Every stock trade involves both a buyer and a seller. Each one has access to roughly the same information, yet each chooses to make polar opposite decisions about a stock. If you want a shot at winding up ahead of the pack, you have to accept that fact.
To succeed, you must intuit what the person on the other side of your investment is thinking. Why is he selling when you're buying? Why is she willing to buy the shares you're trying to unload? If you can figure that out, you'll be light-years ahead of the competition.
Go! Fight! Win!
There's simply no such thing as a perfect investment. If there were, investors would soon bid its price up to a point where it was at least as risky as any of its alternatives. As a result, there are always two legitimate sides to any given analysis. To drive home that point, The Motley Fool runs an occasional "Dueling Fools" feature, where analysts square off against each other on opposing sides of a stock.
While most investors look to buy stocks, the bear side of the duel points out the opposite side of the story -- reasons to consider selling shares. Quite often, the bear rightly predicts problems ahead -- ones that were visible to an outside observer, but not yet priced into the stock.
As this chart shows, failure to heed a warning can prove costly:
|
Company |
Duel Date |
Total Return |
Return vs. SPDRs |
Mentioned Warning Signs |
|---|---|---|---|---|
|
Johnson & Johnson |
11/22/2006 |
5.84% |
(6.38%) |
|
|
Cedar Fair |
8/9/2007 |
(13.64%) |
(12.44%) |
|
|
Washington Mutual |
10/5/2007 |
(64.24%) |
(55.94%) |
|
|
Blue Nile |
10/25/2007 |
(31.93%) |
(26.06%) |
|
|
Crocs |
12/6/2007 |
(76.55%) |
(71.25%) |
|
|
Sprint Nextel |
12/31/2007 |
(39.91%) |
(37.13%) |
|
|
Chipotle Mexican Grill |
1/17/2008 |
(18.68%) |
(25.22%) |
Since their duels, each of these companies has underperformed the SPDRs -- an exchange-traded fund that tracks the S&P 500. Worse yet, they've nearly all lost their investors money. The risks were well-known, in public, for all who wanted to pay attention.
Protect your money
Because there is no such thing as a perfect investment, and because there are always two sides to every analysis, any given stock will move up and down quite frequently. As our dueling bears have shown, even great businesses can easily become overpriced and head for a fall. On the flip side, however, there are times when the worrywarts take full control of a stock, sending it plummeting to well below its true worth. That's when value investors, like those of us at Motley Fool Inside Value, get interested in buying those same great businesses.
Always considering both sides of the story makes it that much easier to see the times when the market is driven to excess. Too much optimism? We sell. Too much pessimism? We buy. That's the simple truth of how we've invested since our launch in 2004.
Make sure you're considering both sides of any potential investment. If this article has taught you to be skeptical enough not to buy blindly, congratulations -- you've mastered the first step to becoming a successful value investor. As your prize, we'll give you a 30-day trial of Inside Value, free.
This article was originally published Nov. 22, 2006. It has been updated.
At the time of publication, Fool contributor and Inside Value team member Chuck Saletta owned shares of Johnson & Johnson and Washington Mutual. Johnson & Johnson and Cedar Fair are Income Investor recommendations. Washington Mutual is a former Income Investor selection. Sprint Nextel is an Inside Value selection. Blue Nile and Chipotle Mexican Grill are Rule Breakers recommendations. Chipotle's Class B shares are a Hidden Gems pick. The Fool owns shares of SPDRs and has a disclosure policy.
