- The best thing that happens to us is when a great company gets into temporary trouble... We want to buy them when they're on the operating table. - Warren Buffett
A quick history lesson...
In 1963, the world's largest credit card company, American Express, was involved in the 'salad oil scandal'.
AmEx had just created a warehousing division to make loans to businesses using inventory as collateral.
A commodities trader (and known swindler) named Anthony 'Tino' De Angelis saw an opening for a massive fraud.
He began stockpiling his warehouses with tanks of soybean oil. He then used warehouse certificates from American Express as collateral to borrow heavily from American Express and as many as fifty other lenders.
When American Express sent inspectors to check De Angelis' inventory, they did not notice that - except for the thin layer of oil floating on top - the tanks were filled with water.
When the fraud was finally exposed, AmEx stock crashed more than 40%. The eventual damage to the company would be US$175 million.
At the height of the fallout, an unknown 35-year-old fund manager from Omaha decided to bet big on American Express, putting 40% of his fund's money into this one stock.
His name was Warren Buffett, now the world's richest and most famous investor.
Buffett knew the brand power and consumer business of American Express would survive the scandal. The company's prospects were as bright as they were before the scandal. It was a play on rising affluence levels worldwide.
More importantly, the stock was available at a bargain price. Buffett was only too happy to lap it up.
Within a year, AmEx had rebounded more than 40% and has been a compounding machine ever since.
No wonder Buffett says he likes to buy great companies when they're on the operating table!
What can we learn from this?
Whenever you find a stock that's been beaten down due to one specific problem in the business, ask yourself the following questions...
- Will the core business survive? In the case of American Express, the answer was yes. People were still going to use traveller's cheques and credit cards.
- Can the balance sheet withstand the hit? Having analysed the financials, Buffett knew American Express could.
If the answer to both questions is yes and the stock has already fallen about 40%...then you might just have a big winner on your hands.
Keep the American Express example in mind when you read through this month's Hidden Treasure report. We believe this could be a case of history repeating itself.
Editor's Note: Warren Buffett is known as a value investor. And for good reason, as we saw today...
But that bold move back in '63 would also put Buffett in the category of 'contrarian investor'.
Because he was making a bet few others had the gall to make. As the markets panicked, Buffett loaded up.
This is what smart contrarians like Buffett (and Soros and Templeton and Rogers) do. These guys make it look easy, but contrarian investing...smart contrarian investing...requires a level of discipline and fortitude that most investors simply lack.
Do you think you have what it takes to follow in their footsteps?
Beginning next week...more on how to approach the markets like a smart contrarian.