Written by: Francisco Olivera Dubón

Retail investors typically view the stock market as either place to play with their money, like in a casino, or as a place to grow their savings by investing. The “gamblers” like to trade stocks rapidly and dream of investing in the next Microsoft. They like to brag when they make a killing with a stock, but they never tell you about their losses.

On the other hand, you have the “savers.” Savers like to add money monthly, quarterly or yearly to their portfolios, preserving their money for retirement or for their offspring. The common “savers” portfolio may be a combination of a diversified group of stocks and safe bonds.

Professional investors though, practice a variety of investment strategies, but they will never admit to be “gambling.” Whether some professional investors gamble in the market is not the concern of this article. It is to introduce you to a group of investors who are not afraid to call the stock market a casino, the value investors.

Value investors recognize that a stock at one price would be like betting on a single number at a roulette table (when the probability of winning is 2.63%). But the same stock at a much lower price would be like playing at a special roulette table, in which the probability of winning is over 50%.

Stocks with “special roulette-like” features do not necessarily hide in plain site and they are usually unpopular. The fact that these “special” stocks are shunned and ignored makes them high probability bets.

By way of example, let’s say you’re searching for a “value style” bet in professional sports. You probably wouldn’t place a bet with the favorite team because the payout is not big enough and you wouldn’t bet on a weak team because the chances of loosing would be high.

Value investors would bet when there is skepticism surrounding great teams. Bad rumors, a specific player’s injury or a rare losing streak could create high probability betting opportunities in sports. The same is true for stocks.

Under the “value investing” school, there are two types of practitioners: those who find stocks with favorable odds of doing well, “the diversifiers”; and those who seek stocks with very favorable odds of not losing value, “the concentrators.” Both strategies have worked well for investors and some combine both strategies.

The diversifiers tend to search for stocks that are priced below their cash and assets, and or stocks that trade at very low multiples of their earnings.

The reason why the market sometimes hands out these bargains is because there is usually something wrong with the companies. A stock may be priced cheaply because (1) it is part of an unpopular industry, (2) it is reorganizing and changing management, and/or (3) it may have had an unexpected bad year.

The fact that a company faces problems does not make it cheap; but if it sells at a good enough price, the chances of the stock outperforming might be favorable. Diversifiers recognize that you can’t bet all your money on one bargain stock. As the saying goes, “don’t put all your eggs in one basket.”

Diversifiers purchase a bunch of bargain stocks, recognizing that not all of them will do well, but together they can be exceptional investments.

Concentrators search for companies with very small odds of losing value, but with favorable odds of performing well. One recent example is American Express. From early January to mid April Amex trade below $20 a share and at one point reached $10. At $20 a share, Amex traded at a small multiple of what it could earn in a normal economic environment. Amex’s powerful brand and strong relationship with customers provided the safety that concentrators need when investing. Investment opportunities in companies like AmEx are rare; concentrators have to be very patient.

Whether you are a value investor or not, it is important to recognize how the market works and how it can help you. If you want to gamble with your money, go to a traditional casino. The stock market will reward you only if you use it for your benefit.

Full Disclosure: At the time of writing Francisco Olivera Dubón did not own shares of American Express. His positions might change at any time.