Mega Millions Mentality
By Sam Ro - Last Friday, I did not win the $336 million Mega Millions jackpot. But I played. Sure, the chances of hitting the right numbers are only 1 in 175 million. Even if you hit the numbers, you may have to split the winnings. And this is all before taxes.
But how often are you presented with an opportunity to earn a 336,000,000% pre-tax ROI on a minimum investment of $1? And in the worst-case scenario, you lose a buck.
Obviously, playing the lottery is not a prudent investment strategy. But the mentality of taking unreasonable risks for unlikely returns exists in the stock markets. Consider bankrupt companies whose stocks are worthless. Lehman Brothers (LEHMQ.PK) hit 32 cents on August 31, just a day after trading at 5 cents. Motors Liquidation Company (MTLQQ.PK), formerly known as the old General Motors, traded as high as $1.20 on August 12. Each stock sees millions of trades every day. But neither is trading on fundamentals. Even if a company were to emerge from bankruptcy, the old common equity is almost always cancelled. In other words, the stock price movements of bankrupt companies are not signs of life; they’re more like postmortem muscle spasms during rigor mortis.
However, if you were savvy enough to buy low and sell high in August, you could’ve gained up to 700% on LEHMA and 140% on MTLQQ.
Then there are the stocks on government-sponsored life-support including Freddie Mac (FRE), Fannie Mae (FNM), and AIG (AIG). Even after significant declines in recent days, these stocks are up between 260-350% in just six months. However, many question the rationale behind these price moves. Some analysts have suggested the common equity in these companies could be worth nothing. Even the more bullish arguments for these stocks come with warnings of high uncertainty.
My favorite pitch goes like this: “FRE and FNM were $60 stocks two years ago! They’re trading at under $2 right now! I could see them at $10. But if I get $5, that’s still a pretty good return.” It’s an unsound argument but not unused. Structurally, it’s very similar to the rationalization that goes into buying a lottery ticket: limited downside and tremendous upside. And you have to pay to play.
Perhaps you’re disciplined enough to avoid irrational investment decisions. But it would be totally irrational to ignore the existence of irrational behavior in the markets. According to La Fleur’s World Lottery Almanac, Americans spend around $50 billion each year on lottery tickets. Surely this includes a lot of amateur and professional traders and money managers who are unknowingly bringing that mega millions mentality into the stock markets. They get the newswires about FRE, FNM, and AIG. Some might also follow the pink sheet action of bankrupt companies. They know these are not good investments. But the allure of outlandish gains is irresistible, even if those gains are highly unlikely.
But how often are you presented with an opportunity to earn a 336,000,000% pre-tax ROI on a minimum investment of $1? And in the worst-case scenario, you lose a buck.
Obviously, playing the lottery is not a prudent investment strategy. But the mentality of taking unreasonable risks for unlikely returns exists in the stock markets. Consider bankrupt companies whose stocks are worthless. Lehman Brothers (LEHMQ.PK) hit 32 cents on August 31, just a day after trading at 5 cents. Motors Liquidation Company (MTLQQ.PK), formerly known as the old General Motors, traded as high as $1.20 on August 12. Each stock sees millions of trades every day. But neither is trading on fundamentals. Even if a company were to emerge from bankruptcy, the old common equity is almost always cancelled. In other words, the stock price movements of bankrupt companies are not signs of life; they’re more like postmortem muscle spasms during rigor mortis.
However, if you were savvy enough to buy low and sell high in August, you could’ve gained up to 700% on LEHMA and 140% on MTLQQ.
Then there are the stocks on government-sponsored life-support including Freddie Mac (FRE), Fannie Mae (FNM), and AIG (AIG). Even after significant declines in recent days, these stocks are up between 260-350% in just six months. However, many question the rationale behind these price moves. Some analysts have suggested the common equity in these companies could be worth nothing. Even the more bullish arguments for these stocks come with warnings of high uncertainty.
My favorite pitch goes like this: “FRE and FNM were $60 stocks two years ago! They’re trading at under $2 right now! I could see them at $10. But if I get $5, that’s still a pretty good return.” It’s an unsound argument but not unused. Structurally, it’s very similar to the rationalization that goes into buying a lottery ticket: limited downside and tremendous upside. And you have to pay to play.
Perhaps you’re disciplined enough to avoid irrational investment decisions. But it would be totally irrational to ignore the existence of irrational behavior in the markets. According to La Fleur’s World Lottery Almanac, Americans spend around $50 billion each year on lottery tickets. Surely this includes a lot of amateur and professional traders and money managers who are unknowingly bringing that mega millions mentality into the stock markets. They get the newswires about FRE, FNM, and AIG. Some might also follow the pink sheet action of bankrupt companies. They know these are not good investments. But the allure of outlandish gains is irresistible, even if those gains are highly unlikely.
Full Disclosure: Author is long FRE and 1 Mega Millions lottery ticket.
posted by Sam Ro | 6:58 AM
3 Comments:
We all get bombarded every day with mails, morning briefs as to which stock we should pick and how will be the market trend today. Every time the brokerage houses will send the stock market tips as if we all are playing a gamble and need the tricks as to how we can win it. And anticipating as to how to do stop loss and at least will make smaller profits. What most of the investor do is they consider short term trading as the long term investment and believe as to how it can be doubled in a day. Buying a stock just because the price is low and some stock market tip you received that this will boom in the market today. What most of us do is that we all trade with money which we can’t afford to lose but the market always says that invest only that money which is in excess to you. All of these are the big mistakes which we commit every day in spite of being reminded every time that we should complete our home work for the next day.
Things to Remember when invest in stock market:
We believe that the fundamental says invest in those company about which you know completely , but that doesn’t mean you fall in love with a company and a particular stock just because you are familiar with it or it create news in the stock market every time. Most of us just try proving our fundamentals are right and for that we apply too many technical indicators on that stock. It’s not true that the stock will go according to its fundamentals and technical, many stocks behave opposite to their indicators, thus they do not guarantee as to whether it will go up or down.
Investors jump to penny stocks as they immediately boom in the market due to rumors what need to understand is that the Penny stocks are very risky , and on this basis make your strategy as to which one to pick from that lot and how much to invest . The portfolio of the investor should be constructed in such a manner that it allots weight age to different sector and the sizes of the stocks so that the diversification is there and the risk can be mitigated. Therefore the weight age of penny stocks in one‘s portfolio should not be more that the 15%. This is to minimize the losses and to accumulate the profits also.
Keep a watch on the industry of the particular stock. Most of the stock behaves according to their industry trend. Thus if in the budget the government committed to play large role in the infrastructure sector , all the stocks will go react as per the budget and the whole sector recorded the jump of 12% on the next day. But it might be the case that the industry is booming and the stock is going down, therefore along with Industry, Company information is also vital.
Past performance of any company doesn’t not hold true or affect its future performance. Many of the Indian stocks which were heavy weight in the past few years and were considered the blue chip companies in this market are either bankrupt or have become extinct in the market. Thus continuous performance analysis and evaluation is important.
STOCK MARKET TIPS || TIPS FOR STOCK MARKET || STOCK MARKET IDEAS
Hi Sam,
This was an excellent idea. This is true that investors are getting stocks at penny , which were trading in high double digits, just 12 months ago. In this game, few may mint money like anything, given that they are able to select companies which can prove the sustainability & can erect itself in down the line. In doing so, if investors just go by the historical trend then they may get trapped & may not be able to get their money back. During the recent crisis, most of the companies( mostly those, which have faced severe impact of crisis & whose share price have fallen much more than the average market had fallen) have undergone management change & corporate restructuring. Before taking investment decision in these companies we need to wait until management structure becomes clear & we can make an idea about their ability.Just by going the sentiment, nobody can make money always.
Regards
Pankaj Kumar
In general, I will not make a major investment in a company that lacks stability in management, operations, and capital structure.
On the other hand, if you wait for stability, then stability will already be priced in.
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