Mel Brooks on Value

There was a peaceful town called Rock Ridge .
Aside from the earth-shaking campfire 'n' beans gag, my absolute favorite scene in Mel Brooks' Blazing Saddles comes when the Waco Kid, played by Gene Wilder, wakes up in the Rock Ridge jail. When the new sheriff, played by Cleavon Little, asks him about breakfast, the Kid says, "Food makes me sick," and he gets his morning glory by upending a bottle of bourbon and draining it in one pull.

The sheriff says, "A man drinks like that, and he don't eat. ... He is going to die."

The Waco Kid stares off into space, unsure of whether he believes it, and asks, "When?"

Too many investors are like the Waco Kid. They buy stocks at any price. You can point out to them that sooner or later, the bubble will pop. But they can only see that the bubble hasn't popped. And they've been told plenty of times that it will. But like the Waco Kid, they haven't crashed and burned yet. That's all the proof they need to prove to themselves that their behavior is safe.

Google's Waco Kids
The problem is, when you make like the Waco Kid and, say, guzzle a bottle of Google (NASDAQ:GOOG) at 100 times earnings, reality always does catch up. The fact that people can't tell you when it will happen is no refutation of the certainty that it will.

Remember Google? Remember a few weeks back, when everyone kept pointing to the stars and saying "$500 next. Then $2,000?" Well, the recent CFO comments only made clear what many of us have known for months: Even Google can't defy gravity. And those who waited until now to realize it are sitting on a quick 25% loss.

Well, welcome to Painsville, Kid. Population: you.

None of this is meant to imply that Google's not a healthy company, but a company and a stock are entirely separate entities. A stock has a price, and buying at the wrong price means you can lose your shirt on healthy companies every day of the week.

Waco 's long saga
Google is only the latest chapter in a long, repetitive story. Investors nowadays tend to think that only techs can get crazy, but back in 1972, McDonald's (NYSE:MCD) traded for 75 times earnings, Black & Decker (NYSE:BDK) at 51, Johnson & Johnson at 60, and Avon Products (NYSE:AVP) at 63. Take a look at what happened to Wall Street's Waco Kids when the bottle caught up two years later, in 1974 -- the very year Blazing Saddles was released.

Figures from The Davis Dynasty -- a great book to reread when you need to remember the importance of price.

The bottle always catches the Kid
There are reams of research proving the simple maxim illustrated in that table: If you overpay, you underperform. And what drags down individual investors can drag down market averages, as Jeremy Siegel found. In The Future for Investors, he points out that the reason the constantly "updated" S&P 500 index underperformed the original members is precisely because the indexes added (bought, in investor terms) companies exactly when they were overvalued.

This is, of course, why I, and my like-minded colleagues at Motley Fool Inside Value, don't engage in the Waco Kid method, even when it comes to "great companies." Don't get me wrong. We love great companies. We prefer them. But we buy them only when they are priced at a discount. Sometimes, we require a pretty big bargain, sometimes less.

If we're talking about a company the world could live without, we might demand a 35% to 50% markdown. With a stalwart like 3M (NYSE:MMM) or Home Depot (NYSE:HD), we might require only a 15% mark-off from what we consider the right price. We won't always be right. And we will get our share of losers. Promise. But our losers are fewer and far less traumatic when we pay less up front.

The odds shift dramatically just by our avoidance of unhealthy investor behavior. The Waco Kid method may be good for a giggle, but it's no way to invest. If you'd like to step away from Waco's breakfast bourbon and learn how Philip Durell beats the market with stocks that will keep you healthy, wealthy, and wise (make that "Foolish") for as long as possible, a guest pass to Inside Value is free.

Seth Jaysonfigures he should do all his article research with Mel Brooks on a big screen. At the time of publication, he had shares of Home Depot and 3M but no positions in any other firm mentioned. Home Depot and 3M are Inside Value recommendations. View Seth's stock holdings and Fool profilehere. Fool rules arehere.