On financial television shows, market commentators have a rationale for everything that happens in the market. And most of the time, their analyses of the past seem plausible -- at least on the surface. This raises the question: If things are so obvious after the fact, why didn't they spot a particular trend ahead of time and make tons of money?
In reality, investors know very little with absolute certainty, and that's especially true about the future. Trust me, that's OK. If you admit that you can't know the future, you can focus on maximizing the benefits of what you do know: revenues, earnings, assets, dividend yields, and a company's history.
As a Foolish writer, I get bombarded with questions about the companies I cover. When I make the right call, the questions people ask are often about how I knew things were going to turn out the way they did. The truth is, I didn't. As seen below, the answers may surprise you, both because of how little I actually did know and because of what information led me to the conclusions I eventually reached.
You ask ...
"You bought Doral Financial (NYSE:DRL) on the day it hit its lowest price during this scandal. How did you know that it was done dropping when you bought it?"
I answer ...
In truth, I didn't know. The Puerto Rican mortgage bank is going through a very tough time. Its complex derivative transactions ran afoul of accounting rules. As a result, it will have to restate past financial results and take multimillion-dollar asset writedowns. Also, just before my purchase, Doral said it technically defaulted on loan agreements because it hadn't filed its financial reports with the Securities and Exchange Commission on time.
I had no earthly idea whether Doral was done dropping. What I did know was that even if the worst likely outcome were to take place, Doral was a tremendous bargain at less than $11 a share. It wasn't at risk of cutting its dividend, which was yielding 6.5%. Following restatements, Doral's per-share book value wouldn't be much less than the stock's under-$11 price. And the company's business was still gushing cash.
The market had presented me with an offer I couldn't refuse. I was willing to buy the stock and wait for the dust to settle.
You ask ...
"You've warned of potential competition to Taser (NASDAQ:TASR). Which specific competitors are legitimate threats to the stun-gun maker's business?"
I answer ...
Again, the answer is an enthusiastic "I don't know." Profitable monopolies don't tend to last forever, especially without government support, so their ability to raise prices ultimately comes under pressure. Cable television companies, such as Comcast (NASDAQ:CMCSA), in spite of often having monopolies in the markets they serve, have rarely sustained solid, long-term profitability. The costs of building and maintaining their networks, along with the cost of content from providers such as Disney's (NYSE:DIS) ESPN network, are significant ongoing cash drains. Then there are technological innovations, such as affordable satellite TV from the likes of EchoStar (NASDAQ:DISH) and DirectTV (NYSE:DTV).
Taser doesn't yet face legitimate competition, but rest assured that profits bring competition. Taser has enough trouble sustaining its business in the absence of a strong competitor; add a hungry rival into the mix, and the company's stumbles will be harder to overcome.
You ask ...
"Two weeks after you recently estimated that Bank of America (NYSE:BAC) would pay $1.90 in dividends this year and boost its dividend at about an 11% pace, the bank announced exactly that. How did you know what the bank was going to do?"
I answer ...
Yep, you guessed it: "I didn't know." To make my estimate, I simply read the same public information available to anyone. I judged Bank of America's prospects based on its past dividend practices, its growth potential, and the current rough banking environment, which I knew made a big hike unlikely. I also figured that Bank of America's board wouldn't boost the dividend by less than the company's expected earnings growth rate, since that would signal weakness.
Based on a rational interpretation of available public data, I made an educated estimate for my projection. In this case, my projection turned out to be dead-on accurate.
The secret of investing success
Know your limits. Accept that the future is not completely certain. Make the best, most fact-based and rational judgment you can with the all the data you can find. Readjust your thinking if facts change.
That's our strategy at the Motley Fool Inside Value newsletter, and it's helped us more than triple the market's performance since last August, when we started up. Lead analyst Philip Durell is astutely able to ignore the unknowable and focus on the facts. This logical approach has served masters such as Benjamin Graham, Warren Buffett, Bill Miller, and, yes, even Philip Durell. With Philip's help, it can serve you, too.
Click here to try Inside Value free for 30 days. You'll get access to all of Philip's monthly stock picks and the newsletter's message boards. There's no risk, and you can quit with no obligation before the trial is up. Seriously -- if Chuck can beat the market with as little as he knows simply by using the rational approach embraced by Inside Value, you can, too.
Doral is one of Philip Durell's Inside Value recommendations. Taser is a Rule Breakers pick.
Fool contributor and Inside Value team member Chuck Saletta owns shares of Doral and Bank of America. He doesn't have a financial position in any of the other companies mentioned.The Fool is investors writing for investors.
