It's easy -- and useful -- to follow the crowd at times. Folks follow trends in fashion (what's in for spring?) and electronic gadgets (another iPod, anyone?), for instance. But following the crowd as an investing strategy? That's an entirely different story, and for those of us who had huge losses in the post-2000 Nasdaq crash, it's one we'd like never to repeat again.
Sure, if you get in early enough, you can make some big short-term gains following what's commonly called momentum investing. There's even a pretty savvy measure you can use to push these dollars up the hill -- it's called "relative strength." But for most of us, that's a recipe for buy-high-sell-low disaster.
Take advantage of the herd
A little thing called value investing -- preached by a few luminaries you may have heard of (Graham, Buffett) -- can help you buck such a herd mentality. Value investing involves using financial metrics to determine what companies are great and have potential for long-lasting returns. But the important thing is to wait for the rainy day when the market panics -- and buy the stock at a discount to its intrinsic value.
Consider a few examples.
Case in point No. 1: The aforementioned tech bubble.
In 2000, Cisco
Year-End Prices |
1998 |
1999 |
2000 |
2001 |
2002 |
---|---|---|---|---|---|
Yahoo! |
$29.62 |
$108.17 |
$15.03 |
$8.87 |
$8.18 |
Cisco |
$23.20 |
$53.56 |
$38.25 |
$18.11 |
$13.10 |
Lucent |
$41.70 |
$57.04 |
$10.98 |
$5.14 |
$1.26 |
But if you'd recognized the worth of these companies and their business models while the market was reacting to the crash, you could have found some real value -- the average gain for these three companies since the end of 2002 is more than 150%. That's a lot of incentive to be contrarian when the masses are screaming "Buy!" or "Sell!"
Case in point No. 2: Overanalyzed and overhyped IPOs.
For a more recent example, take a look at CBOT Holdings
Case in point No. 3: Great business, short-term worry.
According to Jeremy Siegel's The Future for Investors, the best-performing stock in the entire S&P 500 since its inception has been Altria
Up and down, and back around
Value investing can help you beat the momentum crowd. It's where you find a great company and simply wait for it to go on sale.
If you think this can't happen, even the greatest of great companies -- Microsoft
Motley Fool Inside Value analyst Philip Durell waits for exactly these opportunities. He creates a wish list of stocks and waits to pay the right price. Philip did this to uncover Microsoft when the market was bearish on it, and it has since returned almost 25% to his subscribers. This contrary strategy has put his service more than six percentage points ahead of the market, and 11 of his recommendations are still trading at what he considers to be bargain prices. To find out what they are, click here to be Philip's guest at the service free for 30 days.
Everyone wants a piece of a stock on the rise. But by being a value investor, you can find stocks before they rise.
This article was first published on April 17, 2006. It has been updated.
Motley Fool sector head Shruti Basavaraj owns shares of Microsoft. Yahoo! is a Motley Fool Stock Advisor choice. The Fool's disclosure policyis sealed for freshness.