Market Darlings That Disappoint

There is a lot of talk currently about Apple Computers whose shares reached an astonishing $644 in April 2012. Today they trade at $585 which is a 9% drop in value. It is reminiscent somewhat of the painful share performance of Research in Motion (RIMM) which reached an equally astonishing $148 in 2008 and now trades at $7.50, and is showing further weakness. The issue is that greed and the herd instinct often betray investors.

When a stock has a spectacular rise in value, or when the media concentrates on an upcoming IPO, normal rational thought seems to abandon investors. The history of the stock market shows that market darlings normally retrench after reality sets in. Of course there are exceptions to this rule, such as Apple Computers when Steve Jobs returned to the company, and when Google went public. But these are the exceptions, rather than the rule.

How to Value a Stock

A stock is normally valued by analysts and the market based on expected future earnings. In essence, the market values stocks based on what they are expected to achieve in earnings and market presence, rather than on the reality of what the company is doing today. When a stock becomes a market darling, that expectation of what will happen in the future is the primary factor in what investors will pay for the stock. There is one glaring problem with this method of valuation. No-one can accurately predict the future. When someone does achieve the ability to predict the future, then investing criteria will change. But until then, investors listen to the hype and nonsense of Analysts and the media. So investors jump on the bandwagon for every new market darling.

Apple Computers is an amazing company. When Steve Jobbs came back to the company, it became an amazing place, that changed the world with its constant stream of radical innovation. But stop for a moment and think about reality. There was only one Steve Jobbs. His replacement is not Steve Jobbs. It is possible that his replacement will create something equally astonishing, but think about the odds of that happening. Pretty slim aren't they. Now think about the stream of new products developed by Steve Jobbs' fanatical personality. I am confident that there still are some surprises in the pipeline of product improvement and innovation, but Steve Jobbs is gone.

Now think about earnings. Earnings come from the sale of products. The last quarter's earnings were a bit disappointing, but think about how high a standard was established in sales volume by the iPhone and similar products, each more amazing than the last. But Samsung is now breathing hard on Apple's heels. The Android open source system is establishing more and more market presence. Google is entering with its own device. Microsoft has announced that they are entering the competition. It will be very difficult to repeat the astonishing sales records of the recent past.

Yet investors remain faithful. Perhaps there is a new product coming which will revolutionize TV, or travel, or whatever, but why would an investor bet that new management will exceed the brilliant success of the past? This is a hard bet and one that investors should be cautious about. Yet the market price of Apple shares remains high.

Gambling on the Stock Market

There is a long established belief that a portfolio should consist of blue chip stocks and that this represents safety for investors. But blind categorization of a stock as being in the class of Blue Chip Stocks is far more of a gamble than one might expect. Perhaps Apple will announce something amazing, but if it doesn't, the downside is far greater than the upside. Think about the sheer size of needed sales by Apple in order to match previous records. What a difficult task to achieve. Now think about what will happen to the stock if earnings disappoint in the future. The downside is far greater than the upside.

This is a gamble and not worth taking. If you wish to gamble with the odds stacked against you, go to a casino. If you wish to make money in the stock market, apply normal intelligent thought to the process. Accept no-one's advice without applying your own rational thought to the matter. Common sense is a far greater contributor to making money in the stock market, than tips, gossip, and the latest hype from the media.

There is life cycle to all stocks. When a stock is 'hot', everyone jumps on the bandwagon. Realistic valuations are forgotten and the herd instinct takes over. If your neighbor is buying a stock, it would be most embarrassing to see him next month at a neighborhood party and have to listen to how much money he made on a stock that he mentioned, especially if he can say "I told you to buy it". How embarrassing that would be.

The problem is, that the guy that gave you the tip, is no more knowledgeable than you are, and unfortunately, that is also the case with most Investment Advisors. They work in an environment of rumour, gossip, hot tips, and competition. They have to perform. If a client calls him and asks about a hot stock, that is a bad thing. What is a good thing is that the Investment Advisor calls the client first to mention a hot stock.

Trends in the stock market are a strange thing. If you catch a trend, that is normally the way to make money. But trends always fade, and the last ones on the bus are the ones left holding the stock that is now falling. The smart money has long since moved on and they sold their holdings to the ones getting on the bus most recently. It is a tricky game and best played by those working in the industry, not by the casual investor listening to neighborhood tips.

Some Simple Rules

Use common sense. After you hear the hype, think about it logically.

Buy because there is a real and recognizable value being increased, not because of past glories.

Buy because the future looks far more promising than the past.

The views expressed in this blog are opinions only and are not investment advice. Persons investing should seek the advice of a licensed professional to guide them and should not rely on the opinions expressed herein. This blog is not a solicitation for investment and we do not accept unsolicited investment funds. Larry Cyna and/or the CymorFund may have positions in the shares of companies mentioned.