The Magic of Low Expectations

 | Jul 30, 2013 | 3:00 PM EDT  | Comments
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When I was engaged five years ago, I sat down with my soon-to-be wife to have a crucial talk -- about how we could ensure a life of happiness even when life would throw us a curve ball. I told her that I could almost guarantee her a fun-filled marriage if she did just one thing: maintain low expectations of me. Boy, did I turn out to be prophetic with that piece of advice. As long as she's kept her expectations low, odds have been high for me to consistently exceed them -- and, as we men all know, that makes for a happy life. 

So it goes with the finding value in the stock market. In other words, you should seek out securities for which the masses have the absolute lowest hopes when it comes to future potential. If those businesses start to exceed the market's expectations, odds are very high that you will be happy, if not ecstatic, with the returns that you will enjoy. With that in mind, let's turn to one of my longtime favorite groups: the financials.

Despite the stock market's nice run-up over the past few years, one only has to go back a couple of years or so to recall the hatred that America's top financial institutions were getting -- not only from the general public, but the investment community as well. In 2011, Bank of America (BAC) saw its shares plunge more than 50% because of the incredibly low expectations Mr. Market had put on the company. At that point, of course, there were plenty of things not to like about BofA: lawsuits, growing loan losses, government scrutiny, and on and on. 

Yet, while most everyone focused on the bad, they largely ignored one obvious signal: The market was offering BofA shares for less than $6 at the end of 2011. At that price, expectations were so low that they'd be exceeded with even the slightest bit of future good news. People seemed to forget that, with more than $1 trillion in consumer deposits, BofA wasn't going anywhere. It just needed time to heal -- and heal it did. Shares now trade close to $15, making for a near-200% return in less than two years. 

This is not an isolated incident, either. It is human psychology at work. Remember housing? Another company I looked at during that sector's crisis was Builders FirstSource (BLDR), which was then trading for around $1.75 a share, when pessimism for the industry was at its peak. Today, the company's stock sits above $6. 

You don't need to possess above-average intelligence to enjoy these types of opportunities in investing. You simply need to understand that prices are most attractive when pessimism is growing, and that they're less attractive when optimism is growing. It's really that simple. The hard part -- and the reason few investors beat the market -- is having the emotional fortitude to sit still and let time do the trick. Of course, you also need the ability to analyze a business and make sure it passes the test of investment suitability.

Thanks to today's euphoria, it is hard to find low expectations on anything. However, there are still pockets of interesting opportunities. Natural gas, anyone?\

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