Be a Bear in Bull's Clothing

Investing optimists go broke. (Disclaimer: I am not a pessimist. I am an optimist. But I am also a realist.)

Just ask those people who put money in Cisco and Yahoo! at the height of the tech bubble in 2001. Ouch. To turn a profit in the investing world, its best to listen to your inner bear.

Join the masses
When a stock keeps rising, it's natural to want to get in on that action. And there are usually some great reasons behind the skyrocketing value. Just take a look at the following companies:

That's some phenomenal five-year growth, not to mention some phenomenal fundamentals backing it up. All four of these companies had a high -- and improving -- return on invested capital to boost the stock price. Each company also has been able to key into crucial consumer trends to increase market share -- the quest for a healthier lifestyle, the unrelenting affection for our pets, and the need for more and better health care.

Uncover the cynic within
But there's more to a stock than its skyrocketing price. Sometimes, it's better to keep your hidden skeptic at hand. For example, Pediatric Services of America, a company that provides home health-care services to chronically ill children, has had a solid 180% increase in stock price in the past five years. Based on that news, your sunny bull self might see momentum and buy buy buy! But if you looked more closely, you'd see that the company's ROIC has been negative for two years, with a declining ROIC for the three years before. So that level of price growth in a non-returning investment won't be sustainable unless the company can turn its business around and fulfill its growth promises.

Pep Boys (NYSE:PBY) stock has posted solid 230% gains in the past five years. But this company, too, has had a declining ROIC recently, due to loss of market share and lower sales. Pep Boys still has to prove that a turnaround is possible. Momentum aside, why would you buy into a company where the future returns to the shareholder are less than you could get elsewhere?

Find your safety
Be a bull. Be a bear. Just be thorough. Your hard-earned money deserves all the angles you can use to analyze a stock. And by analyzing both sides of an investing story, you can determine the margin of safety. This is the key to value investing.

This pragmatic value strategy is precisely what Philip Durell employs in his Motley Fool Inside Value newsletter. Instead of following the bullish crowd and buying into the hype, he looks at key metrics -- return on invested capital, intrinsic valuation, and future growth prospects -- to determine whether a company can continue to increase shareholder value. And that strategy seems to be doing the trick so far -- his picks are beating the market by nearly four percentage points since the newsletter's inception. Philip has even managed to stud his newsletter's portfolio with stars like Omnicare (NYSE:OCR), which added returns of 102% before the bear in him said sell.

This same strategy led Philip to pick stalwart Coca-Cola (NYSE:KO), which he still believes is trading more than 15% below its intrinsic value (based on future cash flows to the company). That's a pretty high margin of safety for investing in a proven brand and business model.

Take a free 30-day guest pass to the Inside Value newsletter to take learn how to be a bear in bull's clothing. You'll get access to all 35 of Philip's recommendations, along with explanations of key metrics and CEO interviews. Bare the bear within; you can do it!

Shruti Basavaraj does not own shares of any company mentioned in this article. Coca-Cola is an Inside Value recommendation. The Fool's disclosure policy is a disclosure policy in disclosure policy's clothing.