Teamwork Wins Tournaments

Wall Street is a guessing game. Investors forecast the potential long-term cash production of a business, estimate how risky those projections are, and use that information to determine how much they're willing to pay for the firm. If the company is trading for more than that level, investors will sell. If it's trading for less, they'll buy. The stock will rise or fall depending on the relationship of buying pressure to selling pressure. Eventually, a shifting price will change investors' perspectives, altering the balance of buyers and sellers, and creating an equilibrium price for each stock.

It's a great mechanism for both providing liquidity and determining the market's real consensus forecast for a business. Still, it's important to remember that a stock's market price is nothing more than an aggregate guess. No matter how you build your projections, the odds are that you're wrong. However, being wrong can be good for your portfolio -- if you're wrong in the right way.

The right way to be wrong
There are two ways to be wrong: being too aggressive in your predictions or too cautious. Get too aggressive, and any surprises will likely disappoint you. But if you're too cautious, those surprises will likely be happy ones. Since major shifts in stock prices are driven more by surprises than expectations, you're better off setting yourself up for a positive surprise by estimating a low, conservative value for the business. If you buy a company's stock when it's trading below what even your rock-bottom expectations suggest it's worth, you'll be poised to catch the upward move if it reports and projects better numbers.

That's known as investing with a margin of safety, and it's a key part of what we do at Motley Fool Inside Value. This time-tested approach was pioneered by Benjamin Graham more than half a century ago. Today, it's followed by the world's most successful investors, including Graham's former pupil Warren Buffett.

Of course, no matter how cautious you are, you could still find yourself on the "too aggressive" side of the market, as I was when I first bought shares of pharmaceutical giant Merck (NYSE:MRK) in November 2003. Sure, I knew Merck had a relatively weak new-product pipeline and that it was facing the ever-ticking clock of expiring patent protection. Even so, I believed that the company was worth more than the $41.04 per stub I paid. But I hadn't counted on the Vioxx fiasco. The premature loss of that major drug, combined with the associated lawsuits from the scandal, simply never entered my analysis. As a result of Vioxx, Merck turned out to be worth less than I had originally projected.

Build a winning team
No matter what you do, your investment decisions are based on projections of the future. If you place all your faith and investments in a single company, you run the very real risk of being surprised by the inevitable corporate stumble. Even Warren Buffett spreads out his bets. Although Buffett's personal wealth is largely tied up in Berkshire Hathaway, Berkshire owns a stake in multiple businesses, including such greats as American Express (NYSE:AXP), Wal-Mart (NYSE:WMT), and Coca-Cola (NYSE:KO). Having its money invested in multiple places helps Berkshire protect itself from the catastrophic impact of any one investment's potential failure.

To be a truly successful investor, you can't put your faith in a single superstar stock to rocket your portfolio to greatness; the potential of getting ruined if your projections prove too aggressive is just too great. At Inside Value, we take that lessons to heart and operate accordingly. Our goal is to find solid companies, each trading below our conservative estimate of its true worth. While not every investment will work out on its own, the whole collection has done stunningly well. As of this writing, the current and former members of Inside Value's team of stocks are leading the market, gaining a collective 13% versus the S&P 500's 8.3%.

I did mention former members of the Inside Value team. Yes, it's true: Five companies are no longer members of our market-beating service. Fortunately, only one has left on less than favorable terms. The table below shows our alumni roster, along with the primary reason why each pick is no longer around.

That's three completed or initiated buyouts, one company that rocketed too high for comfort, and only one complete flop. These results show the strength of the total Inside Value roster. Its team of solid performers has proved that it can stay on top of the competition.

The Foolish bottom line
Championships are typically won by an extremely strong overall team, not by a superstar carrying the weight of an otherwise weak group. Assembling a solid group of value-priced companies in your portfolio is the best way to build your own champion-level team.

Are you ready to begin assembling your portfolio of solid companies? Do you want a team with the potential to go the distance? Click here for a 30-day free trial to Inside Value to start recruiting your roster. Subscribe today, and we'll throw in the Fool's international stock report,Around the World in 80 Minutes, absolutely free.

At the time of publication, Fool contributor and Inside Value team memberChuck Salettaowned shares of Merck, Doral Financial, and Omnicare. Coca-Cola is a Motley Fool Inside Valueselection. Merck has been recommended by Motley Fool Income Investor. The Fool has adisclosure policy.