Avoid These Bracket-Busters

Over the past few days, I have been inundated with invitations to join various March Madness office pools -- all sent by rabid basketball fans whom I have little chance of beating. These contests reward the most astute (or lucky) handicapper who correctly picks the most winners in the NCAA college basketball tournament.

Unlike in prior years, I haven't followed the sport too closely this season, memorized pages of statistics, or even watched an entire game. That lack of preparation makes it pretty tough to come up with an educated guess -- let alone an accurate prediction -- of who will make it to this year's Final Four.

It's all for fun, of course, so I won't lose sleep over losing a dollar or two. But some people are equally capricious when it comes to managing their investments. Don't let these common bracket slipups influence your investing picks.

Sticking with your favorite teams
As a graduate of the University of Arkansas, I usually pencil in the Hogs for at least a reserved spot in the Sweet 16. Sure, it's been 12 years since their last national championship, and this year's squad might be outclassed, but it's hard to bet against your personal favorite.

When it comes to your portfolio, though, it pays to be a fair-weather fan. When times get tough, there's nothing wrong with switching your allegiance elsewhere.

Data-storage giant EMC (NYSE:EMC) used to be one of my dependable go-to teams, racing from around $10 in the summer of 1998 to just less than $100 in August 2000 -- a 10-bagger within two years. However, the company's winning streak abruptly halted a year later, when a broad downturn in IT spending slashed revenues and squeezed gross margins from 58% to 40% year over year.

Faced with mounting losses and a grim outlook, any objective observer would have thought twice about sticking with the company -- but I remained steadfastly loyal, and it cost me. The stock quickly relinquished its earlier gains, falling all the way back to the single digits within the next 24 months.

Jumping on the bandwagon
No one admits to being a bandwagon-follower, but I don't remember seeing too many Gonzaga fans until the unheralded 'Zags advanced to the Elite Eight in 1999 and then kept on winning. In the years since, legions of fans (myself included) have developed a soft spot for the scrappy team. But when it comes to investing, I seldom follow the crowd.

While there is no such thing as too much fan support in basketball, an overzealous fan base in the corporate world usually leads to an overvalued stock. Take Google (NASDAQ:GOOG), for example -- not exactly a Cinderella story, but like Gonzaga, it has emerged from nowhere to quickly become a fan favorite.

Admittedly, the company is a top seed among tech heavyweights and a force to be reckoned with in the lucrative online-search business. However, between its wildly popular technology and the 115% surge in its shares last year, the company has attracted too much attention for my taste. Even after retreating nearly $150 from its peak, the stock still trades at excessive trailing P/E and price-to-cash flow ratios of 67 and 40, respectively.

Clearly, the company is executing its game plan flawlessly right now, but at this price, all it takes is one airball to send disappointed fans scrambling for the exits.

Overrating your favorite conference
As a huge fan of the Southeastern Conference, I've noticed that a disproportionately large number of SEC teams always seem to advance far into my tournament brackets. Sometimes this works out (thank you, Kentucky); other times it doesn't. In any case, it's a biased approach that should be avoided when it comes to investing.

In the financial world, it can be dangerous to load up on too many companies operating within a single industry. Regardless of the reason, showing too much partiality to one group is a good way for your portfolio to get shellacked, should there be a downturn in the sector.

For example, no matter how much you love Midwestern regional banks, it might be overdoing it a bit to load up on National City (NYSE:NCC), U.S. Bancorp (NYSE:USB), and Fifth Third Bancorp (NASDAQ:FITB). Just think what might happen if the yield curve began to flatten, compressing net interest margins and crimping interest income. Wait -- that did happen last year; if these companies had been teams, they'd have been eliminated in the first round. I'm not suggesting that there's anything fundamentally wrong with the banking industry; I'm just pointing out the perils of overexposure.

Never picking the underdog
When it comes to picking winners, we all seem to have different methodologies. However, nearly everyone agrees that it is impossible to climb to the top of the standings without correctly calling several major upsets. Picking the same favorites as everyone else makes it hard to gain ground, and increased parity has made the smallest teams more competitive with the perennial powers.

Consider this:

• The No. 1 ranked team has won only three of the past 20 tournaments.
• A double-digit seed has advanced to the Sweet Sixteen in 19 of the past 20 tournaments.

Similarly, you might be wise to add a few underdogs to your portfolio. Businesses that have been widely overlooked or disregarded -- in other words, value companies -- often soar past higher-seeded growth companies, catching everyone off-guard.

Most people might think that young, fast-growing firms would run circles around an aging company such as Motley Fool Inside Value pick Colgate-Palmolive (NYSE:CL). There's certainly nothing flashy about the mature toothpaste-and-oral-care market. Yet over time, Colgate has learned to perfect the fundamentals. It may not be an energetic rookie anymore, but the stock has still racked up annual gains of 13.3% over the past decade -- easily outscoring the S&P. Clearly, there's something to be said for experience, on and off the court.

Wall Street may have assigned them unfavorable seeds, but over the past 10 years, value stocks have consistently proved their mettle. Not surprisingly, renowned investors like Warren Buffett and Bill Miller turn to undervalued companies time after time when the game is on the line.

Can you afford to guess?
Are you still having trouble filling out this year's tournament brackets? When in doubt, I recommend No. 10 seeds. However, if you are second-guessing a few of your investment picks, don't play hunches -- turn to the experts at Inside Value.

Philip Durell's team separate the winners from the losers, and with carefully calculated intrinsic values, Inside Value also gives you a good idea of just how far each pick will advance. Want to know how much higher Philip thinks Colgate (and more than 30 other sleeper companies) can climb? Take a free peek and find out.

Next to Duke over Southern, it just might be the easiest decision you'll make all month.

Fool contributor Nathan Slaughter scored more than 12 points in his junior high basketball career. He owns none of the companies mentioned. U.S. Bancorp and National City are Motley Fool Income Investor recommendations.The Fool has a disclosure policy.