Get Positive About Buying Negativity

2. Linearity distorts stock prices. Investors think in a linear fashion, projecting recent events far into the distant future. Companies that put together a string of years of successful operating performance --- like, until recently, Coke and Colgate -- are priced as if they will continue to be successful without disruption. The opposite is true for companies enmeshed in negativity. Current problems of a company are priced into the stock as if they will continue for a long time.

3. Think cycles. The basic stuff of business is not linear. It's cyclical. So it follows that buying into companies at or near a nadir in their cycle will produce outsized returns for the prudent investor. Cycles can be company-specific (e.g., Coke and Colgate), sector-specific (like the current problems facing insurance stocks) or specific to the economy (e.g., homebuilding, finance or auto stocks).

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4. Risk is lower. This is one variable largely ignored by investors because it is counterintuitive. But buying into companies that are beset by short-term, fixable problems is a lower-risk strategy than buying into companies that are not struggling with problems. It's a function of the price vs. value relationship. You are not going to get problem-free companies at a hefty discount. When these problem-free companies eventually run into problems, the resulting discount to the stock can cause large losses.

The stock market sector that currently has the most problems -- and is rife with the most bargains -- is clearly the insurance sector. The current insurance imbroglio will be over in time and the industry will thrive again. While the insurance industry is slapped with negativity, many patient, value-centric investors are busy picking through the debris, looking to pick up heavily discounted assets.

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At time of publication, neither Alsin nor ACM held a position in any securities mentioned in this column, although holdings can change at any time.

Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor and portfolio manager of The Turnaround Fund, a no-load mutual fund. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to [e-mail].