Did your portfolio underperform the market last year? If so, you were in pretty good company.

Following 15 consecutive years of outperformance, Bill Miller's Legg Mason Value Trust (LMVTX) underperformed the S&P 500 for the second year in a row. He wasn't alone, either -- consider the terrible 2007 returns of two other great investors:



2007 Return

Notable Top Holding

Bill Nygren

Oakmark Select I (OAKLX)


Western Union (NYSE:WU)

Ron Muhlenkamp

Muhlenkamp Fund (MUHLX)


Corning (NYSE:GLW)

Bill Miller

Legg Mason Value Trust (LMVTX)


UnitedHealth Group (NYSE:UNH)

Source: Morningstar.com; top holdings as of March 31, 2008, Oakmark as of June 30, 2008.

Indeed, the past three years have been rough on many successful investors. According to SmartMoney magazine, "71 funds in the bottom quintile of their peer groups during the past 36 months are in the top 20% over the past decade."

That trend seems to be affecting these three managers. Despite smashing the market for more than a decade with contrarian investing strategies, they've seen investors pull billions of dollars in assets from their funds because of short-term underperformance.

Fair-weather investors
Yanking money away from proven winners because of a bad year or two doesn't make much sense. Heck, even Warren Buffett's Berkshire Hathaway has occasionally underperformed the market in the short term, particularly during the dot-com boom.

Yet Buffett didn't abandon his proven strategy and jump into the hot tech stocks of the day. Instead, he continued to invest in companies with good valuations and profitable business models. Sticking with Buffett through the tough times would have paid off -- since January 2000, Berkshire has returned 138% to its shareholders.

Bill Nygren echoed these sentiments when he claimed that investors "need to ask themselves if the past quarter is a predictor of future performance or if the past decade is." His rhetorical question reminds investors that long-term performance is more important -- and more meaningful -- than short-term.

You can learn a lot from a "dummy"
So how can you improve your odds of beating the market over the long term, like these three managers have? Bill Miller explained his strategy for creating long-term value in his most recent communication to shareholders:

More particularly, just as the right thing to do in 2002 was to buy what everyone was panicked about, I think the greatest gains over the next 5 years will be made in those securities people are panicked about today. For specific names, consult the 52-week new low list.

Interested? Here are a few well-known stocks that touched 52-week lows in the past week:


52-Week Range

Fannie Mae (NYSE:FNM)


J. Crew (NYSE:JCG)




Tween Brands (TWB)


Harman International (NYSE:HAR)


Source: Yahoo! Finance, as of Aug. 18, 2008.

Additionally, many auto, retail, restaurant, and financial stocks have been beaten down over the past year, as concerns about a recession, reduced consumer spending, and the subprime crisis continue to mount.

But back in 2002, as Miller aptly notes, the market had similarly turned its back on the energy and commodity sectors, which have turned out to be two of the most profitable sectors over the past six years.

A huge opportunity for contrarian investors
Sectors and industries naturally ebb and flow at different points in the economic cycle. Investors should be prepared to buy proven winners when the market bets against them.

Just as it was unlikely in 2002 that global demand for oil and metals would continue to stagnate, it's unlikely in 2008 that American consumers will never return to eating in restaurants, stop gambling entirely, or leave the real estate market in a perpetual slump.

Not all companies can effectively turn things around following a severe market decline; some turn into value traps, or just downright ugly stocks. But the best companies continue to generate cash and reinvest in their businesses even when times are tough. When the fair-weather investors and sunshine analysts once again find them attractive, the gains will be that much greater.

If you need help separating the wheat from the chaff, Philip Durell and the Motley Fool Inside Value team can help. They look for stocks that have not only been beaten down by the market, but are also gearing up for huge returns once they return to favor.

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This article was originally published on April 18, 2008. It has been updated.

Todd Wenning eschews obfuscation -- most of the time. He does not own shares of any company mentioned. Berkshire Hathaway and UnitedHealth are Motley Fool Stock Advisor and Inside Value picks. Western Union is another Inside Value choice. ONEOK is an Income Investor recommendation. Muhlenkamp Fund is a Champion Funds and Hidden Gems recommendation. The Motley Fool owns shares of Berkshire Hathaway. The Fool's disclosure policy does it all for the glory of love.