The Value of Counterintuition

 | Mar 21, 2013 | 12:30 PM EDT  | Comments
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Stock quotes in this article:

bbry

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APPL

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wen

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mcd

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jcp

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m

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dds

In value investing, there is this notion that being a contrarian -- i.e., going against the crowd -- is immensely valuable. There's no denying the value of an independent thought process. But I often see people being contrarian just because it sounds like the noble thing to do: Wall Street is a casino they say, so I will bet against it. Guess what? A majority of time, the odds are always in the house's favor. To simply go against the consensus of the market -- or the tens of thousands of other participants who determine the market's moves -- without an intense level of research and analysis is indeed gambling.

What I see as very important aspect of investing, however, is the notion of counterintuition. The great Howard Marks of Oaktree Capital Management defines counterintuition as the idea that a low-quality asset can be safer than a high quality one. It's the understanding that securities get riskier when more and more people begin to praise them. Most of all, risk can be elevated when you think you know something vs. admitting that you don't.

How can a low quality asset be a superior investment to a high quality asset? Think about why Warren Buffett is scooping up small town local newspapers. The Internet has permanently impaired the earning power of traditional newspapers, so nobody wants to own them. Buffett is sweeping in and buying the small town papers, where the newspaper is still the source of information, at incredibly cheap prices.

Price is paramount in investing. Look at the performance between Blackberry (BBRY) and Apple (AAPL) over the past six months. When Apple was trading at an all-time high,  Blackberry was being valued only for the cash on the balance sheet. Most would easily agree that Apple possesses the far superior assets, but Blackberry proved to be the superior investment: The stock had moved up nearly 150% in the past six months vs. a decline of 35% for AAPL.

Comparing Wendy's (WEN) to McDonald's (MCD) today, I would argue that Wendy's – No. 3 vs. No. 1 -- could likely prove to be the better investment. McDonald's stock has been a tremendous success over the past decade and the price appreciation naturally makes the share's riskier. Wendy's – which, until recently, saw its shares remain stagnate for years -- is in turnaround mode and working to improve the value of its assets.

One name to watch now is retailer J.C. Penny (JCP), which has been one of the worst performing apparel retailers over the past year. At the moment, CEO Ron Johnson has not been able to create value from JCP's assets. Its brand name may be its biggest asset, but it is arguably far inferior to names like Macy's (M) and Dillard's (DDS). The market is valuing Macy's and Dillard's at nearly 3x and 2x book value, respectively, while J.C. Penney is valued at approximately its stated book value. If J.C. Penney can win its customers back, perhaps it will turn out to be the better investment.

Counterintuition is a valuable investing concept to grasp. Consider this simple analogy: Is buying a brand new car for $30,000 a more reliable purchase than buying a comparable year-old car for $20,000? Before answering, you would conduct some research. Approach the stock market the same way. 

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