Go ahead. Call me crazy. It's music to my ears.
See, my best investments tend to happen when people call me foolish (with a lower-case "f"). Conversely, my worst investments are usually made when people tell me how great the trade is sure to be.
That makes sense. If people agree with your thesis, there's a pretty good chance that thesis is already priced into the stock. When this happens, there's not a lot of room left to be proven correct.
This is exactly what NYU finance professor Aswath Damodaran meant when he told Fool co-founder Tom Gardner in a 2005 interview that "one of the riskiest investments you can make is to buy into a company where everybody thinks the company is superbly run." In this case, any negative surprise could pummel the stock, while any positive news is already priced in.
Sure, it always feels nice to receive immediate positive feedback for your idea, but it's likely a sign that you've made a poor longer-term investment.
Avoid the lovefests
None of this should suggest that you can't make money buying shares of well-run companies; there just needs to be another factor the market is missing, in order for you to buy them at the right price.
Suffice it to say, then, that you won't hear about me recommending Apple anytime soon. Look, there's no denying that Apple's a great company, and the stock could trade higher from here. Still, I'm skeptical whenever there's such a cheery consensus around a stock, as there is today for Apple.
Though I'm sure I'd get some congratulatory emails if I said "buy Apple," I'd also have some unwelcome company -- according to Thomson FirstCall, 49 of the 54 analysts that cover Apple have it as a "buy" or "strong buy." Only one brave analyst thinks it's a sell. Their median target price for Apple is $375 (13% above today's price), and they expect Apple's long-term earnings to increase by 19% per year. That would be quite a feat for a $300 billion company.
Consider the comparative long-term earnings growth expectations for some of the other largest S&P 500 companies:
LT EPS Growth Estimate
Procter & Gamble
Source: Capital IQ, as of Jan. 3.
The problem with well-known, well-loved companies like these is that the law of large numbers kicks in, and it becomes increasingly difficult to continue the rapid growth rates of the past.
Frankly, I would avoid any megacap company with well-above-average growth expectations.
Against the wind
On the other hand, Professor Damodaran also noted in the interview, "The best investment to make might be in a company where everybody is convinced the company is run terribly, because then all they have to do is walk and chew gum at the same time, and the market is incredibly surprised when things go right."
This is essentially what's happened with Kinetic Concepts, a medical equipment company that I recommended to our Motley Fool Pro members in October 2008.
At the time of the recommendation, the market was really down on Kinetic Concepts; it traded for just nine times trailing earnings. A few months prior, Kinetic Concepts had made a hefty acquisition that left it saddled with a large amount of long-term debt. Adding to the bearish case, competition in the advanced wound-management sector was heating up, and concerns about health-care reform were growing larger, since it seemed more likely by that point that Barack Obama would win the presidential election in November.
Though the market saw few bright spots for Kinetic Concepts, I found in my research that things weren't as bad as they appeared at first glance. First, Kinetic Concepts' CFO had successfully paid down the company's debt once before, which gave me confidence that he could do it again with the company's consistent free cash flow.
Second, I learned that Kinetic Concepts' Vacuum-Assisted Closure ("V.A.C.") wound care treatment was well-accepted in the medical community and had a mountain of clinical support in its favor. Given how busy doctors and nurses are, they aren't quick to change or learn a new system if the one they're currently using works well.
Finally, when I traveled to San Antonio for the company's analyst day, I came away very impressed by Kinetic Concepts' innovative culture and its plans for the future.
In short, all the things that could have gone wrong at Kinetic Concepts were for the most part priced in to the stock at the time we bought it, leaving the upside potential greater than the downside risk. Since then, Kinetic Concepts has achieved much of what I expected it would -- the debt is being paid down, and the V.A.C. business continues to generate sizable cash flows. Our position at Pro is up 84%, versus 42% for the S&P 500.
Put the odds in your favor
As the legendary value investor Sir John Templeton famously said, "If you want to have a better performance than the crowd, you must do things differently from the crowd." It's a simple notion, but often overlooked. When we buy along with everyone else, we increase our risk of paying too dearly. Frankly, I can't think of a crazier way to invest.
At Motley Fool Pro, we have an ambitious goal of profitably closing at least 75% of our trades. So far, we're ahead of this mark. The best way to keep up that performance is to buy things for less than they're worth, which often means going against the grain. We combine our rigorous valuation work with options strategies, to generate additional income and obtain better buy and sell prices.
If you'd like to learn more about our strategies at Pro -- as well as get a free report with strategies to grow your wealth -- just drop your email address in the box below.
This article was originally published on June 14, 2010. It has been updated.
Fool analyst Todd Wenning has fingers crossed that the Bengals can rebound next season. He owns shares of Kinetic Concepts, Procter & Gamble, and Intel. Costco Wholesale, Walt Disney, and Intel are Motley Fool Inside Value recommendations. Apple, Costco Wholesale, and Walt Disney are Motley Fool Stock Advisorrecommendations. Chevron and Procter & Gamble are Motley Fool Income Investor selections. The Fool has created a bull call spread position on Cisco Systems. The Fool owns shares of and has bought calls on Intel. The Fool has created a protective collar position on Kinetic Concepts. The Fool owns shares of and has written covered calls on Procter & Gamble. The Fool owns shares of Apple, Costco Wholesale, and Intel. Motley Fool Alpha owns shares of Cisco Systems. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.