It's one of the most frustrating things in investing: You find a company that you believe to be cheap. Really, really cheap. You buy it. This is the one -- this company is gonna make you rich. So why isn't it going up?
It's not so much that the stock is dropping. It's that it's just sitting there, like cement.
Sloth stocks
There are a number of reasons that a stock doesn't move the moment you hit the "buy" button. The first and most important of them is this: The market doesn't particularly care what you think. The market existed in a state of equilibrium before you made your brilliant purchase, and it will exist in that same equilibrium for a long, long time.
"What's wrong with people that they can't figure this out?!" you scream, watching your stock sit still in the same way that a litter of kittens doesn't.
Even for the most patient, assured investors, the waiting game can be interminable. How many times have you looked at a company and said, "Well, I'd buy it, but this stock hasn't done anything in years!"
Of course, stocks don't get to be cheap without reason. In fact, there are three main reasons they might be cheap:
- The company has operating or earnings problems.
- The company's industry is out of favor, boring, or confusing.
- The company is of low quality or is in decline.
Rewards for the patient
Although there are plenty of people out there who do fine by buying garbage companies because they are underpriced, let's throw out the third scenario. Instead, let's focus on the Philip Fisher special -- a company with rising sales and profits that is temporarily out of favor.
I'll give you some examples. In 1999, I watched people get "rich" on companies like Beyond.com, Internet Capital Group (NASDAQ:ICGE), MicroStrategy (NASDAQ:MSTR), and many others. All the while, my chosen few, including consumer products firm Church & Dwight (NYSE:CHD) and White Mountains Insurance (NYSE:WTM), floundered and got very cheap. Anything not named ".com" was out of favor, and the fishing grounds were well-stocked with companies that were making huge amounts of money. The catch was that you had to be patient. Few people were. But great investors -- such as Joel Greenblatt and the team at Grantham, Mayo, Van Otterloo & Co. -- had the opportunity to buy enormous positions in extremely profitable companies like Costco (NASDAQ:COST) and UnitedHealth (NYSE:UNH) while most of the investment community drooled over slobber.com and its ilk. What happened after this? The neglected turned into multibaggers, while the anointed turned into half-baggers. Or worse.
Consider Valero (NYSE:VLO). Oh sure, everybody loves the oil refiners now. But how many people liked them in 2002 and 2003? I did, because I saw the incontrovertible fact that no major refineries had been built in 20 years, while demand continued to grow. Eventually demand would exceed supply, and Valero would be able to name its price. I made Valero my first pick for what is now the Motley FoolHidden Gems newsletter. The result has been a five-bagger. And guess what? Now everyone is excited about refineries. Being patient and being right paid off big time.
The Foolish bottom line
This doesn't mean that waiting isn't excruciating. You can be right and way in the red. Stocks move for unknown reasons, and studies have shown that these reasons do not necessarily correlate with earnings growth, particularly over the short term. Over longer terms, they correlate highly with earnings and cash flows. Which is why at Hidden Gems those are the criteria we look for. It's a simple, simple philosophy. Buy great, don't worry about the wait. The results continue to be very pleasing.
Hidden Gems recommendations are beating the market at large (as measured by the S&P 500) by more than 20 percentage points since inception in July 2003. You can view all of our picks (as well as everything ever published in our pages) for free with a 30-day trial. Did we mention it was free? Click here for the details.
Bill Mann is the co-advisor of the Motley Fool Hidden Gems newsletter. He owns shares of Costco. Costco and UnitedHealth are Motley Fool Stock Advisor recommendations. The Fool has adisclosure policy.
