Pardon me while I polish off an old chestnut
There's an old joke about investors and academics who believe that the market always knows the right price for an equity -- "efficient market" types. It goes something like this. Two EM guys are walking down the street and notice a green slip of paper that says "$20" and has a picture of Andrew Jackson on it. One considers picking it up but the other stops him, saying, "No, if that were really a $20, someone would have picked it up by now."
And they walk away. Of course, if you stick around and imagine the credits on this wisecrack, it's easy to picture someone less well-educated, someone too naive to believe in completely efficient markets, stopping to pick up the bill. This Fool, not prone to overthinking, would have just stuffed that $20 in his pocket and walked before the wind blew it to Jersey or the rats shredded it for bedding.
Value missing value
Those of us who believe that buying underappreciated stocks is the key to beating the market like to think we're that credit-reel Fool. We Inside Value types believe that we are the ones who can see that the market isn't always right and that there may be free money for the taking.
Truth be told, last year was pretty good. A couple of solid, though non-traditional values, such as rebounding retailer and flash memory maker SanDisk (NASDAQ:SNDK), turned in better than 100% gains. I had a few mere 50%-60% returners, the likes of Elan (NYSE:ELN). These were tempered, of course, by some major stinkers -- cough! FARO Technologies -- but on the whole, I can't complain.
Yet, as much as I like to think I can spot a bargain and capitalize on it, I like to look back once a year at the ones that got away. The $20s I left lying on the sidewalks. The fat pitches I took for strikes. Pick your poetry, but last year, I missed a few doozies.
Red hat? Red face
Company: Red Hat (NASDAQ:RHAT)
Return I missed: 100% or more
The story: This one kicks me just about every time it releases earnings these days. You might ask, "What kind of a value guy would regret not buying a company trading at a P/E of 100?" One that regrets seeing something in the low teens double, or more, to $28 and change today on a strong business model that has great leverage and an expanding customer base.
I first began eyeballing Red Hat in September 2004, after some drama had beaten the shares down to a point where even a skeptic had to take notice, and a good-looking earnings report was greeted by a 13% drop in the stock's price. Sure, I had some concerns about stock options, but this didn't look like a deal breaker to me. And I never really believed that Microsoft (NASDAQ:MSFT) was going to squash the upstart. There's plenty of room for Mr. Softy and his competitors.
So what was my excuse when last December's good numbers rolled around and investors got a bit edgy? I wish I had one. Will you accept "too much eggnog"?
As my colleague Nate Parmelee -- who is also mumbling under his breath about missing the boat on this one -- recently discussed, Red Hat continues to fire on all cylinders. Margins keep improving. Cash flow is good, and it really appears to be the leader in its field. Tragically for me, and anyone else who didn't buy last year, the same thing was true then. Worse yet, the company traded in the low teens for months this year, providing for a quick double once the Street finally decided that the good news was for real.
The lesson: Sometimes things really are as good as they look. You could do worse than to buy when the Street slams these winners.
Somebody get me some drugs
Company: Omnicare (NYSE:OCR)
Return I missed: 100%
The story: I have pretty crummy excuses on this one, too. This 100% gainer was, after all, an Inside Value pick back in November 2004. It rose a bit, then fell and offered us all another chance to get in around $30 a share. Stubs currently change hands for almost $60 each. How'd you like a bit of this in your portfolio? Yeah, me too.
Why wasn't I in on this? Quite simply, I was lazy. Sooo lazy. Omnicare wasn't the simplest of businesses for me to understand, with its drug-delivery enterprise and database biz. Quite simply, it was outside my circle of competence, moderately levered-up, and had some exposure to government medical programs. It was also on a bit of an acquisition binge, a situation that continued through 2005.
My fears were, of course, the same as the market's. But when the Street finally realized the value of the mergers and the company's solidified status as the gorilla in its field and came to believe that the acquisitions would work out, the price began to move up to reflect the enthusiasm. And that, of course, is the essence of value investing. Wish I'd looked hard enough to see the obvious.
The lesson: Get off your duff. Don't be so afraid of debt, and learn more about businesses outside your circle of competence.
Buried by earthmovers
Companies:
Caterpillar (NYSE:CAT) and Joy Global (NASDAQ:JOYG)
Return I missed: About 30% to 35% on Cat; 100% on Joy
The story: At least I've got a little company in my misery here. My colleague Stephen Simpson knocks his head against this one too. (See this recent take on Joy.)
The old wisdom on heavy machinery companies like Cat and Joy are that you need to buy when things are bad and get the heck out when things look good. Except that this time around, things are different. OK, if not different, the good times have rolled a lot longer than anyone expected. And there's something to be learned from that.
The energy situation and increased demand for coal get credit for the assist for Joy, and housing and other heavy construction gets the nod for the results at Cat, a few more recent earnings warnings and stock jitters notwithstanding. For my part, despite all the grousing I do about the high costs of housing, I don't really believe the party's going to come to a complete halt, and even if there are pricing pressures in construction, it doesn't mean equipment makers are going to see the end of the line.
On the other hand, the long-lived high times doesn't mean these two are immune from ye olde cycles, but it does mean that this Fool, at least, will try to think a bit harder about just what constitutes a cycle, and keep his eye fixed a little more firmly on the prize.
The lesson: Don't fear the cyclicals. Don't assume you know when the party will end. Capital spending may surprise you.
Foolish bottom line
If you want to pick up all the free $20s the market leaves around, you need to remember the ones you missed. There's no shame in that. Investing is a game in which you are guaranteed to make mistakes. Learning from lost opportunities is the best way to invest in your investment future. That's why it pays to take a look back at the year and see where you did well, why you did well, and how you can do better.
We do that every month with our recommendations in Motley Fool Inside Value because we know that the key to success isn't just buying low and selling high, it's getting smarter all the time so you can recognize cheap before the market does. If you want a risk-free peek at how we do it, a free trial is just a click away.
For related Foolishness:
- My colleagues dive into the Dow. See what they think of Cat.
- See Caterpillar get bulldozed.
Seth Jayson hopes that in next year's look back, he'll have to explain why his entire portfolio went up 100%. At the time of publication, he had shares of Microsoft, Elan, and SanDisk, as well as covered calls on the latter, but he had no position in any other company mentioned. View his stock holdings and Fool profile here . Microsoft is a Motley Fool Inside Value recommendation. Faro Technologies is a Hidden Gems pick. Fool rules arehere.
