Conventional wisdom erroneously holds that sheep are not the brightest of creatures. This bad impression stems from the common flocking behavior lambs display; they'll follow one another off a cliff, or trot head-on into busy traffic. Many investors are looking similarly wooly these days, following the crowd in writing off any company remotely connected to subprime lending.

Don't get me wrong -- investors are right to be cautious of the subprime mortgage sector. After all, unless you have Nostradamus on speed dial, you can't definitively say that the painful underperformance of Bear Stearns' (NYSE:BSC) subprime-centric hedge fund isn't the tip of a very long and painful spear. But for those willing to dig deeper into businesses' valuations, subprime jitters may present buying opportunities. If you can stand volatility, and you don't invest on margin, a few subprime names could yield impressive returns in the next year or two.

Learning from history
I'll spare my Foolish readers a long-winded rehash of the subprime debacle; it's already gotten enough press to make even Paris Hilton blush. In brief, companies such as HSBC (NYSE:HBC) and Bank of America (NYSE:BAC) greedily gobbled up securitized pools of risky home loans, assembled by the likes of Accredited Home Lenders (NASDAQ:LEND) and the dearly de-listed New Century Financial. In return for continued cash baths, these mortgage loan companies would gladly underwrite vacation homes for anyone who could sign on the dotted line. When those borrowers failed to meet their payments, the ensuing pain extended all the way to the big banks that had purchased the high-risk loans.

Let's step back a few years and look at another implosion reminiscent of this whole subprime mess: the Enron collapse. In the months following the energy giant's devastation, the market punished numerous other firms for their mere association with energy trading. While investors were right to shy away from debt-strapped stocks that derived significant revenue from trading, the market overreacted against several undeserving names in the general energy sector.

In 2002, TXU (NYSE:TXU) took just such a hit. Sure, TXU looked similar to Enron, given its off-balance-sheet partnerships and forays into communications businesses. Sure, the possibility of deregulation hung over energy stocks like a smog cloud over a coal-burning factory. And yes, the company got a bit stingy with its dividend.

But TXU enjoyed major differences from Enron, including conservative management and diversified operations in heavily regulated regions. As the energy industry reeled, largely because of the lingering Enron scandal, TXU got hammered in mid-October 2002, eventually trading for a measly $5 and change. Any investor savvy enough to buy in then would have earned a 10-bagger five years later.

A value opportunity
Similarly, a protracted housing slump and rising subprime defaults have contributed to continued "guilt by association" for several undeserving names in the real estate and lending businesses. Just as energy trading was mistaken for representing the energy industry as a whole, residential subprime is the misplaced face of real estate-related securities.

On one earnings call I recently observed, management's first slide was emblazoned with the words, "We have not one single dollar of subprime exposure." Yet if you looked at this company's share price, the market was punishing it as if subprime were its main business.

There's an added benefit to finding the babies thrown out with subprime's bathwater. While energy companies are harder to value, many of the stocks being dragged down by the subprime situation have more clearly defined business lines, with holdings and credit characteristics that are easier to assess.

The sky is indeed falling on companies heavily invested in residential subprime mortgage-backed securities. But the emotion that has gripped this sector presents an opportunity for patient investors. In the world of value investing, daring to stray from the rest of the flock is hard to do in the short term, especially if you're worried about getting sheared. But as TXU illustrates, a bit of independence can also increase the chance that your investment returns will stand out as well.

In my next article, we'll look for opportunities presented in the wake of the storm.

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Fool contributor Rimmy Malhotra is a New York City-based money manager. He owns shares of Bank of America, an Income Investor pick, on behalf of his clients. He welcomes your feedback at rimmy@gratiocapital.com. The Fool's disclosure policy prefers cotton to wool.