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Peter Lynch, legendary investor of the Fidelity Magellan Fund, used to promote the philosophy of "investing by walking around," or "invest in what you know." He would suggest people go to the mall and simply observe what people are buying. His common sense approach provided simple and understandable concepts for the everyday investor. Warren Buffett has a very similar philosophy. I once heard him discuss the purchase of Dairy Queen. He simply said, "when I go out, where do I go? I go to Dairy Queen," he said, so he bought it.

These simple approaches capture the most important aspect of investing - change and understanding.

Identifying change in my opinion is what will always be essential to outperforming the markets and developing extraordinary returns. The reason is simple. By definition the markets are discounting mechanisms that discount all known information. If in fact the efficient market hypothesis holds, the only way to beat the market would be to see around corners and identify change before the market has an opportunity to discover it and discount it into the price. That is why insider trading and material non-public information is so widely policed. People that have information that is material and not known to the markets can exploit that information for a profit. It is like betting on a horse race after the race has been run.

For most of us retail investors however we have to rely on gathering data on our own from the outside and form what is called a "mosaic." Going to the mall and walking around you might observe long lines outside the toy store where the new Iron Man toy is being sold, or outside the shoe store where the new styles are often displayed. In this video the concept is applied to driving around a neighborhood that had recently been impacted by Hurricane Sandy. While driving around the neighborhood, the reporter mentions that boxes for generators line the streets. Those boxes contained generators made by a company named Genrac (NYSE:GNRC), and not coincidentally, GNRC is releasing outstanding earnings and getting added to the most underrated companies list. The company has had multiple earnings triple plays beating earnings, revenues and guidance 3 out of the last 3 quarters. While it would be foolish to invest in a company whose earnings are largely based upon damage from a past hurricane, the concept of homebuilders going forward offering generators as an option represents a real and ongoing "change" potential to this firm.

Past earnings, however, have been explosive, largely due to the hurricane. Net income went from just $9.3 million last June to over $50 million in March. Clearly there is room for earnings to fall, and comparable earnings next March will be very difficult to exceed ... baring another major storm. GNRC isn't cheap either with a P/E(ttm) of over 24. The other problem is that it produces electric generators, and the company is relatively small at a $2.7 billion market cap. Another company that uses electric in its name - General Electric (GE) - is a behemoth that might want to play in this pool if the water gets warm enough.

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The other concept is investing in what you understand. If you don't understand something, it is hard to know when and what change would be good or bad for a firm. If you don't understand the microchip the firm you own makes, how can you know when it might become obsolete? Generators and home appliances are pretty well understood by everyone, so GNRC fits into that category as well.

In conclusion, when life gives you lemons, make lemonade. Even when bad things happen, there are almost always silver linings to every story. Events whether good or bad cause change, and change is usually good for some companies and bad for others. The new term is "disruptive." You often hear about a new "disruptive" app that is being introduced into the Android ecosystem that will revolutionize the way things are going to be done. Back in the late 1990s it was the "killer app." Way back in the early 1900s it was the automobile, and before then the railroads. Economist Joseph Schumpeter wrote about his "gales of creative destruction." Bottom line, throughout history, change has been good to investors that were the "early adapters" of it, and identifying investment opportunities created by change are essentially the only way to outperform a truly efficient market. The early bird gets the worm so to speak. GNRC represents a classic change investment that is understandable and ironically emerged from the destructive gales of Hurricane Sandy. If there are any silver linings to the clouds of Sandy, GNRC may be one of them, but investors should use caution entering the pool because hurricanes don't happen that often, and the one year forecast is for stormy weather as June comparable earnings loom overhead.

Disclaimer: This article is not an investment recommendation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.

Source: Sandy's Silver Lining: Generac