What the Best Investors Do

How can you know if you're a great investor? Well, one clue might be if your last name ends in U-F-F-E-T-T. To me, though, you're a great investor if you've earned high returns over a long period of time. Some examples:

• Warren Buffett himself, who has increased the per-share book value of Berkshire Hathaway by a compounded annual average of 21% between 1965 and 2006 -- 41 years!
• Peter Lynch, who increased the value of Fidelity's Magellan (FMAGX) fund by an annual average of 29% from 1977 to 1990 -- 13 years.
• Eddie Lampert, who has grown his private investment fund, ESL Investments, by an annual average of roughly 30% since 1988 -- 19 years and counting. He's also the current chairman of Sears Holdings (NASDAQ:SHLD).
• Sir John Templeton, who increased the value of his flagship mutual fund by an annual average of around 16% between 1978 and 1998 -- a full 20 years.

Be contrary
Once you identify the best in the breed (and there are others, but I'm just focusing on a few here), it's instructive to see what their investing approaches have in common. As I've read about each of these investors, there's one thing I've noticed in each of them: being contrary.

Think of Buffett, for example, who has advised investors to "be greedy when others are fearful and fearful when others are greedy." That's contrarianism in a nutshell.

Contrarian investing also involves taking positions in companies that the majority of investors have written off. Look at Lampert, grabbing Kmart and Sears when it seemed to many that the companies were doomed. The merged company, Sears Holdings, has increased in value by more than 10-fold in less than four years!

Seek value
Contrarian investing is often another way of referring to value investing, an approach in which investors aim to buy stocks for significantly less than their intrinsic value. In Money Masters of Our Time, John Train profiles John Templeton and notes two of his principles:

• Search among many markets for the companies selling for the smallest fraction of their true worth.
• The best bargains will be in stocks that are completely neglected -- other investors are not even studying them.

Some great investors, such as Warren Buffett (influenced by his business partner, Charlie Munger), would probably not go so far as to seek out the absolute cheapest stocks they could find. Their thinking has evolved so that they seek out high-quality companies at good prices rather than so-so companies at great prices. Still, Templeton is onto something: Value matters. It's very effective to make sure, to the best of your ability, that you're buying an undervalued company. And that's frequently one that others are ignoring -- which is why, to some degree, the stock price will be low.

This is also the approach Philip Durell uses in our Motley Fool Inside Value newsletter service, and his recommendations are beating the market 23.6% to 16.8% on average. Here's how Philip explains his method: "As value investors, we believe that the market can overreact to news, both good and bad. We take a long-term view of a company's business, so we dig into price disparities as we scan for punished companies that the market may have driven down for no good reason."

Do it yourself
So now that you have an idea of how the world's best investors view investing, can you put it to use somehow? Of course. You can become a contrarian, value-oriented investor -- if you're not one already.

To start, you might screen for investing candidates. Below are some companies that turned up when I used Yahoo! Finance's screener to seek out companies with P/E ratios below 20, profit margins of at least 10%, and five-year estimated sales growth of at least 10%:

These are certainly promising possible investments. You'll just have to do a lot of further research to see which ones are the most promising, because that can make a big difference in your ultimate bottom line.

As you go about that process, remember the lessons of Buffett, Lynch, Lampert, and Templeton: Be contrary to find the market's values.

And if you don't have the time, the interest, or the stock-analysis chops for that, I invite you to test-drive our Inside Value newsletter -- free, with no obligation. Doing so will give you full access to all past issues and all recommendations.

Longtime Fool contributor Selena Maranjian owns shares of Berkshire Hathaway, Johnson & Johnson, and McDonald's. Berkshire Hathaway is an Inside Value recommendation. Johnson & Johnson is an Income Investor pick. The Motley Fool is Fools writing for Fools.