Hogs Still Get Slaughtered

There's an old stock market saying that goes something like this: "Bulls make money and bears make money, but hogs get slaughtered." In plain English, that means that investors can make money regardless of whether they're buying shares or selling them short -- as long as they don't get greedy.

It's that last part that's key -- greed destroys many paper gains. Unfortunately, greed is pervasive in the market and can derail even sound investment strategies. Interestingly, however, greed -- other people's greed -- can also help you profit. Consider the sage words of Benjamin Graham, the man who taught investing to Warren Buffett, who said: "In the short run, the market is a voting machine, but in the long run, it is a weighing machine." In other words, the price other investors are willing to pay for a stock changes moment by moment, based on their moods. Eventually, however, a stock's price will reflect the true value of the company it represents.

But be careful. While you can make money riding an undervalued stock upward as other greedy investors jump aboard, if you wait too long, you're likely to lose a large chunk of your returns. Hence the saying, "hogs get slaughtered."

The pain of greed
As much as I stress the importance of knowing how to buy low and sell high, none of us is immune to greed. I bought employment and income verifier Talx (NASDAQ:TALX) dirt-cheap back in December 2004. While I'm sitting on a market-beating return right now, it could have been much, much better. Back in January of this year, for instance, Talx peaked at more than $36 per share.

At that point, I knew the stock was overvalued. I could and should have sold. In fact, I had a limit sell order open, but I kept pushing my price upward as Talx's stock rose, trying greedily to capture an even larger gain. I was the definition of a market hog, and I got slaughtered. Talx currently trades closer to $18.

The importance of value
Clearly, then, a key part of successful investing is knowingwhen to sell. You absolutely need that discipline in order to keep the money you make. The first step in mastering the sell decision comes from understanding what the company is really worth -- what Graham's weighing machine would peg as its true value. Once you have that number firmly in hand, any time its stock trades above that level, you've got yourself an overvalued company that's a candidate for selling.

Why? Because once a company gets overvalued, it's liable to fall -- and fast. Consider this handful of companies with market caps of at least $1 billion that have fallen at least by half from their recent highs:

It's not as if all these companies' drops came as a surprise. Eagle Materials and DR Horton, for instance, are heavily tied to the housing market. Some Fools have long predicted the popping of this real estate bubble. It's really no shocker that higher interest rates and stretched affordability have finally taken their toll on the housing market, taking homebuilders and related companies down with them. Yet, if you weren't paying attention to their true values, or if like me, you kept hoping for just a little bit more in the way of gains, you've found yourself in a world of hurt.

The Foolish bottom line
If you'd like to learn more about how to value the stocks you own or would like to learn about a few stocks that are trading for less than their true worth, consider joining my friend and colleague Philip Durell at his market-beating Motley Fool Inside Value investing service. Your free trial will give you 30 days to check out all of our stock picks, research, and investing tips, with no obligation to subscribe. Click here to learn more.

At the time of publication, Fool contributor and Inside Value team member Chuck Saletta owned shares of Talx. The Fool has a disclosure policy.