A Patient Investor's Guide to Profit

Patience may indeed be a virtue, but when it comes to investing, it seems we're all in a hurry, spurred on by the vices of avarice and greed. All too often, we feel that we must buy a stock rightthisminute or else the train will surely leave the station without us. Instead, we just end up on the wrong track.

Growth investors are often guilty of this investing "sin," feeling that when a stock is moving up, they better climb aboard. Did Forward Industries (NASDAQ:FORD) double from $4 to $8 and then double again to $16? Let's buy in! And momentum investors, well, they're simply a highly caffeinated version of growth investors. They're not even concerned with what the company does, so long as it's going up, and going up fast! ViroPharma (NASDAQ:VPHM) just ran from under $2 to above $15? Better get in line as we run it up more. Just watch out below when it plummets back to Earth.

The rest of us need to take care to invest not only in the right stocks, but at the right price and at the right time. Jump in too soon and we may catch the clichéd "falling knife." Jump in too late and we'll have missed our chance to maximize our returns. Patience is a valuable key to winning investments. And profits.

Magical elixir called "patience"
So how do we go about acquiring this mystical stuff called "patience"? Well, it certainly takes time. I think most every investor at one time or another has hastily purchased a stock and been burned in the process. Even though my mother used to tell me that "the burned hand learns best," I'd rather know the right moment to buy a stock ahead of time than walk around with blisters and bandages.

One of the primary techniques to attain patience is, quite simply, to do nothing. That's it. Don't buy. Don't sell. Don't watch CNBC. Just ignore the market and wait. Actually, you do have to do something. Use your time ignoring the market to get to know your company. Know it, understand it, value it. And once you get a good idea of what your company is worth, just wait some more.

It took me a long time to understand this principle of value investing. The stock market at times is quite exuberant, at others quite depressed. Master value investor Benjamin Graham described it as a manic-depressive friend who is always willing to give you a price for your company. Some days he is upbeat and overvalues your stock. Other times he is downcast and undervalues it. More often than not, he over- or undervalues your company again and again. It just takes time for him to switch moods. Just look at what happened to LaBranche& Co. (NYSE:LAB) after the New York Stock Exchange specialist trading firm reported weak earnings earlier this year. The market punished it for being inferior to cheaper and faster electronic trading systems, but failed to consider that it still acts as a specialist for more than 600 firms. LaBranche, which had been cut in half, has since climbed back up to near its 52-week highs.

And that's why we wait. Because the stock market has been wrong in the past about the value of our company, we can be assured it will be wrong about it again in the future. If we are willing to wait -- if we are patient -- the stock market will give us the price that we want to pay for our company.

No one knows this principle better than Philip Durell, lead analyst of the Motley Fool Inside Value newsletter service. For the past year, Philip has been patiently picking undervalued companies and just as patiently watching them beat the market as investors realize their value and bid their prices up. Since August 2004, Philip is besting the market by nearly five percentage points.

Philip has the patience to find good companies and then wait until they come down to his price before pouncing on them. For example, consumer products giant Colgate-Palmolive (NYSE:CL) was an early Inside Value pick, beaten down by one of the market's manic overreactions. Here was a company that had missed analyst earnings estimates and reported revenues 10% below the prior year. It's a $27 billion company that lost 10% of its value. Philip's call to profit from this consumer stalwart was timely as investors have seen their shares rise 12% in less than a year versus the market's 2% rise.

That's what happens when Mr. Market overreacts to bad news. Opportunities arise that allow savvy investors to step in. If you've priced it right, you can profit handsomely.

Catalyst for a fresh start
Yet bad news and a deflated share price don't necessarily make for a value pick. Heck, you can look at any financial paper and see stocks hitting all-time lows on a daily basis. Instead, you need to understand the company and what's going to change the thing that's wrong with it.

Noodle maker American Italian Pasta (NYSE:PLB) has been facing some tough competition from private pasta makers and large rivals such as Kraft (NYSE:KFT). Around the time Philip was recommending First American (NYSE:FAF) to subscribers -- and realizing a subsequent 47% gain for them -- American Italian Pasta was warning investors that consumers were still cutting back on high-carb foods and pasta was in the crosshairs. The stock began tumbling and immediately fell more than 10% off its highs. Good time to buy, right? Not so fast! There were more revelations to come as the company reported accounting irregularities, the founder and CEO both resigned, the SEC launched an investigation, and trial lawyers bombarded the company with class-action lawsuits. The stock is now down more than 76% from its 52-week high and the pain doesn't seem to be over.

To give you an idea of how much a little bit of patience can affect your returns, consider the following:

*May still not be a value.
**Denotes prior Inside Value pick.

What did Philip see in First American that others ignored? And equally important, why was it not present in American Italian Pasta?

In First American, Philip saw a company that was the No. 1 company in its primary business segment -- financial services for title insurers -- and is a strong second in its other segments. Where the likes of American Italian Pasta were decimated by changing demographics, an industry leader like First American uses changes in customer demographics to its benefit. Mortgage refinances may slow due to rising interest rates, but the trend is for more people to own their homes. The company's services will be necessary regardless. Moreover, Philip is willing to wait for the companies he likes to reach his price. Those who jumped into American Italian Pasta at $10 did so too soon, as did those who jumped in at $7. The catalyst for First American is a proprietary database of information. American Italian is still coming to grips with its finances.

Catching the exact top and exact bottom is not necessary to handily beat the market. Beating the market requires the patience to wait for the right buy or sell price. Doing so requires that you learn about your company, value it, and then wait for the market to give you that price, as it invariably will. Moving too soon can hurt you. It may just be that value investors are really virtuous investors.

This article was originally published on May 6, 2005. It has been updated.

Want to join Philip and the Inside Value team on their hunt for bargain-priced stocks? Try a risk-free 30-day trial on us. In addition to receiving two value recommendations per month, you'll have access to all our back issues and our Foolish community of message boards.

Fool contributor Rich Duprey does not own shares of any of the stocks mentioned in the article. Kraft is an Income Investor pick. The Motley Fool has adisclosure policy.