On first glance, self-storage units seem like unlikely sources of investing wisdom. But cobwebbed concrete bunkers full of yesterday's junk can actually teach us a lot about finding great investments.
Just bear with me
A recent segment of public radio's This American Life documented an unusual cottage industry: the auction of foreclosed storage units. Each eight-by-ten space up for grabs most often houses junk. But sometimes, bidders can score untold treasure for a fraction of its value.
If bidders were allowed the opportunity to comb the unit's contents, bidding might be a fairly rational, efficient process. But they can't. They stand behind a line, crane their necks at what they can see, hypothesize over what valuable contents the spaces contain, and bid. It's an exercise in the unknown, as the segment's author, New York Times Magazine columnist John Mooallem, put it.
This bidding game, an elaborate probability ring with largely unknown odds, is no different from investing. Quarterly earnings reports, news blips, and flashes of economic data whir about the markets on a daily basis. They may give us cues to a company's true worth, but they don't tell the full story.
As investors, we're forced to make educated guesses on what we can see -- putting odds on the unknown. Our success, or lack thereof, depends upon developing a rational, calibrated process for filtering these nuggets.
The fallacy of logic
Most of the storage-unit scavengers start with a coherent strategy. They comb over the space with Maglites, punching the keys of a mental calculator -- the rational part of the equation. But racing minds and the fantasy of a big score interfere, and the right brain takes hold. What starts as a mostly rational process soon gets hijacked by the brain's penchant for dreaming.
Investors, you've seen this before: It's what famed economist John Maynard Keynes called "castles in the air" -- the very genesis of bubbles.
In search of the next big score, investors apply rules of thumb, seek confirming evidence, extrapolate wildly optimistic projections, and dramatically overvalue stocks in the process. How about a few more jogs down memory lane?
% decline from highs
Tale of the tape
|Turns out, corn-based ethanol might not be the solution to our nation's—or the world's—energy woes. Even if it is, Pacific Ethanol was not the way to play. Enthusiasm bid the shares up, and when margins collapsed, the debt burden associated with new capacity builds crushed them.|
|Cool product, innovative idea, and a monopoly position on the satellite radio market. Alas, a monopoly in satellite radio is worth as much a monopoly in landline phones -- at the dawn of cellular era.|
Avoiding the tempestuous lure of castles requires us to shun sexier, more speculative fare.
Here, it pays to remember that investing is a probability game. In a portfolio where a single hugely winning investment accompanies 10 stomach-churning losers, the odds suggest that you're not coming out ahead. Unfortunately, for every Amazon-esque success story, there are a thousand failed impostors.
So if we can't give rein to our wildest dreams, what strategies will help us find good investments?
Don't lose money
For investors, the solution is clear: Stack the odds in your favor, and buy what you can see. That doesn't mean sacrificing your upside. As hedge fund manager extraordinaire John Paulson's mentor said: "Watch the downside; the upside will take of itself." At Motley Fool Special Ops, where I'm senior analyst, we're obsessed with making good bets.
Here's one example. On first glance, there's no reason to invest in Hilltop Holdings
So why did we invest? Hilltop's chairman is Gerald Ford, a legendary bank investor. Ford made a fortune buying distressed banks during the S&L crisis, alongside famed investor Ron Perelman. So as Hilltop trades at roughly the value of its cash, our downside is virtually nil: Hilltop consistently operates at breakeven. But our upside is mammoth: Bank failures are happening at an historic rate, and if the right opportunity comes his way, Ford could mint profits.
Simply put, we bought what we could see: The cash. The odds of us losing a lot of money are infinitesimally small, and the upside potential tremendous. At Special Ops, we seek precisely those types of bets. Here are two similar opportunities:
Shares trade just north of the value of its cash and investments. Near-term results haven't been pretty, but even at the credit crisis's nadir, TheStreet never burned cash. In better times, TheStreet has made good money, and the economics of its subscription newsletter biz are pretty compelling, if well-run. And newly installed management seems intent on just such steady operations.
Tomo's a small fry in a big market: Radiation therapy. It has no history of profitability, and competitor Varian
The bottom line
Investing -- in stock or storage units—presents two challenges: Making money, and preventing losses. At Motley Fool Special Ops, we focus on both. If that sounds appealing, just enter your email address in the box below for a peak at three premium stock ideas and a personal invite to join Special Ops when we reopen for an extremely limited time later this month. I hope to see you there.