You know that book When Bad Things Happen to Good People? I think a good title for a value investing book might be When Bad Things Happen to Good Businesses.
An even better title might be When Temporarily Bad and Fixable Things Happen to Businesses With Wide Moats, Growth Prospects, and Sustainably High ROICs. Unfortunately, I don't think that title would be a best-seller, but you get the point.
This "bad things, good companies" approach is a bread-and-butter play for the world's greatest investor, Warren Buffett.
So easy, a caveman could do it
Some examples? Let me count the ways. Back in the '60s, American Express
With the benefit of hindsight, the incident was clearly a great buying opportunity. Getting swindled by salad-oil speculators was obviously a bizarre, one-time event that didn't permanently impair the company's profitability.
GEICO is another great example. The company's move away from insuring only the safest drivers back in the '70s brought it to the brink of bankruptcy. Buffett again capitalized on this buying opportunity and eventually ended up buying the whole company. Today, GEICO is one of the brightest crown jewels in Berkshire Hathaway's
This might not sound politically correct, but investors should be happy when bad things happen to good companies -- it gives them a chance to buy shares at a discount. If nothing bad happens, there's no such opportunity.
In good company
So how do we identify these opportunities? First, we need to define what a good business is. In a nutshell, a good business has a wide moat. This moat allows it to earn a high return on capital for a long period of time. AmEx, Coca-Cola, and GEICO have strong brand recognition. In addition, they all have substantial distributional advantages. For the most part, it's not hard to figure out if a company has a wide moat -- historical returns on invested capital will tell the tale.
Good bad things
Investors also need to figure out if a bad thing is temporary and fixable. AmEx's salad-oil scandal was a one-time bizarre event that really had nothing to do with its core business. GEICO's moat of low-cost direct distribution was still intact -- it just had to go back to its roots of insuring safer drivers.
Strong management teams are integral to companies overcoming temporary challenges. Harvey Golub and Jack Byrne are some of the management hall-of-famers that helped fix AmEx and GEICO. If you combine a great leader, a great business, and a low stock price, you get fireworks.
In this jubilant market, it's hard to find opportunities of the magnitude of a GEICO or American Express. However, there are usually a couple of decent businesses trading at compelling valuations.
A couple that I find interesting are newspaper publisher McClatchy
I also like homebuilder MDC
Last, although it doesn't have as much hair on it, lately Wal-Mart's
I think these companies could be bargains at their current prices, and I advise investors to take a hard look at companies such as these suffering from temporarily tight situations.
- Lessons From a Legend: Harvey Golub
- Oak Value Interview: More on the Portfolio
- Should Your Portfolio House MDC?
Not to give away the farm, but Berkshire Hathaway, Coca-Cola, and Wal-Mart are Motley Fool Inside Value recommendations. To find out what other companies Philip Durell and his team of analysts are currently recommending to subscribers, check out an all-access 30-day free trial.
Berkshire Hathaway is also a Motley Fool Stock Advisor pick.
Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. Emil appreciates your comments, concerns, and complaints. MDC Holdings is a Motley Fool Hidden Gems recommendation. The Motley Fool has a disclosure policy.