"Don't catch a falling knife."
"Bulls make money. Bears make money. Pigs get slaughtered."
And who could forget the infamous "Let's put some lipstick on that pig"?
If there's one thing Wall Street talking heads love, it's a platitude. But here's a saying the pinstripe and wingtip crowd too often forgets: "Don't throw out the baby with the bathwater."
Wall Street didn't think up that maxim, and brokers sometimes fail to heed it. Therein lies opportunity for the crafty value investor -- the guy or gal with the courage and foresight to adopt the market's unwanted, but valuable, companies when they're unpopular.
Gettin' ziggy wit it
If you've spent any time reading The Motley Fool, you've certainly heard us speak about cycles. Industry cycles. Market cycles. The occasional bicycle. But here's a little secret for you: Sometimes, "cycle" is just analyst-speak for "fad."
There are two ways to play a market fad. You can, of course, day trade, sitting all alone in your PJs, typing away in front of a glowing box as you bid up and short down a Phazar or a JDS Uniphase. But if gambling's your poison, wouldn't you have more fun doing it in Las Vegas? At least the drinks are free, and if you lose all of your money, no one has to know about it. After all, "what happens in Vegas, stays in Vegas."
The Foolish way to play a fad stands in marked contrast to the Vegas approach. Use fads to your advantage. Zig when the market zags. The great thing about this approach is that it avoids the bidding wars that accompany crowds. For example, when eBay (NASDAQ:EBAY) was popular, you couldn't get a bargain price on that company if your life depended on it. But, hey, as soon as the company announced a bit of extra capital spending on its Chinese business, it was "name your price," and "no reasonable offer refused." The stock dropped like a rock and savvy investors rejoiced.
Ready to swoop
Zigging when everyone else zags works great if you've already watched a stellar company like a hawk, ready to swoop in and pick up shares when the market makes a mistake. But what if you're not sure what company you want to buy? How do you find long-term winners then? Look for out-of-favor industries.
You see, just as the market can turn on a dime and whimsically label yesterday's "favorite son" today's "dog of a stock," Wall Street also withdraws its favor from entire industries in one motion. Right now, it's Detroit-based automotive stocks such as General Motors and Ford that are getting the Street's cold shoulder. They've both suffered mightily from fears that their junky credit ratings will cripple their ability to finance operations.
Yet, not coincidentally, while Wall Street has zagged as far away from these stocks as it can get, one very clever investor by the name of Kirk Kerkorian has zigged right in to double his stake in GM. It's beginning to look a bit like history repeating itself: In the early 1990s, Kerkorian invested $1.4 billion in troubled automaker Chrysler. That investment grew into $6.4 billion when the company was merged to found DaimlerChrysler. Kerkorian scored a 350% return in less than eight years by zigging when the market zagged.
Babies and bathwater
That brings us back to the sage advice about babies and bathwater. When frightened investors abandon an industry in droves, that's when a value investor's eyes begin to sparkle and a bargain seeker's ears perk up.
At Motley Fool Inside Value, we've made a lot of money for our subscribers by listening keenly for screaming babies -- er, bargains. For example, do you remember that little brouhaha a few years back over a company called WorldCom? Well, that company emerged from bankruptcy as MCI (NASDAQ:MCIP) last year, and, amid the general fear and loathing investors held for telecom stocks, MCI was left for dead. When Wall Street threw out this industry's bathwater, it didn't just toss MCI. The scandal-tainted company was also given a swift kick for good measure.
Yet, when our research team at Inside Value went fishing in the troubled telecom sector for investment prospects, we took a special liking to MCI. Although despised by Wall Street, we found the company's turnaround-minded management, its ultra-cheap price, and the piles of cash it generated quite endearing. And so we picked MCI up, gave it a brisk toweling off, and adopted it on behalf of our subscribers.
After hopeful parents Verizon (NYSE:VZ) and Qwest (NYSE:Q) came knocking on our door, asking to adopt little orphan MCI, the stock was up 40% against a market return of just 8%.
More happy hunting grounds
We recommended MCI in the first issue of Inside Value in September, and it's been our best pick. Since then, we've adopted 18 more prospective winners. Some have declined a bit, and others are doing nearly as well as MCI, which we sold in February. Overall, our picks are defying the market, having gained 9% versus the S&P 500's 2% return.
Over the next few years, we'll roll up our sleeves and continue our search for valuable companies that Wall Street is ignoring. We've got a few ideas already, with the intensely cyclical semiconductor industry offering up companies such as Intel (NASDAQ:INTC) and Applied Materials (NASDAQ:AMAT) at potentially attractive prices.
If you're of a mind to join us on our moneymaking expedition, take a free 30-day trial to the Inside Value newsletter. Try it and buy it, or try it and cancel with no questions asked. You have our word on it. For a limited time, new subscribers will receive a copy of Benjamin Graham's classic book, The Intelligent Investor.
Fool contributor Rich Smith has no position in any of the companies mentioned in this article. The value of the Motley Fool's disclosure policy is hard to overestimate.
