Time Off For Good Behavior
Investors are an ill-behaved lot. They're moody. They make short-sighted decisions. They make choices based on what their neighbor is buying. They buy when they should sell and sell when they should buy. Though every one of them will claim to make rational, unemotional decisions based only on an investment's merits and risks, it's just not so.
While we can't cure the bad decision making of everyone else, we can at least avoid making the same mistakes and potentially benefit from theirs. Emotionally and psychologically-driven decisions by others provide us the chance to improve the odds of making good investments ourselves.
There are two sides to every investment decision: someone buys and someone sells. If one of those folks is making a bad decision, then the investor on the other side is making a solid investment. We want to be that "guy." We can achieve those better odds by proactively seeking investments where the investor on the other side of the table is behaving badly.
Bad Behavior
At an investor conference in late 2011, the host polled the audience with a series of questions about their investment plans and perceptions for 2012. The poll was electronic and anonymous. One question asked if investors would consider investing in Europe during the coming year. Europe, at that time, faced monumental structural problems that terrified most investors; all of those problems persist today. Of the 200-plus audience members, two said they would consider investing in Europe. One of those two was me.
In one room, 198 successful and intelligent people offered to sell European stocks to only two buyers. At certain times, investors ignore the underlying value of investments altogether and determine price only by supply and demand. The odds in this case surely stack against the sellers getting the better deal.
Good Behavior
I don't know who the other Europhile was, but I was happy to hear that I faced so little competition in cherry-picking shares of quality companies at bargain basement prices. Only two of us considered that prices in Europe might be cheap enough to offer good investment opportunities. And that assumes my compatriot didn't hit the wrong button by accident. Everyone else substituted a simple question asking "is Europe risky?" (answer: yes) for the right question: "is Europe risky relative to the price of stocks?" This answer is more complicated. For certain European stocks, they're cheap compared to their risk.
Double Coupon Days
To wit: our friends from the conference recently herded out of shares of Wendel (MF), a French investment holding company. The company's two worst offenses: (1) it's European and (2) it's French. MF holds most of its portfolio in shares of global industrial companies. These holdings are mostly European public companies and our colleagues drove those shares down, too. MF's portfolio value fell in lock-step.
However, our conference buddies weren't done yet. They decided to chop a further 40% off the price of MF shares compared to the value of its holdings. As an investment holding company, MF should be valued close to that of its portfolio. Such is the case with similarly situated companies in the U.S., like Loews Corp. These investors left us with a stock whose underlying value comes from shares of other cheap companies while the stock itself also trades at a discount.
Attitude Adjustment
That investors make decisions based on what side of the bed the woke up on or what Johnson is buying in the office next door is easy to see. Since the first step to solving a problem is admitting we have one, we all must admit our own emotional and psychological biases. Done with that?
The next step is to actively seek out bad decisions made by other investors. If you have the chance to be one of two buyers compared to 198 sellers, take it. You gain the luxury of picking what shares you buy and what price you pay. Such tactics won't work out 100% of the time. After all, there are good reasons Europe is not popular with investors. But by evaluating the special situations of individual companies, you can find good investments caught in the fray.
In the case of MF, it was a matter of evaluating the company's holdings and determining that there is a large margin for potential pitfalls before the value of the company slips below the market price and a good chance that its worth a great deal more than that. By seeking opportunities, such as MF, where investors emphasize the context of the company rather than the company itself, we can find better odds for long-term investing success.