Don't Buy Boardwalk

My family is competitive when it comes to the board game Monopoly. But not too competitive. After three hours of wheeling and dealing with my parents and sister, I almost always prevail. They think it's luck, of course, but the secret to my success is a value investing strategy.

Familial failings
Take my dad, for instance. He loves Boardwalk and Park Place, the crown jewels of the Monopoly empire. He will do anything to buy or trade for them -- and that's his downfall. He overpays for these properties and never earns a good enough return on investment to win the game. Those precious properties end up mortgaged to the hilt, and he's left holding the bag.

Then there's my mom. She's thrifty. To her, every property is too expensive. Her portfolio ends up being filled with the cheapest of the cheap -- Baltic, Vermont, and Connecticut -- and she loses because her properties don't have enough earning power to make a difference.

As you can see, my dad's stuck in a growth trap and my mom in a value trap. The winning strategy, of course, lies somewhere in between.

My strategy
Although the red and orange properties like Illinois Avenue and St. James Place often go overlooked, they provide the best return on investment. They have middle-of-the-road prices, and their location on the board ensures that they get landed on repeatedly (Illinois Avenue is the most landed-on property in the game; Tennessee and New York avenues are not far behind). And if I'm not the first to buy them, I can generally get a good trade for these properties since others overlook their value.

From Monopoly to investing
Bidding up the prices on the most sought-after investment is a recipe for bad returns. So, too, is sticking with the absolutely cheapest investment. In many cases, they're cheap for a reason.

We already know about the pain of growth traps from the recent economic dot-com bust. But the lesson still doesn't seem to have sunk in. Google and Baidu.com -- the Boardwalk and Park Place of Internet search -- still trade at exorbitant multiples despite their recent swoons. It will be some time before the investor who bought Google at $450 sees a return on his money, if ever.

The value traps, on the other hand, can be more difficult to identify. After trading for some pricey multiples during the tech bubble, RadioShack (NYSE:RSH) looked like a bargain at 12 times earnings in 2003. However, this is a classic example of a value trap. Competition from Best Buy, problems with wireless sales, and underperforming stores took their toll on results. The P/E multiple continued to collapse, and an investment three years ago would be in the red today.

StarTek (NYSE:SRT), XL Capital (NYSE:XL), Verizon (NYSE:VZ), and British Sky Broadcasting (NYSE:BSY) are other examples of cheap stocks that stayed cheap. Like purchasing Mediterranean Avenue, you sometimes get exactly what you pay for.

Fool analyst M.D. Mitchell especially liked reinsurance outfit XL Capital after Hurricane Katrina, when it was trading near its 52-week lows. At seven times earnings, the stock seemed like a bargain to him. Six months later, the stock price hasn't budged. That's not to say XL and these other companies will never break out of the value trap. The lesson here is simply to be cautious even when an investment is suspiciously cheap.

Find your orange monopoly
Last summer, World Wrestling Entertainment (NYSE:WWE) was getting beaten up pretty badly as interest in pro wrestling declined in the United States. However, I couldn't help noticing the growing popularity of wrestling in Europe, Asia, and Australia. I bought some shares realizing that this company was not the value trap it appeared to be. Sure enough, the international revenues began flowing to the bottom line, and wrestling exploded in North America sooner than I had anticipated. There are gains to seeing value where others don't.

Philip Durell and the folks at Motley Fool Inside Value use this strategy every day. He has identified undervalued companies like lottery operator GTECHHoldings (NYSE:GTK). GTECH shares were down in 2005 over concerns about contracts with the Brazilian government. Philip recognized the value in the company even without the Brazilian contracts. The company is now being acquired by Italy's Lottomatica, and the move rewarded Inside Value members with a 48% gain.

The Foolish bottom line
The stock market is clearly more complicated than a family board game, but some of the principles of success are the same: Avoid the growth traps, avoid the value traps, and buy the best companies at the best prices in order to maximize your return on investment.

This is precisely how analyst Philip Durell identifies stocks with outsized return potential for his members. Click here to learn more and ensure you aren't the one taking a bath on Boardwalk.

Fool research analyst Joseph Khattab owns shares of WWE. Best Buy is a Stock Advisor recommendation. The Fool has adisclosure policy.