Where do truly market-thrashing results come from?
For a long time, up through today in some dwindling corners, the Efficient Market Theory exercised great influence in the academic community. It holds that no one can systematically outperform the market's returns since all information relevant to the value of a stock is instantly reflected in that stock's price.
One of the linchpins of the theory is that the participants in the market are always knowledgeable, dispassionate, rational actors acting in their own interest.
Because there's so much evidence that not all investors are particularly rational (or knowledgeable), what has gained more influence lately are various theories of behavioral finance.
Four ways to profit
So I was interested reading through a presentation that noted value investor Arnold Van Den Berg made last spring to his clients. One part of it describes the four irrational states of sellers that you're looking to buy from. Because no matter what form of efficient market you believe in, there is no arguing one point: Whenever there's a buyer of a stock, there's a concurrent seller. And one of them is ultimately going to be proved right, and one wrong. The more that emotion is driving the seller, the better you'll do. So here are the feelings you should look for in a seller:
1. Apathy: When a stock has gone nowhere for years, oftentimes sellers just don't really care whether they own it anymore. Van Den Berg gives the example of Coca-Cola
2. Disgust: "You find that when investors have lost money, or a stock's gone sideways for a long time, shareholders just want to get rid of it. The stock has disappointed you, the company's earnings have declined, its sales have declined -- and you're just disgusted with it. That is truly a deep psychological state."
Fear/panic: While disgust is nice, fear and panic are even better. Some classic examples of stocks getting very cheap are Merck
Anger: The fourth and best state to find in a seller is anger. Van Den Berg claims that when his clients call him up angry over his placement of a stock in their accounts, he has his best results. He has gone back and measured that the "angry stocks" have returned 25% to his clients over his investing career. He cites Wal-Mart
The Foolish bottom line
Van Den Berg has applied the dispassionate pursuit of great value opportunities to the phenomenal benefit of his clients. So, too, we here at Inside Value are finding some great values in today's market. Not surprisingly, given the advantages underlying value investing, we're beating the market with our selections. Take a free 30-day guest pass to find out more -- and always remember to buy from the emotional.