Pay Attention or Go Broke

A buyer and a seller are involved in every stock trade. Each one has access to roughly the same information, yet each one chooses to make polar-opposite decisions about a stock. If you want a shot at winding up ahead of the pack, you have to accept that fact.

To succeed you must intuit what the person on the other side of your investment is thinking. Why is he selling when you're buying? Why is he willing to buy the shares you're trying to unload? If you can figure that out, you'll be light years ahead of the competition.

Go! Fight! Win!
There's simply no such thing as a perfect investment. If there were, investors would soon bid its price up to a point where it was at least as risky as any of its alternatives. As a result, there are always two legitimate sides to any given analysis. To drive home that point, The Motley Fool runs a regular "Dueling Fools" feature, where analysts square off against each other on opposing sides of a stock.

While most investors look to buy stocks, the bear side of the duel points out the opposite side of the story -- reasons to consider selling shares. Quite often, the bear rightly predicts problems ahead -- ones that were visible to an outside observer but not yet priced into the stock.

As this chart shows, failure to heed a warning can prove costly:

Company

Duel Date

Total Return
Since Duel

SPDRs Returns

Return vs. SPDRs

Mentioned Warning Signs

Netflix (Nasdaq: NFLX  )

9/22/2005

2.8%

30.6%

(27.8%)

Subscriber churn, negative free cash flow

Wal-Mart (NYSE: WMT  )

11/23/2005

(6.1%)

24.8%

(30.9%)

Bad image, increasing threats of regulatory costs

TiVo (Nasdaq: TIVO  )

2/23/2006

19.5%

22.3%

(2.8%)

Losing money and market share

Johnson & Johnson (NYSE: JNJ  )

11/22/2006

(0.5%)

21.0%

(21.5%)

Flat margins, slowing growth, weak pipeline

J Crew Group (NYSE: JCG  )

12/11/2006

7.4%

10.1%

(2.7%)

Valuation, debt, competition

AutoZone (NYSE: AZO  )

12/13/2006

3.4%

10.1%

(6.7%)

Crowded industry, debt

Bed Bath & Beyond (Nasdaq: BBBY  )

1/19/2007

(18.4%)

9.4%

(27.7%)

Competition, store layout, valuation

Since their duels, each of these companies has underperformed the SPDRs -- an exchange-traded fund that tracks the S&P 500. Worse yet, some have lost their investors significant money. The risks were well known, in public, for all who wanted to pay attention.

Protect your money
Because there is no such thing as a perfect investment, and because there are always two sides to every analysis, any given stock will move up and down quite frequently. As our dueling bears have shown, even great businesses can easily become overpriced and head for a fall. On the flip side, however, there are times when the worrywarts take full control of a stock and send it plummeting to well below its true worth. That's when value investors, like those of us at Motley Fool Inside Value, get interested in buying those same great businesses.

By always considering both sides of the story, it becomes that much easier to see the times when the market is driven to excess. Too much optimism? We sell. Too much pessimism? We buy. That's the simple truth to how we've managed to beat the market since our launch in 2004.

Make sure you're truly considering both sides of any potential investment. If this article has taught you to be skeptical enough not to buy blindly, congratulations -- you've mastered the first step to becoming a successful value investor. As your prize, we'll give you a 30-day trial of Inside Value, free.

This article was originally published on Nov. 22, 2006. It has been updated.

At the time of publication, Fool contributor and Inside Value team member Chuck Saletta owned shares of Johnson & Johnson. Netflix and Bed Bath & Beyond are Motley Fool Stock Advisor selections. Wal-Mart and Bed Bath & Beyond are Inside Value selections. Johnson & Johnson has been chosen by Motley Fool Income Investor. The Fool has a disclosure policy.


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