Can You Smell the Market's Fear?

American investors worry about Brazil. Despite the most robust economy in South America, its growth was only 2% annually from 2001 to 2003. There's also currency risk, government regulation, and national debt. Moreover, the recent financial collapse in Argentina has investors wary of investing in the region.

But as a smart investor, you can use this fear to your advantage.

Brazilian bathwater
Embraer is an aerospace company based in San Jose Dos Campos, Brazil. And while it is technically a Brazilian company, approximately 97% of its revenues come from North America and Europe. Customers include Continental, British Airways (NYSE:BAB), and US Airways (NYSE:LCC). The company also happens to be New York University finance professor (and Fool contributor) Aswath Damodaran's best investment ever -- as he told Fool co-founder Tom Gardner in a recent interview.

"Investors," Damodaran explained, "tend to discriminate when it comes to emerging-market companies. When there is a crisis in an emerging market, they dump everything." This includes well-managed and diversified companies like Embraer.

Perceptions of Brazil being what they are, there have been numerous occasions to pick up Embraer shares on the cheap. Just take a look at how many times the stock dropped sharply over the past few years. An investment at the beginning of 2003 would be good for a four-bagger by now -- or greater than 50% annualized returns.

Discriminating investors
But most investors aren't xenophobic -- they fear anything in crisis. After all, psychologists Daniel Kahneman and Amos Tversky showed in their research just how much it pains human beings to lose money.

Fools can profit by being contrary. While the fears surrounding Brazil may be well-founded, they should not extend to Embraer. As Damodaran said, "They [Embraer] are about as Brazilian as Boeing."

For another example, think back to 2001, when the stock market was coming down around us. Investors sold off tech stocks indiscriminately -- even the that were well-positioned and smartly operated -- to levels that understated their potential.

For levelheaded investors, the returns across these companies have been pretty good:

Foolish bottom line
Most investors fear losing money, and they'll sell off even great stocks when the future looks difficult. You can make money by seeing unfounded fears for what they are, and picking up good companies with clear competitive advantages like eBay at bargain-basement prices.

This is precisely the strategy that Philip Durell uses to help subscribers beat the market at Motley Fool Inside Value. To access all of Philip's research and recommendations free for 30 days, simply click here. There's no obligation to subscribe.

This article was originally published on Jan. 11, 2006. It has been updated.

Tim Hanson does not own shares of any company mentioned. Embraer, eBay, and Amazon.com are Motley Fool Stock Advisor recommendations. No Fool is too cool for disclosure ... and Tim's pretty darn cool.