How to Profit from a ‘Bad Idea’ in the Stock Market

Forget macroeconomic disasters.

Forget geopolitical disasters.

Forget money printing, central bank, and iron ore price disasters.

Those disasters have nothing on this disaster.

Most investors see it as the worst sector in which to invest.

In fact, famed investor Warren Buffett says ‘It’s been a death trap for investors.

Two bits of news in the past 48 hours would seem to confirm that view. But is it right…?

Here’s the news.

First from the Australian:

Qantas has posted a massive $2.8 billion net loss as it wrote off a big chunk of its fleet and moved to take as much pain as possible in the previous financial year.

The net loss was almost double the worst expectations of analysts although the underlying pre-tax loss of $646m was better than consensus estimates.

The net loss of $2.84 billion for the year to June 30 compared with a $1 million profit a year ago.

Ouch! Who’d invest in an airline?

But that’s not where the bad news ends. The Sydney Morning Herald reports:

Virgin Australia Holdings has reported a full-year underlying loss of $211.7 million in line with market expectations as it set out its vision for the next three years.

As we say, who would invest in an airline? We would…

Turning $250 into $2,450

You’ll often see us blow our own trumpet when we get a call right.

For instance, we tipped a natural gas tiddler in early 2012, when no one else would touch the industry.

Small-cap analyst Tim Dohrmann recently told subscribers of Australian Small-Cap Investigator to lock in profits. Many of those who took the initial advice have managed to clock up gains of 758%.

Subscribers who ‘ignored’ that advice and bought the stock up to 18 months after we first tipped it could have made more than twice those gains.

One reader wrote to us yesterday to say that she had bought 1,429 shares at 35 cents. She has just sold 700 of them for $3.50 per share. That’s a 900% realised gain.

In effect, that reader has turned $250 into $2,450.

Even if the value of the remaining shares she owns falls like a stone, she has still bagged a huge profit.

You can’t get much better than that.

But it’s obvious we don’t get everything right. We’ve picked some big winners. We’ve picked some losers too. Backing Quickflix [ASX:QFX] to stir up the TV industry was a bad pick.

In that case we got it half right. We got the trend right, but we got the investment wrong. We recently told subscribers to sell it for a 91% loss.

But that’s the rough that goes along with the smooth of speculative investing. If you can’t handle the potential to lose 50% or more of your stake, you really shouldn’t speculate at all.

However, we’ll say one thing: every investor should speculate to some degree. Without speculation you’ll miss out on even achieving average returns.

Buffett speculates too

We put the airline sector in the speculation camp.

We don’t care whether it’s a big airline or a small airline. All airlines are speculative.

Earlier we mentioned Warren Buffett. He said airlines were a ‘death trap’. Too many investors have missed out on big opportunities by following what they think is the Warren Buffett way of investing.

We won’t cover this in detail, as we’ve done so before.

But if you think Buffett is a safe and conservative investor, you need to ditch that thought right away.

Buffett is about as big a speculator as you can get. This includes huge derivatives investments as part of Berkshire Hathaway’s [NYSE:BRK/A] insurance businesses. Buffet likes speculating, it’s just that some people listen to one or two of his comments about a sector and assume it applies to all sectors.

Also remember that Buffett buys stocks (or businesses) when most investors are running away from the market. Most of the supposed ‘Buffett followers’ we’ve spoken to would never dream of buying stocks when things look risky.

Instead they’ll trot out lines about expensive valuations even after a crash.

But just because Buffett doesn’t like speculating on airlines or technology, that doesn’t mean you shouldn’t speculate on these sectors.

History has shown both are and can be profitable.

Even ‘bad ideas’ can make big returns

The tech story is a well-trodden path.

We’ve shown you many times before the kinds of returns tech has given investors over the years. Stories of Amazon [NASDAQ:AMZN], Microsoft [NASDAQ:MSFT], and Apple [NASDAQ:AAPL] are almost clichés.

But even though they’re clichés, it doesn’t change the fact that investors who were brave enough to back those stocks in the early days achieved huge returns.

So when Buffett dismisses all tech stocks, it is in our view an ignorant position.

That’s why we don’t automatically ignore the airline industry…even though the conventional wisdom says it’s a dog.

The fact is airlines aren’t always a bad investment. Take this chart of Delta Airlines [NYSE:DAL]:


Source: Google Finance
Click to enlarge

Since 2009 the stock has gained 882%. We don’t know about you, but that’s pretty good. And compared to the ‘genius’ Warren Buffett’s Berkshire Hathaway, well, Berkshire has ‘only’ gained 159%.

That’s still pretty good over five years.

Now, long term we’d agree that Berkshire is probably the safer bet in your portfolio. The point is while Buffett may be a genius, just investing in Berkshire stock would have resulted in a return lower than the S&P 500. The index is up 171%.

That’s even with Buffett’s derivatives speculation included.

We’re not saying that taking a punt on Qantas [ASX:QAN] and Virgin Holdings [ASX:VAH] will give you the same kind of return as Delta Airlines.

But we are saying that as an investor you shouldn’t automatically exclude a stock from consideration just because you think it’s a bad idea. Sometimes even bad ideas have merit.

Cheers,
Kris
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Kris Sayce

Kris is never one to pull punches when discussing market developments and economic events that can affect your wealth. He’ll take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money. Kris is also the editor of Microcap Trader — where he reveals the best opportunities he’s discovered in the markets.

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