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ELL Blog

Retail Investors Are Stupid

Please repeat after me. Efficient Market Hypothesis does not mean stocks are valued fairly. It just means that stock prices reflect the latest news that is parsable by algorithms or is being parsed by many, and I mean many, decision making humans. So a news piece that is very obscure, like a journalist on Twitter is not going to have an impact on the markets unless it goes viral (fake news example).

So what have we learned? That the market is a monolith where stock prices reflect the majority shared opine. So if most people are stupid and believe everything they read on the internet or buy stocks based on the same feelings (e.g. I shop at Costco, Costco is always packed, Costco stock will always go up). Obviously, with Costco, it’s a 300B+ company that isn’t correcting anytime soon. Let’s take an example of “the future.”

The Future is Y. NOT

The pandemic gave everyone messiah vision. Zoom is the future, Purple Mattress is the future. Everyone will be purchasing Pelotons (my family replaced our broken treadmill with some generic one). When people start claiming companies are the future, they are making a claim that these stocks should be growing almost at 100% year on year. Now what is the difference between a stock that is definitely growing 100% yoy and a stock that is priced at that growth? Past-history and future timeline. Past-history, as in the company already existed and was already known (e.g. CELH). When the pandemic first hit, we all knew the lockdown was temporary. There’s no way staying in doors for 5 years was a viable solution. 2 years max. Therefore, stocks like ZM and PTON are temporary high growth stocks and should be bought (if at all) with the expectation to sell once the price has run up. Greed makes it hard to sell.

But we Want to Make Money

Okay, so why do we care. If we sit out, we miss out. FOMO is a real thing right? Well, it’s not just a FOMO, you also have to time your sells. Based on these stocks, people might get scared for an entire month, so while owning these stocks, keep in mind they are temporary so best way to play these stocks is with a trailing stop loss of 20%, and when this trailing stop loss is executed DO NOT PURCHASE THE STOCK AGAIN. The 20% trailing stop loss is not a guarantee that the stock has hit it’s peak and is on its way down, but it limits your exposure before you are trapped in a situation where no one else is buying into the company and people are starting to take profit. Here’s a list of stocks where a 20% trailing loss could prevent further losses. If you do buy at the peak; a 20% loss in capital should signal to purchase a well-tested stock (e.g. tech company) or ETF (VOO / ITOT / VUN.TO, QQQ / QQQ-C.TO).

Do not short the companies either. The goal is to make money; invest according to the most probable scenario.

A new herd stock spotted in the wild is most likely to keep going up with maybe a hiccup or two and then it will pop and go down either very quickly or over time with hiccups. An old herd stock could go up for a very long time before popping to a fair valuation. The difference between an old and a new herd stock is that the old herd stock at least has a fundamental value, so a re-entry at that valuation is fine. P/E is a horrible valuation; PEG is better as it accounts for earnings growth (though I wish there was a metric that used PEG and tangible book value for companies that keep billions in cash). So with these old herds, it’s best to have a set ratio that is ideal and the market kind of conforms to implicitly.

What to Watch out For

Ask yourself if the stock would be added to the S&P500 if it suddenly went to a higher market cap and is profitable? If not, it’s a new herd stock, otherwise it’s an old herd stock.

The thing with old-herd versus the new herd is that the returns are front-loaded and so the company performance has to catch up to the valuation whereas with new herd the valuation is so ridiculously high that logic will force the valuation to catch up with the fundamentals (reality).

Case Study: $NAT

Oil prices tanked and so OIL storage stocks were the play except this stock was pumped by a YouTuber. Wow great play. Stock blew up the same day it peaked.

Case Study: $ZM

When the kids are informing parents to buy the stock, that’s when you know shit is tough.

Case Study: $PRPL

This is the stock that made me write this article. No one talks about this stock anymore. “direct to consumer is the future.” Nope, in-store has been here even when the internet took off and even when Amazon took off. Plus a mattress? Advertising would replace the cut to the wholesaler, and even then, customers have to trust the product versus trying something more affordable in a market that has existed for centuries, probably millenniums. It’s like investing in a laptop OEM because they only sell directly to you.

Case Study: $W(ayfair)

I had no idea this was a pandemic stock but I guess it makes sense considering I also bought stuff on their site. The fact that people found out about wayfair in such a short time once the pandemic hits astounds me.

Future Case Study: $TSLA

This can be classified as an old herd stock. Therefore, it was a good company before, but it also got the pandemic craze which can’t wear off due to it being the largest of all the pre-pandemic stocks.

  • people believe in Elon Musk; people look at him as if he is Tony Stark
  • Tesla was overvalued? pre-pandemic ($60B in November 2019 and $117B in January 2020)

The stock was already so pumped which is why it withstood the pandemic wear-off by being large enough to be added into the S&P500. It was overvalued before, then it was overvalued before December 2020, and then it got added into teh S&P500 meaning that S&P500 ETF managers had to purchase it and will keep purchasing it. At this point, unless Tesla suddenly becomes unpopular, the bleed will take forever before Tesla is valued fairly. Fair value is most likely $124 (-31%) or $400B market cap (assuming no competitors do not eat Tesla’s market share) which is lower than the market cap in December 2020. Given a 20% year on year expected growth from then, we should expect Tesla to be fairly valued in 2027-2029.

Yes, make money off the S&P500 inclusion. No, don’t actually think that Tesla is more than EVs. It got big because of EVs and Elon Musk, it can’t stay big forever.

Case Study: Cathie Wood and ARK

They called her the modern Peter Lynch; she was the complete opposite. ARKK is below pre-pandemic levels. The only reason this ETF went up in the first place was due to owning TSLA when it’s price blew up.

Case Study: SPACS

The worst part of the pandemic was the cheap equity capital that got taken advantage by corporations abusing securities rules and going public through reverse mergers in order to skirt off regulations. Investors get completely misled, and projections went down the toilet for sure. I’ll be writing a more concrete article about why SPACs should be banned in the future.