The Market Is a Cheap Hotel Shower

Have you ever taken a shower in a value-priced hotel somewhere? First, you have to figure out how to get hot or cold water out of the silly thing, and then the real games begin. 200 feet from the water heater, the changes you make to the water flow take a while to make a difference. "Ow, hot!" OK, turn it down a bit. "Frr-frr-frreeeezing!" That adjustment went a bit too far. Repeat until you find a happy medium, hoping that nobody throws it off by taking a shower in the next room or flushing the toilet downstairs.

That, my friend, is exactly how the stock market works.

Cold shower or lava bath?
In a perversion of Newton's third law of motion, every action in the market has an opposite and usually massive overreaction. Ever since the financial crash in September, we've seen months of enormous volatility. Mr. Market is still fiddling with the water knobs, still trying to settle on the proper temperature for his money shower. Before the panic started, the water was way too hot. Now, I think it's freezing.

Take blue-chip General Electric (NYSE:GE), for example. A multinational giant with built-in diversification across several industries and geographies that is accustomed to trading for more than 20 times trailing earnings, GE's valuation has dropped to less than eight times earnings. Averaging out the stock's outperformance in the late 1990s and the recent woes, you could make the argument that GE is worth three times today's wimpy $160 billion market cap. Freezing, I said!

It's human nature to overreact a bit, of course. Burned by the hot water, we don't want to get scalded again, so we leap a bit past "reasonable" changes and straight into "way too safe." And this creates some massive investment opportunities for the contrarian adventurers among us.

Cheap stocks aplenty
Have a gander at these icy-cold steel baths:

Data from Capital IQ, a division of Standard & Poor's.

All of these well-respected companies have seen their stock prices absolutely bludgeoned by an overreacting market. Best Buy is the only one of the lot to have rebounded significantly from 52-week lows, as all the others remain just a few clicks off the bottom. But rest assured that they've all seen volatility that makes nitroglycerin look timid by comparison. An opportunistic investor with some cash to spare could make a killing by investing in solid businesses like these at historical rock-bottom prices. Every single household-name business on my list sports at least three CAPS stars (and five for Ingersoll-Rand), and the Fool itself already owns two of them.

Mass psychology, individual opportunity
This theory of the stock market acting like a huge low-budget shower works because of the mass-psychology involved. It's the average reaction of thousands, or even millions, of individual investors and financial institutions. Each individual is still free to act much more reasonably and take smaller leaps between extremes of buying and selling. That could, would, and should be you, dear Fool. Let the masses go over the cliffs of insanity like a well-heeled lemming herd, and reap the rewards of the mispriced stocks they leave in their wake.

And the next time you check into a cheap motel, ask for a room as close to the water heater as possible. You'll thank me for that advice in the morning.

Further Foolishness:

• 4 Steps to Protect Your Portfolio From the Financial Crisis
• What to Do When the Dow Hits 7,500
• The Best Investment Values in a Decade