Trading Against the Herd

 | Nov 02, 2011 | 12:35 PM EDT
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Before this week got under way, many investors were wishing they had established positions when uncertainty was at its highest over what plan of action the European Union would take to avert a financial catastrophe. Today, thanks to the curve ball Greece threw the market over the weekend, investors may get another opportunity. My guess is as good as yours as to whether the market will touch lower lows, or if it will merely provide a better price point than what it did when the S&P 500 was sitting near 1300 last week.

 As I've said over and over again, foolish is the one who tries to precisely time markets. Over the past several weeks, the market has perfectly showcased the herd-like behavior of investors. The herd wanted nothing to do with stocks in September. All of a sudden the European Union comes to a resolution, and the U.S market goes up 15%. Then the markets plunge nearly 6% when the Greeks told the EU to go take a hike -- that they would decide whether to accept food from the hand that feeds them.  

Individual stocks, of course, experienced greater volatility. In September, names like Walter Energy (WLT) dropped from $90 to less than $60, or nearly 40%. Then, in October, shares advanced by nearly 50%. The question I ask is: What do Europe or Greece have to do with a coal company, or most or other businesses, being appraised for 40% less in three weeks? Carl Icahn had planned to sell Federal Mogul (FDML) several months ago, but scrapped the deal in September because the share price sold off. Thinking like a businessman, Mr. Icahn had no interest in selling his company for 50% less just because the animal-like behavior of panicked investors.

Of course, not all investors follow the herd. Bill Ackman, Warren Buffett, Wilbur Ross and other notable investors publicly stated in one form or another that they were buying stocks late in the third quarter. My guess is that, by ignoring the herd and thinking independently, these folks have enjoyed tidy profits in excess of 20% on paper. This issue with Greece will likely generate a familiar story. Over the next several weeks, setbacks will lead to a selloff, and good news will cause a market pop.

 Consider the setbacks as an opportunity to buy at a good price. Emerson Electric (EMR) is a high-quality business, and it has an impressive CEO in David Farr. The company just reported solid earnings, capped by a 16% increase in the dividend payment. When appropriate, the company has been buying back its stock. Otherwise, management has stated that it manages the business in order to "control our own destiny." The company also pledges to return a healthy portion of cash flow via dividends.

Advance Auto Parts (AAP) is another fantastic business that is as close to recession-proof as you can get. The business generates almost half the earnings before interest, taxes, depreciation and amortization as that of AutoZone (AZO), yet it trades for less than one-third of AutoZone's enterprise value. Advance Auto Parts CEO Darren Jackson is doing all the right things: buying back an undervalued stock, divesting weak stores and focusing on the high-growth commercial segment.

Keep a close on your watch list now. Excellent buying opportunities can be brief, especially in this volatile market. When the market gives you an inefficient price, step aside from the herd and buy. Sooner or later, you will sell back to a happy herd when the price has climbed much higher.

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