In the last few weeks, we have featured interviews with John Templeton discussing the concept of maximum pessimism. Lauren Templeton and Scott Phillips discuss the principle of maximum pessimism and its relation to Templeton:

The principle of maximum pessimism has the potential to be a puzzling concept to many casual observers. To begin, this investing maxim—at least on the surface—projects a negative connotation that contrasts heavily to the starkly optimistic nature of its originator, Sir John Templeton. Upon further inspection though, the principle of maximum pessimism and buying at the point of maximum pessimism is unequivocally an act of optimism.

When we place the principle of maximum pessimism more squarely in the context of a value investor searching for a stock whose price has become too low in relation to the intrinsic worth of the company, we can better understand the contrast between connotation and reality. As Sir John explained, “People are always asking me where is the outlook good, but that’s the wrong question . . . the right question is: Where is the outlook the most miserable?”  His reasoning was that the only way a stock price can become too low in relation to its intrinsic worth is from other people selling and pushing the price down. Clearly, the most intense selling and therefore the widest disparity between a stock price and the value of the company it represents occurs where people have become the most pessimistic. For that matter, the most extreme mispricing, and therefore the greatest opportunity, will occur at the point of maximum pessimism. For those investors able to distinguish what should only represent a temporary cause for pessimism from a permanent problem,  then an opportunity may be presented for a wise long-term purchase . . .

Lauren Templeton is president of Lauren Templeton Capital Management, LLC, and Scott Phillips is author of the newly released Buying at the Point of Maximum Pessimism: Six Value Investing Trends from China to Oil to Agriculture (FT Press, 2010). Templeton and Phillips are also coauthors of Investing the Templeton Way: The Market-Beating Strategies of Value Investing’s Legendary Bargain Hunter (McGraw Hill, 2008).