When asked about his contrarian business style, Las Vegas Sands (NYSE:LVS) CEO Sheldon Adelson, who was once one of the world's 10 richest people, smiled and said, "Everyone has always told me I'm nuts when making investment decisions, but when you can look at something differently than other people, you can find opportunity."
No matter how well a company manages its business, it's bound to encounter bumps in the road. Some of the world's greatest investors, including Warren Buffett, Peter Lynch, Eddie Lampert, and Mohnish Pabrai, have made incredible sums of money by investing in good companies that come across short-term problems. Investors who have the courage to swim against the current when good companies encounter scandals, lawsuits, and other gut-wrenching events can make out quite well once the storm passes and the company returns to business as usual.
Making investment decisions seems pretty easy when everyone agrees with you. Getting a vote of confidence from high-profile analysts, top fund managers, and overconfident CNBC guests can give you a feeling of investment invincibility. But this comes at a price.
The problem with making those easy decisions is, so is everyone else. It's unlikely you'll find much opportunity when stocks have a rosy consensus; the premium prices you'll pay can already reflect any positive developments and leave investors wondering what happened to their road to riches.
Digging for gold where others see fear
Thankfully, just as quickly as investors pile into popular stocks, they can run for the exits en masse when news tarnishing the profile of their once-beloved company develops, giving Foolish investors opportunity where others only see fear. Achieving stellar investment results doesn't come from following the herd: It requires investors to stick their necks out once in a while and accept that the crowd isn't always right.
Now, don't get me wrong, a lot of news truly is bad ... and should scare you. Enron and WorldCom are good examples of once-popular stocks that bit the dust because of jaw-dropping corporate greed and management fraud.
Thus, just because a stock falls on negative news doesn't automatically make it an attractive investment candidate. It's important to realize when a company is undergoing an event that will fundamentally change its business model or cause it to shut down altogether. For instance, whether AIG (NYSE:AIG) survives or fails, it's unlikely to go back to making the highly leveraged bets that caused its problems in the first place.
The types of events that can hurt stocks and lead to profitable opportunities are those frightening -- even profit-losing -- developments that will have a short-term impact but won't affect a company's long-term prospects.
|
Company |
Year |
Event Causing Short-Term Pessimism |
Estimated Change in Stock From Event |
Subsequent Five-Year Return |
|---|---|---|---|---|
|
Tyco (NYSE:TYC) |
2002 |
CEO misappropriating funds |
(80%) |
227% |
|
USG (NYSE:USG) |
2002 |
Asbestos lawsuits |
(57%) |
691% |
|
Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) |
2000 |
Refusal to invest in technology stocks during the Nasdaq boom |
(40%) |
98% |
|
Washington Post (NYSE:WPO) |
1973 |
Government challenges after Watergate coverage |
(38%) |
308% |
This, too, shall pass
As we've seen, there is a serious nearsightedness problem in the market when it comes to making investment decisions: Even if the consensus is that a company is facing a problem that will only last a short period of time, many often sell anyway, in hopes of buying it back once the future becomes more certain. Investors who are patient and ignore the short-term pessimistic views Mr. Market serves up can be rewarded handsomely in the face of others' fear.
Warren Buffett has achieved incredible investing success buying good companies at bargain prices when they encountered short-term negative events. When describing his 1974 investment in Washington Post, Buffett was quoted as saying, "In the case of the Washington Post, the whole of the company was selling for $80 million. Most analysts would have agreed that the intrinsic value of the assets was around $400 to $500 million. But you could buy little pieces of the business for much less." Buffett was able to profit from the fact that the rest of the market wanted to wait until short-term events had panned out before buying back into the company. When it did, the stock price returned to more reasonable valuations, producing great returns on Buffett's original $10 million investment.
The market is here to serve you, not to guide you
Looking at the big picture while having a reasonable indication of what you think a company is worth is the first step in developing a successful investing mind-set. Don't get too caught up in the noise surrounding a company regarding events that will likely pass in due time.
When good companies encounter painful events, ask yourself some basic questions: Will this hurt the company this year? Probably. Will it affect it next year? Probably not. Is the stock price reflecting next year's potential? Or the next five years? If the answer is no, you might have an opportunity to bypass short-term pessimism and invest in good companies at bargain prices.
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