It’s not always fashionable to go with what’s “hot”…
Sure, stocks can go on incredible runs when they first catch investors’ eyes. The COVID-19 pandemic provided two examples…
Work-from-home superstar Zoom Video Communications (ZM) soared from about $70 per share at the start of 2020 to around $570 per share by mid-October 2020. That’s a remarkable gain of more than 700% in roughly 10 months.
But then, just as quickly, the stock fell out of favor… It has dropped for most of the past 14 months. Shares recently closed at around $190 – a plunge of almost 67% from its peak.
Folks who bought this previously “hot” stock around that time are sitting on huge losses.
Home-fitness favorite Peloton Interactive (PTON) is another case of faded fashion… The stock skyrocketed roughly 750% from mid-March 2020 through mid-January 2021. But it has been a downhill plunge since then… The stock is down more than 75% from its peak.
It’s easy to get into the fashion game. But it can be painful if you miss a change in popular taste.
As I’ll explain today, it’s impossible to get every investor to see that market darlings won’t keep going up forever. So instead, we can use it to our advantage…
Legendary mutual-fund manager Peter Lynch best described this idea with one of my favorite quotes of all time. It comes from Chapter 9 of his book One Up on Wall Street…
If I could avoid a single stock, it would be the hottest stock in the hottest industry, the one that gets the most favorable publicity, the one that every investor hears about in the car pool or on the commuter train – and succumbing to the social pressure, often buys.
And here’s the thing… Lynch published that book in 1989.
More than 30 years later, his quote still rings true. It’s timeless advice for investors…
Companies whose stocks become “hot” in investors’ eyes sometimes have good business prospects… And sometimes they don’t. Either way, when everybody starts falling in love with a stock, you should approach it from a “guilty until proven innocent” perspective.
Beloved stocks fall out of favor and plummet all the time…
Longtime investors will recall the “Nifty Fifty” in the late 1960s and early 1970s. Everybody believed these “hot” stocks would go up forever. But seemingly overnight, the bear market from January 1973 to October 1974 took some of these stocks down more than 70%.
The “dot-com bubble” in the early 2000s is another example. Investors loved companies like Pets.com, Webvan, eToys.com, and even Garden.com… until they didn’t anymore.
This type of love-hate relationship makes the markets tick. It’s human nature to get emotional… If everybody acted rationally all the time, nobody would have any reason to trade.
So instead of complaining, we can embrace this anomaly… Or better still, we can exploit it.
We can do that by trading on the basis of “objective merit” – not chatter from the car pool or the commuter train. In other words, we can find stocks that deserve love from investors.
That’s easy to say, of course. But it can be a challenge to execute…
For starters, you might feel left behind in the short term while the fashionable crowd ignores the stocks you’ve found. It’s great to buy low while the “hot” stocks distract the crowd. But eventually, you want others to properly value – or even overvalue – your stocks, too.
Second, it’s important to recognize when the crowd is right. As I said yesterday, “Mr. Market” isn’t as crazy as he used to be. Sometimes, instead of fighting him, it’s best to just move on to something else… Naïve naysaying isn’t any better than naïve following.
That’s why, as I’ve said several times over the past month, I take my cues from our proprietary “Power Gauge” system. Chaikin Analytics founder and Wall Street veteran Marc Chaikin created this 20-factor model based on his 50-plus years of experience…
The Power Gauge focuses on the more thoughtful part of the crowd – the so-called “smart money,” or institutional investors. It also assesses a company’s fundamentals… That way, we can see when the crowd is favoring stocks that objectively deserve to be favored.
Whatever method you follow, though, keep your eyes and minds open. Always look for evidence of objective merit… Find stocks that deserve the love they’re getting.
If you find merit in a medical genomics pioneer, that’s great. If you find it in a trash collector, that’s great, too.
Remember, investing isn’t about being fashionable… It’s about making money.
Good investing,
Marc Gerstein
