A Patient Investor's Guide to Profit

Patience may indeed be a virtue, but when it comes to investing it seems we're all in a hurry, filled with the vices of avarice and greed. All too often, we feel that we must buy a stock rightthisminute or else the train will surely leave the station without us. Instead, we just end up on the wrong track.

Growth investors are often guilty of this investing "sin," feeling that since the stock is moving up, they'd better climb aboard. Did Taser (Nasdaq: TASR  ) double from $15 to $30? Let's buy in! And momentum investors, well, they're simply a highly caffeinated version of growth investors. They're not even concerned with what the company is, so long as it's going up, and going up fast! Travelzoo (Nasdaq: TZOO  ) is running from $10 to $100? Better get in line as we run it up more. Just watch out below when it plummets back to Earth.

The rest of us need to take care to invest not only in the right stocks, but at the right price and at the right time. Jump in too soon and we can catch the cliched "falling knife." Jump in too late and we'll indeed have missed our chance to maximize our returns. Patience is a valuable key to winning investments. And profits.

Magical elixir called "patience"
So how do we go about acquiring this mystical stuff called "patience"? Well, it certainly takes time. I think most every investor at one time or another has hastily purchased a stock, and has been burned in the process. My mother used to tell me that "the burned hand learns best," and, though true, I'd rather know the right moment to buy a stock ahead of time than walk around with blisters and bandages.

One of the primary techniques to attain patience is, quite simply, to do nothing. That's it. Don't buy. Don't sell. Don't watch CNBC. Just ignore the market and wait. Actually, you do have to do something. Use your time ignoring the market to get to know your company. Know it, understand it, value it. And once you get a good idea of what your company is worth, just wait some more.

It took me a long time to understand this principle of value investing. The stock market at times is quite exuberant and at other times quite depressed. Master value investor Benjamin Graham described it as a manic-depressive friend who is always willing to give you a price for your company. Some days he is upbeat and overvalues your stock. Other times he is downcast and undervalues it. And more often than not, he over- or undervalues your company again and again. It just takes time for him to switch moods. Just look at what happened to Merck (NYSE: MRK  ) after the company announced it was withdrawing Vioxx. The market pummeled it -- sending the price down close to 50% -- without taking time to consider Merck's drug pipeline or other fundamentals. Merck has since begun a slow climb back up, but it has experienced other precipitous drops along the way. Or in the case of ExxonMobil (NYSE: XOM  ) , the market causes the stock to bump and jump every time someone seemingly mentions the price of oil.

And that's why we wait. Because the stock market has been wrong in the past about the value of our company, we can be assured it will be wrong about it again in the future. If we are willing to wait -- if we are just patient -- the stock market will give us the price that we want to pay for our company.

No one knows this principle better than Philip Durell, lead analyst of the Motley Fool Inside Value newsletter service. Since he began a little more than seven months ago, Philip has been patiently picking undervalued companies and just as patiently watching them beat the market as investors realize their value and bid their prices up. To date, Philip is beating the market on average by better than 6 to 1!

Philip has the patience to find good companies and then wait until they come down to his price before pouncing on them. For example, door maker Masonite was an early Inside Value pick, beaten down by one of the market's manic overreactions. Here was a brand that had been in business for 75 years, had little direct competition, and featured a strong corporate culture. Philip advised members to scoop up these discounted shares and his timing paid off. Just three months after Masonite was recommended to members, it was announced that it was being taken over by private equity firm Kohlberg, Kravis and Roberts. Investors realized a cool 35% profit. Not bad for three months' time.

That's what happens when Mr. Market overreacts to bad news. Competitors or equity firms also realize the hidden value locked away in the company and take them over. If you've priced it right, you can profit handsomely.

Catalyst for a fresh start
Bad news and a deflated share price don't necessarily make for a value pick. Heck, you can look at any financial paper and see stocks hitting all-time lows on a daily basis. It requires you to understand the company and what it's doing to solve its problems.

Insurer American International Group (NYSE: AIG  ) , facing scrutiny from prosecutors, regulators, and industry watchdogs, has had a rough go of it lately. Around the time Philip was recommending former Worldcom subsidiary MCI (Nasdaq: MCIP  ) to subscribers -- and realizing a subsequent 39% gain for them -- AIG was notifying investors that the SEC was investigating it for improper transactions. The stock began tumbling and fell more than 30% off its highs. Good time to buy, right? Not so fast! There were more revelations to come, as well as more probes and investigations. The once-venerable chairman and CEO Hank Greenberg was ousted. The stock nearly fell another 10% from those prior lows.

To give you an idea of how much a little bit of patience can affect your returns, consider the following:

Company Seemed low at Actual low Return since seemed low Return since actual low

Merck*

$30.07 $25.49 15% 36%
AIG* $64.96 $50.85 (17%) 7%
MCI** $18.34 $12.74 38% 99%
Mattel** (NYSE: MAT  ) $18.39 $16.97 (1.1%) 7.2%
*May not yet be a value.
**Denotes prior Inside Value pick.


What ingredient of success did Philip see in MCI that others ignored? And equally important, why was it not present in AIG?

In MCI, Philip saw a company that generated a lot of cash with a new management team that had ability and integrity. AIG, it is charged, may have had the first two, but the latter may have been lacking. Moreover, Philip is willing to wait for the companies he likes to reach his price. Those who jumped into AIG at $65 did so too soon, as did those who jumped in at $55. The catalyst for MCI was a new management team and a bankruptcy "Fresh Start Accounting" plan. AIG is only starting to develop its fresh start.

Catching the exact top and exact bottom is not necessary to handily beat the market. Beating the market requires the patience to wait for the right buy-and-sell price. Doing so requires that you learn about your company, value it, and then wait for the market to give you that price as it invariably will. Moving too soon can hurt you. It may just be that value investors are virtuous investors.

Want to join Philip and the Inside Value team on their hunt for bargain-priced stocks? Try arisk-free 30-day trialon us. In addition to receiving two value recommendations per month, you'll have access to all our back issues and our Foolish community of message boards.

Fool contributor Rich Duprey owns shares of Merck and Mattel, but none of the other stocks mentioned in the article. The Motley Fool has a disclosure policy.


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