The Dow Jones Industrial Average's recent single-day 400-point drop may be weeks behind, and thoughts may be turning toward this bull market that's pushed the Dow north of 13,000. But I promise another huge decline is never too far off. It's during these cautious but optimistic times when investors should really mentally prepare themselves for another blood-letting.
Baron Rothschild, the quintessential banking opportunist, is said to have advised that the best time to buy is when there is "blood in the streets." I agree. An investor who embraces this axiom casts aside the bears and turns bullish in times of maximum pessimism.
The bloodiest days
Imagine picking up a company such as eBay (Nasdaq: EBAY ) , which was beaten down from all-time highs of $31 to less than $8 at its lowest during the broad sell-off of technology stocks in 2000 and 2001. eBay today sells for approximately $34 per stub. That's a greater than 325% return. And sure, telling you to buy a fairly risky Internet company like eBay in those days is Grade-A 20/20 hindsight. But consider picking up the more stodgy IBM (NYSE: IBM ) a little later on after its hair-raising drop in 2002. Your returns would still be a robust 75%.
The point is, you can easily profit from a ghastly investing environment. When everyone else is selling, it may just be the best time for you to step in and pick up a great company for cheap.
Sometimes the blood is your own
But Mark Mobius reported in his book Passport to Profits that there is a second part to Rothschild's quote -- one that is perhaps even more impressive and intellectually inspiring. Buy when there's blood in the streets, "even if the blood is your own."
That means being confident enough in your analysis to buy stocks you already own even when the market is telling you your analysis is wrong. And it's hard to do. There have been plenty of times when I have sworn off good companies when chips were down. I advised family members to flee from Corning (NYSE: GLW ) when it got battered in the summer of 2002, only to see it reemerge in a completely different shell. And while it won't soon be a $100 stock again, its future prospects are strong. I made a similar mistake when I pushed an uncle to sell Starbucks (Nasdaq: SBUX ) during an ever-so-brief sell-off in July 2001. Everyone knows the result of that little misjudgment.
In the past year alone, my personal holdings of miner Coeur d'Alene have seen precipitous falls. I've lost about 29% on that stock. There's blood in the streets of the silver industry, and much of it, without a doubt, is mine.
Take advantage of a great opportunity
But Coeur d'Alene is still a relatively strong operator with a bright future, which is very difficult to see through the fog of a poor earnings report or some other negative event. And today, even though I've gotten hammered on the stock, I'm just as convinced of Coeur d'Alene's prospects as I was when I purchased it months ago because the fundamentals haven't changed.
Human instinct persuades us against staying aboard a sinking ship. It's an innate survival tactic that affects the way in which we invest. In many cases, this instinct alerts us to situations that would otherwise doom our portfolio. When I see accounting malfeasance or strong insider selling going on this instinct kicks in and I get scared. But when I see a terrorized market that's unjustifiably killing great companies, including my own, I get excited.
Seeing red on your portfolio is nothing to be afraid of. Admittedly, too much red is just flat-out unacceptable, but sometimes it's opportunity staring you in the face.
Warning and opportunity
While Rothschild's quote is a bit visceral, it's right on the money. At our own Motley Fool Hidden Gems service, which looks for stocks that fly too low for most investors' radar, we have some amazing companies that have seen some "bloody days" of late. For instance, homebuilder MDC Holdings (NYSE: MDC ) has seen a number of steep declines this year. Yet it's a solid company with growth prospects, good management, and a superior product. The falls just means it's gotten cheaper. The same can be said for another Hidden Gems recommendation Radyne (Nasdaq: RADN ) -- which has shed 18% year-to-date.
So when it comes to your own portfolio, I advise you to think twice before selling that dog that's lost money. If your original analysis holds, it may actually be time to hold steady -- or buy more. And if you're looking for some fantastic stocks to buy, many of which are off recent highs, I encourage you to look at our Hidden Gems small-cap investing service. A risk-free 30-day trial is yours to enjoy.
This article was originally published on March 28, 2007. It has been updated.