Pay Attention or Go Broke

Every stock trade involves both a buyer and a seller. Each one has access to roughly the same information, yet each 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 she 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 an occasional "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

Return vs. SPDRs

Mentioned Warning Signs

Home Depot (NYSE:HD)

6/30/2005

(19.7%)

(39.5%)

Housing market concerns, questionable valuation

PDL BioPharma (NASDAQ:PDLI)

7/14/2005

(49.4%)

(65.5%)

Event risk, valuation, competition

Dell (NASDAQ:DELL)

3/16/2006

(31%)

(39%)

Commoditization, lower cost alternatives

CNET Networks (NASDAQ:CNET)

8/31/2006

(21.1%)

(28.7%)

Weak margins, bloated operations

Google

12/7/2006

(3.5%)

(2.7%)

Valuation 

Cisco Systems (NASDAQ:CSCO)

12/13/2007

(14%)

(6.6%)

Valuation, cyclicality, share dilution

All returns as of market close, April 1; all returns adjusted to reflect splits and dividends.

Since their duels, each of these companies has underperformed the SPDRs (AMEX: SPY  ) -- an exchange-traded fund that tracks the S&P 500. Worse yet, they've all lost their investors' 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, sending 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.

Always considering both sides of the story makes it 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 of how we've managed to beat the market since our launch in 2004.

Make sure you're 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 Nov. 22, 2006. It has been updated.

At the time of publication, Fool contributor and Inside Value team member Chuck Saletta did not own shares of any company mentioned in this article. The Motley Fool used to own shares of SPDRs. Dell is a Motley Fool Stock Advisor selection. Home Depot and Dell are Inside Value selections. CNET has been selected for Motley Fool Rule Breakers. The Fool has a disclosure policy.


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