Investing is easy to do, but it's not simple to execute effectively over a long period of time. The evidence is found in the fact that most active professional investment managers fail to beat the market indexes. Time and time again, the most difficult part of investing is ignoring the crowd, and instead, letting data and analysis be the ultimate determinant of the investment-making process. (For a quick refresher, check out The Madness Of Crowds.)
Avoid Cocktail Party Stocks
It's very hard to find bargains among excitement. When investors are excited and happy about a business, odds are the share price is not cheap. The presence of excited buyers almost always means that buying pressure has bid the price of the stock up. The widespread favorable perception investors have over Amazon (Nasdaq: AMZN) and its exciting online business model has the stock trading at over 50-times earnings. In other words, investors are willing to pay $50 for $1 in earnings, or a 2% yield, similar to the rate earned on an FDIC-insured certificate of deposit.
Love What's Hated
On the other hand, you have a name like Dean Foods (NYSE: DF), the largest fresh milk supplier in the U.S., that trades at one-fifth of sales and less than 10-times earnings. Selling milk is not as exciting as selling Kindles online, nor are the growth rates close to those of Amazon. As a result, no one talks about Dean Foods at investment conferences or cocktail parties. Its shares are trading at a historical low and will likely reward investors here.
Darling International (NYSE: DAR) is another company you won't find on the minds of many. This company recycles used animal renderings from processors and used frying grease from names like McDonald's (NYSE: MCD). How many businesses do you know in this line of work? Not many as Darling, despite a market cap of "only" $630 million, is the largest such provider of these undesirable services. As a result, you get a chance to own a business operating all by itself for 10-times forward earnings.
Conversely, a name like BP (NYSE: BP) is probably the talk at every investment table these days. The headlines couldn't be worse for this company. Threats of bankruptcy due to the overwhelming costs of the oil spill have sent the shares down by nearly 50% in over a month. Threats of suspending the dividend have also placed downward selling pressure on the shares. While the crowd is betting on the worst, shares today trade at under six-times earnings. Without question, costs from the oil spill will be substantial and BP's financial position will be weakened. But unless you think the company's assets and reserves are worth zero, going against the crowd could prove very profitable over the years.
A Crowd Of One
The human psyche is not trained to do things alone. Group interaction, in most endeavors, is not only encouraged but preferred. However, in investing, the spoils often go to the one who is not afraid to go at it alone. (For more, see Leading Indicators Of Behavioral Finance.)