Groupthink. Herding. Schizophrenia. These are much kinder words than I could have used to describe the psychology surrounding my former Motley Fool Hidden Gems recommendation Deckers Outdoor (NASDAQ:DECK) over the last two years.

Deckers Outdoor has made for an amazing market psychology case study. It has gone from loved to hated and back again, leading it to post a meteoric rise, a dramatic fall, and finally a reversal of fortune. Since the market behaves like this all the time, let's dissect this particular case to understand what happened, and how we can take advantage of the situation.

The find
I recommended Deckers Outdoor, maker of UGG, Teva, and Simple footwear, in the September 2004 issue of Motley Fool Hidden Gems. I didn't buy the fad argument; the UGG brand grew because the business leaders nurtured it. Orders from Nordstrom (NYSE:JWN) increased as designers created new products that more and more people wanted to buy. The kicker was that the stock price had fallen from its 52-week high.

But after a steady rise to a new 52-week high, things got ugly. Very ugly.

The fall
There's nothing like missing earnings to take the wind out of a stock's sails, especially if its expectations outpaced its fundamentals. So when management announced a serious shortfall at the Teva brand in spring 2005, the stock cratered. To compound the problems, the fad argument resurfaced again, this time with a vengeance.

The stock lost about 65% of its value from December 2004 to October 2005, as the company revised expectations, and the stock grew to become the second-most-heavily shorted stock on the Nasdaq. I thought I was going to lose my mind.

It took every ounce of patience and confidence I had to endure the slaughter. It was hard to watch competitors like Keen, Merrell by Wolverine World Wide (NYSE:WWW), and Chaco eat Teva's lunch. And I almost got caught up in the "conspiracy theory" innuendo that shorts had taken control of the stock. Instead, I rechecked the bear thesis, did my channel checks, and trusted my judgment about the data.

CEO Angel Martinez made the pain a little more bearable by remaining focused on running the business, rather than launching an attack against the short sellers like that of (NASDAQ:OSTK) CEO Patrick Byrne. According to Owen Lamont of the Yale School of Management, fighting short sellers directly (PDF file) doesn't help.

Groupthink and herding led to the fall, and the lemming analogy fits. The bearish viewpoint converged, and the stock price fell. The more the price declined, the more new bears joined the flight, causing the price to fall further. Markets are complex adaptive systems that need thought diversity (PDF file) to function properly. Without it, the market's internal pricing process can break down.

The rise
It works in reverse, too. Since November 2005, the stock has gained about 270% from its low. This is where the market's schizophrenia becomes very apparent. How can a stock go from being overly hated to overly loved? Ivo Welch has the answers in his paper "Herding Among Security Analysts" (PDF file).

Deckers' stock price started to recover when the data confirmed that UGG was not a fad, but a growing brand, and that Martinez was putting serious resources toward repositioning the down-but-not-out Teva brand. Analysts took notice of both developments and began changing their recommendations and price targets. Just last week, two analysts increased their target prices. Finally, short interest has dropped considerably. I have to wonder whether groupthink and herding are reemerging, driving prices up too far, just as they previously drove prices down to low.

You have to love market psychology.

It's like deja vu all over again
So what's an investor to do if this happens over and over again? Here's what I recommend:

  1. Recognize that the market psychology does exist.
  2. Collect and analyze your own data.
  3. Trust your judgment.
  4. Be greedy when others are fearful, and fearful when others are greedy.

I can't take credit for the last one. Warren Buffett gave us that pearl of wisdom, and he seems to have done pretty well for himself as an investor.

The fall and rise of Deckers Outdoor was tough to stomach. I'd rather not go through it again (wouldn't it be great if all our stocks just went up?), but I know there's a good chance that I will. I don't want you to go through that, either, but you probably will, too. That's why I wanted to share my experience.

Hopefully, this case study will achieve three things:

  • Prevent buying high and selling low. That investment philosophy doesn't work.
  • Help you endure the pain, should it happen to you.
  • Encourage you to buy stocks at depressed prices.

If they're sound, sturdy stocks, you can turn around and sell them when there's more than enough love to go around. Now there's a happy ending.

For more on Deckers Outdoor, check out:

Deckers Outdoor is a former Hidden Gems recommendation. To find out more about how small-cap stocks can have a big impact on your portfolio, try Tom Gardner and Bill Mann's newsletter service free for 30 days. was a former Motley Fool Rule Breakers recommendation.

Retail editor and Inside Value team member David Meier owns shares of Deckers Outdoor, but he does not own shares in any of the other companies mentioned. He is currently ranked 300 out of 22,222 investors in The Motley Fool CAPS rating service. You can view his TMF profile here. The Fool takes its disclosure policy very seriously.