is buy now regardless of time horizon. But oh well, then we sell later with a different time horizon. So to switch time horizon means to change my mind (about time horizon) sometime before I sell. Well, then that simply means to buy low and sell high. How insightful! Unless, per chance Jeremy has a way to buy today and sell yesterday. Hmm, shorting a stock works something like that, except that I have to do that in reverse, sell yesterday first, what I then buy today. Fair enough, except that I don't really have a time machine, and to be successful, I have to have a reasonable grasp of future performance. Well, none of this sounds like a new idea. If Jeremy is talking about value investing, then good for him. But I'd say just call it what it is.

  • Report this Comment On October 29, 2010, at 3:18 PM, GregTrocchia wrote:

    >>>2 words : "bull sh*t"

    arbitrage - "the possibility of a _risk-free_ profit at zero cost."<<<

    Varsovia,

    There is a form of arbitrage which is indeed a risk-free opportunity for profit, classic arbitrage, which takes advantage of a price differential of the same item in two different markets. Let's say that gold is going for $1350 an ounce in New York and $1351 an ounce in Chicago (this is likely to be much larger than the difference in the real world, for reasons which will become apparent presently). You simultaneously (as near as possible) buy gold in NY and sell it in Chicago, pocketing the $1 difference. By doing the transactions simultaneously, you negate the chances that prices will move against you in one or both markets. To the extent you can do this, your position is riskless. Note that buying gold in NY will tend to drive the there price up and selling it in Chicago will there down with the net result of diminishing the differential, which is why a full dollar an ounce difference is probably a big exaggeration. Because they offer the opportunity for riskless profit, classic arbitrage opportunities are almost always fleeting and the larger the differential, the more juicy the opportunity, and the more fleeting it is apt to be.

    Time arbitrage, to the extent the concept is valid, is more akin to risk arbitrage, the kind of stuff Boesky did. Let's say a company is selling for $25 dollars a share, an acquisition offer is made at $35 a share. If you can still buy at the $25 price before it starts to rise, you will be in a position to make $10 a share that is safe provided _the_deal_goes_through_ (hence the appetite of Mr. Boesky for inside information, which led to his downfall). This "time arbitrage" stuff is actually a step or two more risky than risk arbitrage, because with risk arbitrage you *know* there is a buyer willing to pay more than the current market price for your asset. With "time arbitrage" you are making an assumption (however well justified) that one will be there at some point in the future.

  • Report this Comment On October 29, 2010, at 5:42 PM, myerslaw wrote:

    Mr. Trocchia: It is hard to think of Mr. Boesky with other than fond pity. There he was, sniffing out insider information, using all the wiles and tools at his disposal. There now are better tools, and corporate leaders with far fewer scruples. We've just been through (not quite through, at that) the harrowing display of how those with the best inside information now no longer need or use middlemen like Ivan. They simply rig the markets for themselves. And Ivan, of course, ran afoul of laws which were then on occasion enforced. Not so more recently. Your main thesis, though, surely is correct. Perhaps the dictionary meaning of "arbitrage" should not be expanded along timelines which change it so significantly.

  • Report this Comment On October 30, 2010, at 4:21 AM, beastofbodmin wrote:

    Buy and hold for 20 years? That is a long time. Things can change rapidly. You do have some criteria by which to decide to get out, right? How often do you revisit your 20 year portfolio?

    For example, you mentioned "Deepwater driller ATP Oil & Gas" - how can these be a 20-year operation? Go and research oil and gas discovery rates. Figure that into the oil or gas supply 10, 15 or 20 years down the line.

    So perhaps the deepwater drilling industry will be nothing in 20 years. At best ATP would be drilling, but not for oil or gas. Maybe to bury CO2? But now I'm speculating.

  • Report this Comment On October 30, 2010, at 2:47 PM, wenger2k wrote:

    Hmmm - I have a very different take on the word "time arbitrage" than you. I generally think of the concept of "pairs trading" that Hedge funds frequently leverage as a way to get disproportionate upside while getting some downside protection. The concept in Pairs Trading is frequently to short a really bad company in a sector against a long position with a company in the same sector that is better and that you believe will outperform the poor company over the next n period. The short position becomes a hedge if the entire market goes south taking all companies with it.

    I think of Time Arbitrage as the exact same thing only utilizing a perceived shift in the market to take advantage of the better or 'newer' company over the older who is losing their way. Shorting Microsoft along with going long on Google or Apple comes to mind as a good example 3-4 years ago. Or Shorting AT&T to go long on Apple as the iPhone was introduced. Another or shorting the "old guard" of handset mfgs Motorola, Nokia, Palm (at the time) and RIMM to go long on Apple and Google. The time aspect is that these things are only concepts early on but become significantly more noticeable even seismic market changes over time and if you get them wrong the worse that happens is that you don't get the separation and the companies just move as the whole industry does. While these examples are largely gone, there are new ones occuring all the time and it is the divergence from a current norm that is the pattern we're looking for.

    As one other commenter has already state, while yours is a time tested strategy, I don't see how the term arbitrage applies what-so-ever to what you're doing.

    Thanks for the article - always good to get folks thinking.

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