Buy the Steak, Not the Sizzle

I don't know whether Philip Durell, lead analyst for the Inside Value newsletter, is a Seinfeld fan or not, but I know he would appreciate Kramer's words while "working" for Brand/Leland: "You don't sell the steak. You sell the sizzle."

Early in the life of great companies, there's a lot of hype. Wall Street supplies plenty of hype to generate transactions because that's how brokerages get paid. Executives hype up their company because it's their job; every CEO worth his weight in gold would say his stock was undervalued. So when a young company with a great concept comes out, all the buzz is buy, buy, buy: "It's going to grow earnings. We're going to grow the top line. EBITDA is on the rise." You know all those stories about unlimited growth? That's the "sizzle."

Unfortunately, not everyone can be the next Microsoft (NASDAQ:MSFT). But guess what? You don't have to find the next Microsoft early in its life cycle to generate great returns. You know the best companies -- the ones that generate the best returns, continue to grow, and create lots of free cash flow. We'll call these the "steak."

Can you navigate through the sizzle in order to find that choice cut of steak? Although it's not always probable, it is definitely possible. But you know what else you can do? You can order the steak when it goes on sale -- after the sizzle has worn off.

Even the best make mistakes
The best companies are easy to spot. They have history and proven track records, and are in the news all the time. And while they typically sell at a premium, that's not always the case. Fortunately for Fools who subscribe to a value-oriented philosophy, nothing in life is perfect. Even the best companies make mistakes, run into trouble, or have to make tough competitive choices.

Have you ever been in a crowded city but felt alone because no one knew who you were? Sometimes great companies feel the same way. They are in plain sight, and yet no one pays attention to them.

In 2000, Dell (NASDAQ:DELL), Best Buy (NYSE:BBY), Amazon.com (NASDAQ:AMZN), and AES (NYSE:AES) were soaring. They were the poster children for everything that is great about American capitalism. And these four great companies hit their all-time highs in 2000. Then, things changed.

Dell was slashing prices at the same time it was extending its product lines. Growth was slowing, and the threat of a price war from the competition was very real. As a result, the stock fell 71% from its all-time high.

Best Buy was also down because of slowing growth in a softer economy and increased spending on promotion and advertising. Wall Street was not happy when Best Buy lowered its earnings guidance and subsequently knocked 73% off the stock price.

From late 1999 to October 2001, Amazon.com lost 94% of its value during the dot-com collapse.

AES dropped from $70 to $1 as it began to experience slowing growth, got caught up in the fallout from the Enron collapse, and felt the pain of foreign currency collapses in South America, where it owed some generation plants.

That kind of carnage hurts to review. But the lesson is: No company is perfect.

The best bounce back
Were these companies without any meat on the bones, made up of only a sizzling story? The answer is no. An emphatic heck no! These companies are all meat -- prime, grade A, U.S. choice.

So why were they punished? It was a combination of out-of-whack expectations that could not be fulfilled and problems with their businesses. You see, many times, the sizzle gets oversold. And as soon as something goes wrong, investors head for the exits. (This is where I am supposed to insert a witty comment about the irony of markets being efficient. You're Foolish. You know they're not.)

Like I said, everyone knew these companies were plenty meaty -- and yet they were sold off heavily. The market was almost giving their greatness away: These companies had solid fundamentals, solid game plans, and plenty of room for growth. Investing in them during the worst of times would have produced the following returns:

Let's face it, the best companies bounce back because they are best. And if you're not looking in the right places, these great opportunities will pass you by. No, none of these investments have made 40,000% returns in the short time frame since their low points. But out of the millions of investors who have put their money into the stock market, how many people do you know that have actually generated a 400-bagger? Finding the 400-bagger as an outside investor is about as likely as winning the lottery.

The value myth
There are two huge misconceptions about value investing. The first is that it's boring. Who wants to brag about buying an undervalued company? There's rarely any news coverage about undervalued companies because there's no sizzle to sell the newspapers and magazines. But I, for one, have never found solid investment ideas boring.

The second misconception is that value investing involves sifting through lots of data and ratios. But don't think of it in terms of low price-to-earnings or low price-to-book ratios -- it's so much more than that.

Value investing is about finding great companies that are underappreciated for a limited time. It's about being a contrarian and going against the grain. It takes guts, as well as the ability to look through the misery in order to assess just how much meat is on the bones.

That's where Inside Value can help
Philip Durell and the Inside Value team are always on the lookout for the best opportunities. Philip knows that to outperform the competition, you have to look in places where others fear to tread and think differently about the best way to invest your hard-earned capital. For good reason, you won't find a whole lot of sizzle in the Inside Value portfolio. That's because Philip is more than happy to wait for the right opportunity to invest, after the sizzle dies down. He doesn't know when the next great company will fall from grace. But he will be there to find them when they do.

Value investing is more than a style; it's a philosophy, a way of life. To see how Philip Durell is beating the market by finding meaty companies, try Inside Value risk-free for 30 days.

Fool contributor David Meier owns shares in AES but not in any of the other companies mentioned. The Motley Fool has a disclosure policy.