Luck, or Skill?

Investor A buys shares in XYZ Corp., confident that the company is undervalued. He or she invests in the business, and shortly afterwards, the stock drops by as much as 50%. For well over a year, the stock price remains dormant. All the while, the investor sees share prices rising at other businesses he or she's familiar with. Investor A reassesses the situation and does nothing.

Investor B, also favorable on XYZ Corp., begins buying shares a year later at about one-half of Investor A's cost basis. The following year, Mr. Market catches up with XYZ, and the stock doubles. Investor A is back to even, and Investor B is sitting on a 100% gain.

Which investor would you rather be? With hindsight, it seems that Investor B looks rather smart and savvy, while Investor A just got unlucky buying at the wrong price or the wrong time. Actually, the situation should be viewed from a totally different perspective.

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Sham Gad: Don't Invest in the Most Valuable Business

Pabrai examined this list and determined that if you had started with $10,000 invested in the most valuable businesses in 1987, when Fortune released its list, and every subsequent year reinvested the funds in what was at the time the most valuable business, in 2002 you'd have an annualized gain of 3.3%. During the same period, the S&P delivered about a 10% annualized return.

You can clearly see from the results that the maximum pessimism approach would yield a far more superior result. As the saying goes, what has risen shall fall, and what has fallen shall soon rise again. Surely not every stock that deteriorates will again rise -- it's up to you to provide the thorough analysis and determine whether or not a superior investment opportunity exists.

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Warren Buffett: Value Investors Only Care About Bear Markets

A value-oriented investment approach in the style of Graham and Buffett does not focus on bull market performance. In fact, by definition, true value investing always focuses on weathering the bear market storms and coming out relatively unscathed. During bull markets, a lot of people are mistaken for investment geniuses when in fact it's the rising tide that's moving them up in the world. Bear markets, on the other hand, distinguish the intelligent investor from the fly-by-night speculator. My approach and the ultimate purpose of value investing is to outperform bear markets.

In his 1961 letter to partners, a 31-year-old investor in Omaha named Warren Buffett told his partners that they should be judging him during times of turmoil and not times of jubilance. "I would consider a year in which we declined 15% and the [Dow Jones Industrial] Average 30%, to be much superior to a year when both we and the Average advanced 20%." Very early on in his career, Buffett was aware that performing well during market turmoil was the key to long-term success as an investor. During the 13 years that Buffett ran his partnership, not only did he destroy the Dow Jones Average during both bull and bear markets, but he also never had a down year. So while other investors have come along and produced records that outshine Buffett's, its Buffett's preservation of capital that has allowed him to compound money at such a staggering rate.

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