23 April 2005

What makes investors pile into a stock?

The answer to this question was of great concern to a Vancouver stock promoter I met many years ago. After all, that was his business: harnessing investors’ greed to sell out his stake in a new company at a juicy profit to himself.

He’d noticed that some newly-listed companies took off, while others with pretty much the same balance sheet and profit and loss statement stagnated or even fell.

By analyzing pairs of such companies, he discovered that the difference that made the difference was the story. The company with the sexy sizzle was the one that caught the attention of the media, that got brokers and investors hot under their collars and excited enough to open their wallets.

When he promoted companies like this – even when they had more story than substance – he could bank a handsome profit.

The boring stodgy company – that made bricks, or industrial parts no-one had ever heard of – was the one that went nowhere. Even when it was the company that was the better investment.

If you pick up any issue of Forbes, Fortune, or any other business or investment magazine, you’ll find the same principle of “boosterism”at work. And I can’t resist using this story from Fortune magazine to make the point. It begins:

The company that pioneered the trading of natural gas is applying its old paradigm to a newer type of commodity: Internet bandwidth.

The writer quotes several professionals. One said for this company to say “we can do bandwidth trading is like Babe Ruth’s saying, I can hit that pitcher. You tell him to get up there and take three swings. The risk is staggeringly low, and the potential reward is staggeringly high.” Another applauds its entry into a business she calls “very sleazy – a bunch of cowboys and carpetbaggers.”

Then – for a little balance – we hear from two competitors, both skeptical. But the second one adds: “I have no doubt those difficulties will be overcome.”

And the article concludes by saying that this company...

has resources most dot-coms would die for. In today’s environment, where every well-funded tech whippersnapper looks like a genius, it’s tempting to root for a graybeard.

As you can gather from these brief excerpts, the entire article exuded great optimism about the future prospects of this company. You couldn’t help but believe they were on to a good thing. And the implication was that this new business would generate profits which would drive up the price of the stock.

What was the company? Well, the article came from the January 24, 2000 issue of Fortune. And was titled: Enron Takes Its Pipeline to the Net.

Enron! That’s right.

Just after that issue of Fortune came out, Enron raised its earnings estimates and the stock peaked at $81.39 per share. On December 2, 2000, the stock was 40 cents as the company filed for bankruptcy.

Perhaps you think I’m being unfair using this story as an example. And I admit, it is extreme. But it’s not uncommon.

You see, business publications are primarily in the entertainment business. Yes, they contain information. A lot of it good. But their primary aim is to get you to renew your subscription. They achieve that, in part, by serving large dollops of exciting success stories about people and businesses that have made lots of money.

I challenge you to find an issue of business publication without such an article.

So next time a report gets you excited about a company, ask yourself: “That’s a good story – but would it make a good investment?”

Even in investing the old marketing adage applies: “sell the sizzle, not the steak.” And sometimes there’s not even any steak. – Mark Tier.

Have a question or a comment? Email it to investorsedge@marktier.com.

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