How to Be a Better Investor

"In the short run, the market is a voting machine, but in the long run, it is a weighing machine."

These immortal words from value investing pioneer Benjamin Graham eloquently summarize why you -- yes, you -- have the ability to beat the stock market as an individual investor. Simply put, stocks always eventually reflect the true worth and earning capability of a business. Yet on any given day, a stock quote might be radically off-base in either direction.

For example: The same stock market that once valued Cisco Systems (Nasdaq: CSCO  ) at $82 a share in 2000 was selling it for 90% less in 2002. That's a huge range. And it's not as if Cisco is some tiny company, too small for analysts and professional money managers to follow. While its stock was bottoming out in 2002, Cisco still had more than $18.9 billion in revenue.

The hidden truth
The market was wrong about Cisco at both extremes. But if $82 a stub was too high a price to pay, and its 2002 low of $8.12 was a practical steal, then Cisco's true worth was somewhere in between.

Of course, nobody knows precisely what a company is really worth, and that number changes as a business matures. Investors can make a good estimate, though -- and when you buy at a large discount to that estimate, you're not only getting a good deal but also giving yourself a safety net in case you made some wrong assumptions in your calculations.

This strategy is called investing with a margin of safety, and it can make you a better investor. It's time-tested, and value investors like those of us at Motley Fool Inside Value have been using it to beat the market for years.

Underappreciated wealth generators
There's a funny thing about the stock market. If its expectations for a company are low enough, any news that shows that a company is not on the verge of collapse tends to be good news. If you can find a company whose earning power is significantly greater than its share price indicates, you can make money. Just buy shares in the firm and wait for the market to reassess its own valuation.

Think it doesn't happen? Here are a handful of companies whose shares shot up 5% or more immediately following their recent earnings releases.

Company

Price before earnings

Price after earnings

Change

Caterpillar (NYSE: CAT  )

$62.07

$65.17

5%

Diebold (NYSE: DBD  )

$37.01

$39.11

5.7%

LandAmericaFinancial (NYSE: LFG  )

$61.26

$68.30

11.5%

Longs Drug Stores (NYSE: LDG  )

$39.45

$43.81

11.1%

OfficeMax (NYSE: OMX  )

$28.02

$30.65

9.4%

Rent-A-Center (Nasdaq: RCII  )

$20.57

$23.80

15.7%



Each of these companies faces problems, ranging from regulatory and political risks to the simple market fear of a cyclical business slowdown and competitive pressures. Yet as their post-earnings price pop indicated, Wall Street's panic was greater than the reality. If you understood these companies' businesses better than the market did, you could have profited.

Believe it or not, two companies from the list, Rent-A-Center and Diebold, are Inside Value selections. Lead analyst Philip Durell told subscribers about these companies before their earnings releases indicated that the market was irrationally discounting them.

The secret to success
Philip found these companies by focusing on the long term and finding wealth-generating operations during a panic sale. To determine their worth, he used a discounted cash flow analysis and then bought with a margin of safety.

With the help of a business-focused investing framework and data-driven company analysis, Inside Value has outpaced the S&P 500 by 4 percentage points since the newsletter's inception. If you'd like to join us value investors free for 30 days, click here to be our guest at the service. Plenty of Philip's recent recommendations are still available with a wide margin of safety, and we even offer a trusty DCF calculator to help you find values on your own.

By buying businesses while Wall Street panics, you can join the school of Benjamin Graham and be a better, more successful investor.

Are you ready to take advantage of those times when the market's voting machine erroneously casts out solid businesses? If you're willing to buy when Wall Street says "Sell", then Inside Value just might be for you. Click here for a totally free 30-day guest pass. Or subscribe today and get a free copy of the Fool's international investing report, Around the World in 80 Minutes.

At the time of publication, Fool contributor and Inside Value team member Chuck Saletta had no ownership stake in any of the companies mentioned in this article. The Fool's disclosure policy is invaluable.


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