Nothing is worse than investing in a company, watching the company perform very well, but seeing the stock price go nowhere or even worse, decline in price. Unfortunately, this situation is a common experience for many investors. The reason? Buying at a high price.
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When a company is favored by Mr. Market because it's growing its profits nicely, odds are very high that the stock price will overvalue the business. That's because investors bid the stock price up to account for the future growth of the business. As a result, the stock price leaves little room for error. Amazon (Nasdaq:AMZN) is a great example. Amazon is an excellent business that is essentially trying to become the Wal-Mart (NYSE:WMT) of online retailing. Sales are booming as the company continues to spend aggressively on growing its market share.
As a result, Amazon has razor thin margins and makes very little money now. But investors are betting that profits will swell in the future. So Amazon shares fetch nearly 180 times earnings, a valuation that is more twice that of Facebook (NYSE:FB), which is currently under pressure from investors over its valuation. Paying nosebleed prices for exciting stocks puts investors in trouble.
On the other hand, there are excellent companies that fall out of favor with "Mr. Market." The result is a business that is untimely but trading at a stock price that could be very rewarding to patient investors. A bad quarter sent shares of retailer JC Penney (NYSE:JCP) down from a high of $45 to roughly $28 today. Despite the disappointing quarter, JC Penney is backed by activist investor Bill Ackman, who has appointed former Apple retailing wizard Ron Johnson to the helm of JC Penney.
SEE: Analyzing Retail Stocks
Hewlett Packard (NYSE:HPQ) shares are very out of favor with investors today. New CEO Meg Whitman has her work cut out for her. The company just announced a poor quarter and plans to cut as many as 27,000 jobs, which will save the company nearly $3.5 billion annually. HP currently has a market cap of around $44 billion, so if the majority of that savings flows to the bottom line, HP stands to benefit from being a smaller, yet more profitable tech company.
The Bottom Line
Investing in out-of-favor stocks requires patience and discipline, attributes that aren't readily found amongst many investors today. The easy answer is to be investing along with the crowd, as failing conventionally is much more accepted than succeeding unconventionally. However, time and time again, the biggest investment gains goes to investors who aren't afraid to abandon the crowd.
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At the time of writing, Sham Gad did not own shares in any of the companies mentioned in this article.