Here's a very short story that demonstrates one of the great principles of winning investing:
New York Yankees relief pitcher Mariano Rivera got off to a bad start last season. In the first two games, he gave up five hits and six runs to the rival Boston Red Sox. Yes, something seemed wrong with the man many believe is the greatest reliever ever.
Seemingly human, he suddenly became trade bait in my fantasy league. I knew, however, that he was still a great pitcher, and offered up the solid but unspectacular Troy Percival in return. The deal was done. I'd just purchased an all-star for a bargain price -- and Rivera did me proud by having another spectacular season and winning Reliever of the Year honors (yet again).
How to find your own Rivera
It's an easy-to-understand yet powerful lesson. Sometimes good companies will take an undeserved hit, leaving you with an opportunity buy in at bargain prices.
For example, Tom Gardner recommended Silicon Labs
At one point, Silicon Labs was down more than 25% from the original recommendation. A quarter of the company's value had vanished. Was Tom worried? Well, probably, but nothing had happened to change his mind about the business prospects -- Rivera was still Rivera, after all -- so he continued to back the stock.
The three-step model
Tom was comfortable recommending this company three times because it fit beautifully into the following three-layer mold:
- An out-of-favor company with fixable problems in a beaten-down, relevant industry.
- Strong balance sheet.
- Significant insider ownership.
Stocks with this profile can point to some solid companies with great turnaround potential. Sooner or later, a relevant industry will reverse course and head north again, and businesses with strong balance sheets will survive to see that day. Meanwhile, managers with a large stake in their business add to the probability of success, because they have heavy incentives to increase shareholder value.
Back to the SLAB
When Tom first recommended it, Silicon Labs was off some 40% from its recent highs for at few reasons, among them misguided concerns about its inventory picture and the bloodbath in the semiconductor industry, whose index was down over 70% from its 2000 high. The carnage was broad-based, taking down big names like National Semiconductor
Eventually, things would get better for the industry. Fast, efficient chips were appearing in more and more products, a trend that would continue to rocket ahead. Silicon Labs -- whose largest customers include Intel and circuit maker Agere Systems
The balance sheet was strong, with $215 million in cash, no debt, and receivables in line with sales. Those worried about an inventory increase didn't understand that there was actually a positive inventory divergence, with a rapid buildup in raw materials and a burndown in finished goods.
Finally, the chairman and the two other co-founders owned a large percentage of the stock, so Tom knew they would be striving for operational excellence.
The dust settles...
I can't let you think Tom is perfect. He has sold solid companies, Websense
Today, the original pick is up 39%, and the three-pick average gain is beating the market 52% to 13%. I don't want to oversimplify things, because there were many other factors in his selection, but the three points above led him down the right path. Silicon Labs is just one of the reasons his recommendations have a total average return of 78% since the Stock Advisor service began in 2002. David Gardner is also doing well with 48% average returns, while equal amounts invested in the S&P 500 would have returned 20%. A 30-day free trial will give you full access to every issue and all of the Gardner's recommendations. Click here for more information.
Rex Moore certifies that no keyboards were harmed in the writing of this story. He owns no companies mentioned in this article. The Motley Fool has a disclosure policy.