"It's not a secret if everyone knows about it." These words of wisdom seem obvious, yet they represent a powerful concept that Foolish investors should think about applying to the market.
Investors like Warren Buffet and Bruce Berkowitz did not get where they are by following the crowd into ideas that everyone already knew about. Good businesses usually sell for dear prices exactly because everyone already knows about them. The key to value investing is finding something that is selling cheap because not everyone has jumped on the bandwagon yet. But that alone isn't enough: You also have to understand why it is cheap in the first place, so you can separate the good secrets from the bad.
Stocks generally go on sale because of uncertainty. It could be uncertainty within the company, the industry, or the market in general. The key is to isolate investment ideas that are experiencing uncertainty in only one of those areas, and analyze that uncertainty to see whether it's being overblown by the market. This way, you can limit the amount of guesswork needed when figuring out whether the idea has long-term legs. If, for example, you find an uncertain company in an uncertain industry, you have to get at least two parts of the investment thesis correct in order to win. Why take on the added headache?
The crowd is right
Take Blockbuster (NYSE: BBI). Some might say that Blockbuster's beaten-down stock is a potential candidate for a contrarian investor, but I would argue that the fundamental competitive dynamics of movie rentals are changing, thanks to players such as Netflix (Nasdaq: NFLX) and Amazon (Nasdaq: AMZN). In addition, Blockbuster's financial trends have not been impressive, so it qualifies as a company floundering within an industry undergoing massive upheaval. I'll pass on predicting Blockbuster's chances of revival in favor of easier-to-understand situations -- Blockbuster is "cheap" for very valid reasons.
The crowd is wrong
What stocks might currently be suffering from an acute case of "groupthink"? Mattel (NYSE: MAT) may fit the bill. The California-based toymaker's past year has been messier than a toddler's toy box. The company has suffered through multiple lead-paint-related recalls and a public scolding regarding its China operations. In April, Mattel was sitting north of $29; today it has been driven down under $20.
So here is the million-dollar question: Did parents deny their little girls' Barbie beggings and rebuff their little boys' Hot Wheels hustles this holiday season? I still can't walk two New York City blocks without bumping into an American Girl shopping bag -- the latest doll fad owned by Mattel.
Plus, given Mattel's past record of successfully dealing with labor issues in its China factories, there's little reason to believe that it won't throw the same energy and resources into the recent product-safety issues. My point is this: Right now, you shouldn't be paying attention to the headlines alone. Look at the business fundamentals, and at Mattel's renowned family of brands. Can you imagine a world without Barbie, American Girl, or Matchbox cars?
When to stand out
Finding iconic brands that have fallen on hard times is a great investing theme. McDonald's (NYSE: MCD) was a great example of that during the mad cow craze a few years ago, and Mattel has many similarities. Brands are hard to build overnight, and usually pretty hard to destroy overnight. For those who remember, Johnson & Johnson (NYSE: JNJ) faced a crisis in the early '80s, related to the safety of its venerable Tylenol brand. At the time, people thought J&J might go under, but it acted swiftly. Now, the only people who remember that event fondly are the ones who bought discarded shares.
When a company enjoys a healthy market lead, a celebrated brand, and can't-do-without-it products, but is being trampled by the crowds heading to the exits, this question must be asked: What would the world look like without X? If you can't imagine the world without X brand or company, it's time to take a deeper look.
